Hawkish Central Banks

It was a soft end to the week for global equities, while the US dollar (USD) rallied further as US Treasury yields pushed higher.  Neither the move in Treasuries or the USD shows any sign of slowing, and if anything, US inflation data will keep the upward pressure on yields and USD intact this week.  Clearly, most currencies, expect notably the Russian rouble are suffering at the hands of a strong USD though Asian currencies have been less pressured of late compared to other currencies. 

The surge in US Treasury yields has been particularly stark and fuelled pressure across many other markets.  The USD (DXY) has been a key beneficiary of the rise in US yields, with the currency propelled to its highest level since May 2020.  USDJPY remains one of the most highly correlated currency pairs to yield differentials and with Japan persisting in its defence of Yield Curve Control (YCC) it looks like USDJPY will continue to move higher, with 130 moving into sight. 

There’s plenty of central bank action this week and much of it likely in a hawkish direction, including in New Zealand (Wed), Canada (Wed), Singapore, Korea, Euro area, and Turkey (all Thu).  Tightening is expected from several of these central banks.  The consensus is expecting a 25-basis point (bp) hike in policy rates in New Zealand, but a significant minority is looking for a 50bp hike

In Korea, the consensus is split between no change and a 25bp hike, with the risks skewed towards the latter amid strong inflation pressures and high household debt, even though the new central bank governor may not be installed at this meeting. Similarly, a hawkish outturn from the Monetary Authority of Singapore is likely, with a steepening, re-centering and possible widening of the Singapore dollar nominal effective exchange rate band expected.  Note that Singapore’s monetary policy is carried out via its exchange rate.

In Canada, a 50bp hike in policy rates is likely, while the Bank may announce balance-sheet run off in a likely hawkish statement in the wake of stronger readings both on the growth and inflation front. Last but not least, the European Central Bank (ECB) may announce an early end to its quantitative easing and prepare markets for rate hikes, possibly as early as June.  In contrast, Turkey is likely to continue to maintain its monetary policy on hold amid some stability in its currency. 

On the data front, US March CPI inflation data will be among the key releases this week.  Another high reading is likely, with the consensus expectation at 8.4% year-on-year, from 7.9% previously.  The data will not make for pleasant reading, with headlines likely to highlight that US inflation is back at over 40- year highs.  While the data will likely keep up the pressure on interest rate markets, I would caution that a lot is in the price.       

India Risks, Highlights For The Week Ahead

It was a strong end to last week for US markets, with S&P 500 up over 1%, helped by stronger than expected new home sales and April US Markit purchasing managers indices (PMI) data. As risk assets rallied the US dollar and US Treasuries sold off.  There are plenty of event risks this week. Also, there will be deluge of US earnings releases this week including most tech heavyweights while markets will likely remain nervous over President Biden’s tax plans.  Geopolitical risks will also remain on the forefront. 

Even as the progress on the vaccination front continues the renewed increases in virus cases in many countries, particularly in India, where the situation has deteriorated markedly, threatens to delay recovery. The acceleration in virus cases has been dramatic, with Prime Minister Modi noting how it has “shaken the nation”. Virus cases hit 349,000 on Saturday and show no sign of receding. The toll on the health system in India has been massive, but the variants also holds risks to the rest of the world while it will also lead to a major disruption in India’s vaccine exports, threatening vaccination programs in several countries.  

Friday’s economic data round was broadly firm. Alongside the US releases noted above, Euro area April PMIs were generally better than expected, with G10 manufacturing PMIs pointing to strengthening momentum overall.  Separately, Russia’s central bank, the CBR surprised with a bigger than expected 50bp rate hike.  Today’s data releases include the April German IFO business confidence survey; consensus expectations forecast an increase to 97.8 from 96.6 previously. In the US, durable goods orders are forecast to rise in March by 2.5% m/m following a weather-related 1.2% m/m drop in February.

