Fed, ECB, BoJ In Focus This Week

Three major central banks meet to decide on monetary policy this week, but after massive and unprecedented actions over past weeks, there is likely to be little new in terms of additional policy measures announced by the US Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BoJ) in the days ahead.  Key data this week include US Q1 GDP, the April US ISM manufacturing survey and China’s April purchasing manager’s index (PMI).

The Fed has thrown everything but the kitchen sink at Covid-19 to combat the severe economic and market impact emanating from the virus.  This included aggressive rate cuts, unlimited asset purchases (Treasuries, MBS), purchases of commercial paper, loans to small businesses, easing rules for banks and provision of US dollar swap lines with other central banks to help ease global USD demand pressures.  Aside from some fine tuning, there may not be much else the Fed will do at its meeting on Wednesday. Meanwhile the US ISM survey (Fri) is likely to post a sharp decline (consensus 37.0).

Markets have reacted well to the measures announced and implemented so far, but as noted there is a growing disconnect between the rally in equity markets over recent weeks and rapidly worsening economic data.  US Q1 GDP data (Wed) this week will likely reveal some of the damage, with a 4% q/q annualised fall in GDP forecast by the consensus. Q2 GDP will be even weaker however, as most of the weakness in activity will have taken place in April and will have likely continued into May and June.

The ECB continues to face pressure to do more as Eurozone activity continues to plunge.  So far the main thrust of the ECB’s measures are EUR 750bn of bond purchases and loosening of restrictions on such purchases.  However, sovereign spreads, especially in the periphery (especially Italy) are under pressure and the ECB may need to act again soon though perhaps not as early as the meeting this Thursday.  The ECB will also likely shift the onus of further easing to fiscal, especially the proposed “recovery fund”, which continues to fuel major divisions between European countries.

Last but not least the BoJ meeting on Monday will probably be the most active in terms of new measures, but on balance they will probably do little to move markets.   At the last meeting the BoJ significantly increased the amount of ETFs they would purchase, which to some extent has helped the Nikkei 225 rally over recent weeks.  At this meeting the BoJ is unlikely to alter its negative interest rate policy, but is likely to remove its JPY 80 trillion cap on JGB purchases and announce an increase in corporate bond purchases along with other measures to ease credit.

On the data front China’s official manufacturing PMI is likely to remain around or just above the expansionary threshold of 50 as much of China’s supply side of the economy opens up.  However, the ability to retain expansion at a time when global demand and therefore China’s export markets are collapsing, will prove difficult.  China’s authorities appear to be increasingly realising this and have stepped up support both on the fiscal (via special bond issuance) and monetary side (targeted cuts in various rates), but so far the scale of easing has been limited and Q1 growth was especially weak.

Oil Surges, Central Banks Galore

Oil prices jumped following drone attacks on Saudi Arabian oil facilities over the weekend.  Oil rose by around 20% to just shy of $72, before halving its gain later.  Even after failing to hold onto initial gains the rise in oil prices still marks one if its biggest one day gains.  Concerns about reduced oil supply have risen as a result of the attacks as they could reduce Saudi oil production for a prolonged period, with around 5% of global oil supply impacted.  Additionally the attacks could raise geopolitical tensions in the region.

As markets digest the impact of the drone attacks, there will also be several central bank decisions globally to focus on this week.  The main event is the Fed FOMC meeting mid-week, where a 25bp cut is largely priced in by the market.  Given that a rate cut is well flagged markets will pay close attention to the Fed’s summary of economic projections, in particular the Fed’s dot plot.  It seems unlikely that Fed Chair Powell is going to sound too dovish, with little to suggest that the Fed is on path for a more aggressive easing path.

Another major central bank meeting this week is the Bank of Japan (BoJ) on Thursday.  While a policy move by the BoJ at is unlikely this week BoJ policy makers have sounded more open to easing.  A consumption tax hike planned for next month together with a strong JPY have increased the pressure for the BoJ to act. Separately easier policy from other major central banks amid slowing global growth are unlikely be ignored.  However, policy is already ultra- easy and the BoJ remains cognisant of the adverse secondary impact of policy on Japanese Banks.