The focus over the rest of the week will turn to central bank decisions in Japan, Sweden and Hungary (all on Tue) and the Federal Reserve FOMC (Wed).  Although the Bank of Canada’s shift last week will prompt a little more nervousness about G10 central bank tapering the policy meetings are likely to be largely uneventful, this week. Nonetheless, the Fed tone is likely to be more positive than in March, while in contrast the Bank of Japan may sound more cautious amid a third state of emergency in Tokyo. 

A key event this week will be President Biden’s address to a joint session of Congress.  After the hit to markets in the wake of the news of a proposal to hike taxes, markets will look for any further details.  Key data releases this week include Australia Q1 CPI inflation (Wed), US Q1 advance GDP (Thu), China’s April purchasing managers indices data (Fri) and Euro area Q1 GDP (Fri).  

Sell On Fact

It was a case of buy on rumour, sell on fact at the end of last week, with US equities falling the most in over a week on Friday in the wake of the much anticipated but largely priced in announcement of President-elect Biden’s $1.9 trillion fiscal plan.  While the amount of stimulus is significant the reality is that it will be difficult to pass through Congress even though Democrats will have control of Congress and the Presidency. Something in the region of $1 trillion fiscal stimulus could end up being the price tag that is eventually passed in Congress given Republican opposition to some of the measures in the stimulus plan.  This would likely be followed by a possible $2trn+ plan for infrastrucutre/green spending.

Note that a 60-vote supermajority will be required to pass the fiscal legislation in the Senate, meaning that several Republicans will need to support the bill given the 50/50 Senate split.  Hence, a likely lower than $1.9trn eventual stimulus bill will be what is eventually passed. However, Democrats can pass the spending bill via “reconciliation”, but they would have to remove unrelated measures such as the proposed increase in the minimum wage, which they will unlikely want to do. 

Treasuries and the US dollar (USD) benefited from a worsening in risk sentiment at the end of last week.  USD positioning is at extremely low level, suggesting scope for some short covering. The VIX equity volatility index ticked higher and continues to remain well above its pre-COVID lows.  Given that many key equity gauges were in overbought territory according to their relative strength index (RSIs) some pullback/consolidation could be on the cards though the glut of global liquidity suggests that there is still plenty of money ready to buy on dips.  Yesterday US markets were closed due to the Martin Luther King Holiday, but Canadian and European stocks ended higher and futures point to gains today. 

US data isn’t helping sentiment, with yet more evidence that the economy was under pressure at the end of 2020.  Retail sales fell for a third consecutive month, the New York Empire manufacturing index fell for a fourth consecutive month in January. Lastly, University of Michigan consumer sentiment fell modestly early January.  Market direction today will likely come from the release of China’s December data dump as well as Q4 GDP.  In contrast to weakening US data Chinese data yesterday highlighted that solid recovery was sustained into year end, with GDP beating expectations, rising by 6.5% y/y in Q4 2020.  

The rest of this week is a heavy one for central bank decisions, with China, Malaysia, Canada (Wed), Indonesia, Eurozone, Turkey, South Africa, Brazil (Thu) and Japan (Fri) on tap.  In terms of policy action Malaysia is likely to cut, Turkey will likely tighten but the rest will likely be on hold.   The main event of the week is Joe Biden’s inauguration as 46th President of the US on Wednesday, and attendant risks of renewed unrest.  US Q4 earnings releases will also be in focus in the days ahead, with earnings releases ramping up over coming days.

China Data Fuels A Good Start To The Week

Better than expected outcomes for China’s manufacturing purchasing managers indices (PMIs) in November, with the official PMI moving back above 50 into expansion territory and the Caixin PMI also surprising on the upside gave markets some fuel for a positive start to the week.   The data suggest that China’s manufacturing sector has found some respite, but the bounce may have been due to temporary factors, rather than a sustainable improvement in manufacturing conditions.  Indeed much going forward will depend on the outcome of US-China trade talks, initially on whether a phase 1 deal can be agreed upon any time soon.