The Bank of England deliberates on policy this week too but it seems highly unlikely that they would adjust policy given all the uncertainties on how Brexit developments will pan out.  Until there is some clarity, the BoE is likely to remain firmly on hold, with the base rate remaining at 0.75%.  GBP has rallied over recent weeks as markets have stepped back from expectations of a hard Brexit, but this does not mean that a deal is any closer than it has been over the past months.  Elsewhere the SNB in Switzerland and Norges Bank in Norway are also expected to keep policy rates on hold this week.

Several emerging markets central banks will also deliberate on policy this week including in Brazil, South Africa, Indonesia and Taiwan.  The consensus (Bloomberg) expects a 50bp rate cut in Brazil, no change in South Africa and Taiwan and a 25bp rate cut in Indonesia.  Overall many emerging markets continue to ease policy amid slowing growth, lower US policy rates and declining inflation pressures.

 

Central Banks Galore

Although markets are quietening down and liquidity is thinning ahead of the holidays there are still a few important and potentially market moving events this week.   These include several central bank meetings, with the Fed FOMC at the top of the pile on Wednesday.  The Fed is widely expected to hike by 25bp to between 2.25% and 2.50% and remove any remaining forward guidance.

A few weeks ago there was little doubt that the Fed would hike rates this month, but since then it has looked like less of a done deal.  Dovish comments from Fed officials suggest that there will be a lot of attention on Fed Chairman Powell’s press conference, especially following his recent comments that interest rates are “just below neutral”.   Although the Fed is likely to hike, it is likely to be seen as a dovish hike, which ought to leave the USD without much support.

In Asia there are three central bank meetings in focus.  On Wednesday the Bank of Thailand (BoT) is likely to hike its benchmark by 25bps to 1.75%, largely due to financial imbalances (household debt and bad loans) rather than inflation concerns.  On Thursday Taiwan’s central bank meeting (CBC) is likely to keep its benchmark interest rate unchanged at 1.375%, with low and declining inflation, suggesting the long held status quo will be maintained.

Also on Thursday I expect no change in policy by Bank Indonesia. Inflation is clearly non-threatening from BI’s perspective and unless the IDR weakens anew, BI will increasingly be in a position to keep its powder dry. Elsewhere in Asia, the Bank of Japan will be in focus.  No change in policy is widely expected on Thursday, with the central bank still well away from any tightening in policy given still low inflation.

Central banks in focus this week

Several central bank decisions are on tap this week including Japan (BoJ), Switzerland (SNB), Norway (Norges Bank), Brazil (BCB) and Thailand (BoT).  Among these only the Norges Bank looks likely to hike rates.

US data is largely second tier this week, with August housing data due for release.  After a run of weak readings a bounce back in starts and existing home sales is expected.   RBA minutes in Australia and NZ Q2 macro data are also in focus.

Political events will garner most attention, with the delayed announcement on China tariffs ($200bn) possible as early as today after being delayed due to the consideration of revisions raised via public comment.  Another twist in the saga is that China is considering declining the US offer of trade talks given the recent Trump threat of fresh tariffs (WSJ).

Other political events include Japan’s LDP election and US trade negotiations (assuming China participates) at the end of the week.   A few Brexit events this week include the General Affairs Council and Informal EU Summit.

 

Catching a falling knife

After a very long absence and much to the neglect to Econometer.org I am pleased to write a new post and apologise to those that subscribed to my blog, for the very long delay since my last post.   There is so much to say about the market turmoil at present, it is almost hard not to write something.

For those of you with eyes only on the continued strength in US stocks, which have hit record high after record high in recent weeks, it may be shocking news to your ears that the rest of the world, especially the emerging markets (EM) world, is in decidedly worse shape.

Compounding the impact of Federal Reserve rate hikes and strengthening US dollar, EM assets took another blow as President Trump’s long threatened tariffs on China began to be implemented.  Investors in countries with major external vulnerabilities in the form of large USD debts and current account deficits took fright and panic ensued.