News on the trade war front shows little sign of improvement at this stage, with reports that a US-China trade deal is now “stalled” due to the Hong Kong legislation passed by President Trump last week as well as reports that China wants a roll back in previous tariffs before any deal can be signed.  Nonetheless, while a ‘Phase 1’ trade deal by year end is increasingly moving out of the picture, markets appear to be sanguine about it, with risk assets shrugging off trade doubts for now.  Whether the good mood can continue will depend on a slate of data releases over the days ahead.

Following China’s PMIs, the US November ISM manufacturing survey will be released later today.  US manufacturing sentiment has come under growing pressure even as other sectors of the economy have shown resilience.  Another below 50 (contractionary) outcome is likely.  The other key release in the US this week is the November jobs report, for which the consensus is looking for a 188k increase in jobs, unemployment rate remaining at 3.6% and average earnings rising by 0.3% m/m. Such an outcome will be greeted positively by markets, likely extending the positive drum beat for equities and risk assets into next week.

There are also several central bank decisions worth highlighting this week including in Australia, Canada and India.  Both the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are likely to keep monetary policy unchanged, while the Reserve Bank of India (RBI) is likely to cut its policy rate by 25bps to combat a worsening growth outlook.  Indeed, Q3 GDP data released last week revealed the sixth sequential weakening in India’s growth rate, with growth coming in at a relatively weak 4.5% y/y. Despite a recent food price induced spike in inflation the RBI is likely to focus on the weaker growth trajectory in cutting rates.

G7 Intervention Hits Japanese Yen

One could imagine that it was not difficult for Japan to garner G7 support for joint intervention in currency markets given the terrible disaster that has hit the country. Given expectations of huge repatriation flows into Japan and a possible surge in the JPY Japanese and G7 officials want to ensure currency stability and lower volatility. Moreover, as noted in the G7 statement today officials wanted to show their solidarity with Japan, with intervention just one means of showing such support.

Although Japanese Finance Minister Noda stated that officials are not targeting specific levels, the psychologically important level of 80.00 will likely stick out as a key level to defend. Note that the last intervention took place on 15 September 2010 around 83.00 and USD/JPY was trading below this level even before the earthquake struck. The amount of intervention then was around JPY 2.1 trillion and at least this amount was utilised today. The last joint G7 intervention took place in September 2000.

Unlike the one off FX intervention in September 2010, further intervention is likely over coming days and weeks by Japan and the Federal Reserve, Bank of France, Bundesbank, Bank of England, Bank of Canada and other G7 nations. The timing of the move today clearly was aimed at avoiding a further dramatic drop in USD/JPY, with Thursday’s illiquid and stop loss driven drop to around 76.25 adding to the urgency for intervention. USD/JPY will find some resistance around the March high of 83.30, with a break above this level likely to help maintain the upside momentum.

The JPY has become increasingly overvalued over recent years as reflected in a variety of valuation measures. Prior to today’s intervention the JPY was over 40% overvalued against the USD according to the Purchasing Power Parity measure, a much bigger overvaluation than any other Asian and many major currencies. The trade weighted JPY exchange rate has appreciated by around 56% since June 2007. In other words there was plenty of justification for intervention even before the recent post earthquake surge in JPY

Although Japanese exporters had become comfortable with USD/JPY just above the 80 level over recent months, whilst many have significant overseas operations, the reality is that a sustained drop in USD/JPY inflicts significant pain on an economy and many Japanese exporters at a time when export momentum is slowing. Japan’s Cabinet office’s annual survey in March revealed that Japanese companies would remain profitable if USD/JPY is above 86.30. Even at current levels it implies many Japanese companies profits are suffering.

Upward pressure on the JPY will remain in place, suggesting a battle in prospect for the authorities to weaken the currency going forward. Round 1 has gone to the Japanese Ministry of Finance and G7, but there is still a long way to go, with prospects of huge repatriation flows likely to make the task of weakening the JPY a difficult one. The fact that there is joint intervention will ensure some success, however and expect more follow up by other G7 countries today to push the JPY even weaker over the short-term.

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