Argentina and Turkey have been at the forefront of pressure due the factors above and also to policy inaction though Argentina has at least bit the bullet. Even in Asia, it is no coincidence that markets in current account deficit countries in the region, namely India, Indonesia, underperformed especially FX.  Even China’s currency, the renminbi, went through a rapid period of weakness, before showing some relative stability over recent weeks though I suspect the weakness was largely engineered.

What next? The plethora of factors impacting market sentiment will not just go away.  The Fed is set to keep on hiking, with several more rate increases likely over the next year or so.  Meanwhile the ECB is on track to ending its quantitative easing program by year end; the ECB meeting this Thursday will likely spell out more detail on its plans.  The other major central bank that has not yet revealed plans to step back from its easing policy is the Bank of Japan, but even the BoJ has been reducing its bond buying over past months.

The trade war is also set to escalate further.  Following the $50bn of tariffs already imposed on China $200 billion more could go into effect “very soon” according to Mr Trump. Worryingly he also added that tariffs on a further $267bn of Chinese goods could are “ready to go on short notice”, effectively encompassing all of China’s imports to the US.  China has so far responded in kind. Meanwhile though a deal has been agreed between the US and Mexico, a deal encompassing Canada in the form a new NAFTA remains elusive.

Idiosyncratic issues in Argentina and Turkey remain a threat to other emerging markets, not because of economic or banking sector risks, but due increased contagion as investors shaken from losses in a particular country, pull capital out of other EM assets.  The weakness in many emerging market currencies, local currency bonds and equities, has however, exposed value.  Whether investors want to catch a falling knife, only to lose their fingers is another question. which I will explore in my next post.

JPY capped

USD/JPY is being buffeted by the conflicting forces of relatively elevated risk aversion and higher US yields, leaving the currency pair in difficult position to sustain gains. Today’s BoJ outcome has the potential to give some direction but its unlikely that the central bank will deliver any surprises after boosting its funding for lending scheme at the last meeting. Nonetheless, additional easing is likely to take place around as early as April. The emergence of US Treasury buyers as 10 year yields approach 2.8% suggests that US yields may be capped for now and it may take the emergence of more positive / less weather impacted data to push yields higher. Consequently USD/JPY will struggle to make much headway over the short term, with resistance seen around 103.77.

JPY firmer ahead of Fed decision

The USD has come under growing pressure ahead of tommorow’s Fed FOMC decision. While by no means a done deal the majority of market participants are looking for the Fed to embark on a fresh round of quantitative easing or QE3. The Fed is also expected to shift its guidance to maintaining highly accommodative monetary policy into 2015 from 2014. There is a non-negligible risk of no action at the FOMC meeting which if correct will result in market disappointment, with an attendant sell off in risks assets.

Heading into the Fed meeting, comments by Republican House speaker Boehner that he was ‘not confident’ about reaching a deal with President Obama on avoiding the fiscal cliff as well as renewed warnings by Moodys ratings on the US AAA credit ratings, dealt the USD a further blow. It seems unlikely that the USD will be able to make much of a recovery if the Fed pulls the trigger for more QE. However, it should be noted that with so much in the price, should the Fed not deliver on expectations, the USD may actually bounce.

One currency that has felt the consequences of a weaker USD has been the JPY, which finally broke through the 78.00 level against the USD yesterday. A stronger JPY was greeted with plenty of disquiet in Japan (I’m in Tokyo this week) at a time when economic indicators are turning south. The fact that both the European Central Bank and the Fed are outpacing the Bank of Japan in terms of balance sheet expansion means that any JPY weakness is likely to be limited, with further upside risks to the currency prevailing.

Much will depend on the impact on US Treasury yields from Fed QE. Currently Japanese investors are disinclined to pour money overseas at a time when the yield advantage of US Treasuries or German bunds versus Japanese JGBs is limited. If US yields remain low, the prospects for further JPY weakness will also be limited while the pressure on the Japanese authorities to act to meet their 1% inflation goal and weaken the JPY will grow.

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