Busy Week Ahead For Central Banks

US equities came under more pressure at the end of last week, with the S&P 500 falling to its lowest in four weeks, down around 2% month to data.  The drop will test the buy on dips mentality as the S&P is once again resting just above its pivotal 55-day moving average, a level that has seen strong buying interest in the past. 

Economic data gave little help to market sentiment, with the University of Michigan confidence index improving a little to 71.0 in early September but falling slightly below consensus expectations at 72.0.  Separately, the inflation expectations measures were broadly unchanged, with the most relevant series for Fed officials (the 5-10y) remaining steady at 2.9%, which is still consistent with the Fed’s 2% goal.

This week is all about central bank meetings, with an array of policy meetings including in Indonesia (Tue), Sweden (Tue), Hungary (Tue), China (Wed), Japan (Wed), US (Wed), Brazil (Thu), Philippines (Thu), UK (Thu), Norway (Thu), Switzerland (Thu), South Africa (Thu), and Taiwan (Fri), all on tap. 

Most focus will obviously be on the Federal Reserve FOMC meeting, during which officials will likely signal that they are almost ready to taper. A formal announcement is likely in December or possibly November.  Most other central banks are likely to stay on hold except a likely 25bp hike in Norway, 25bp in Hungary, and 100bp in Brazil.

Politics will also be in focus, with Canada’s Federal election and the results of Russia’s parliamentary elections today.  Polls suggest the incumbent Liberals ahead though the most likely outcome is a minority government in Canada while in Russia the ruling pro Kremlin United Russia party is likely to renew its supermajority. 

Other issues in focus this week are frictions over the US debt ceiling, with the House voting soon on raising the ceiling.  US Treasury Secretary Yellen renewed her calls for Congress to raise of suspend the debt ceiling stating in a Wall Street Journal op-ed that failing to do so “would produce widespread economic catastrophe”. 

In China, Evergrande’s travails will be in the spotlight on Thursday when interest payments on two of its notes come due amid growing default risks.  Indeed, China related stocks slid on Monday morning as Evergrande concerns spread through the market.  Property developer stocks are under most pressure and whether there is wider contagion will depend on events on Thursday.

The US dollar has continued to strengthen, edging towards its 20 Aug high around 92.729 (DXY) and looks likely to remain firm heading into the Fed FOMC meeting especially as it will hard for Fed Chair Powell to sound too dovish and given risks of a hawkish shift in the dot plot.  Positioning data is showing increasingly positive sentiment towards the dollar, with speculative positioning (CFTC IMM net non-commercial futures) data showing the highest net long DXY position since May 2020. 

Conversely, speculative positioning in Australian dollar has hit a record low likely undermined by weaker iron ore prices.  Similarly, positioning in Canadian dollar is at its lowest since Dec 2020 while Swiss franc positioning is at its lowest since Dec 2019. Asian currencies have been hit, with the ADXY sliding over recent days.  The Chinese currency, CNY has been undermined by weaker data and concerns over Evergrande while high virus cases in some countries are hurting the likes of Thai baht. 

Rocky Road

Despite the rally in US stocks on Friday, led by the technology sector, US stocks have fallen for four straight weeks.  The jury is still out on whether equities and risk assets in general can rally in the face of a host of uncertainties in the weeks ahead including the potential for a contested US election, fading US economic momentum, lack of progress on “Phase 4” US fiscal stimulus and a resurgence in virus cases globally.  What is clear, is that the road ahead is a rocky one, reflected in the fact that equity volatility (VIX) remains elevated and G10 FX options implied volatility around the time of the US election has spiked. 

One of the main beneficiaries of this uncertainty has been the US dollar lately, much to the detriment of precious metals given their strong inverse correlation.  It wasn’t that long ago that most commentators were writing off the USDs prospects and it’s still not clear that its recovery can persist.  The USD has hit its highest level in 2 months but will likely struggle if equities can eke out further gains in the days ahead.  In contrast, gold is trading around its lowest levels in 2 months.  While these trends may persist in the very short term, technical indicators (eg Relative Strength Index) indicate approaching overbought USD and oversold gold levels. 

This week, the main focus will be on the first US Presidential debate on Tuesday and US September jobs report at the end of the week.  While the US jobs report will likely show a relatively strong (when compared to pre-covid levels) increase in hiring (consensus around 900k), the pace of hiring is likely to slow and employment is still likely to be at least 11 million lower compared to February.  The battle for the new US Supreme Court Justice adds another twist, with President Trump announcing the nomination of Amy Coney Barrett and the Senate moving ahead to vote on this nomination this side of the election.  This has changed the dynamics ahead of the election battle, energizing voters on both sides. 

In Asia, China’s September purchasing managers indices (PMIs) and monetary policy decisions in India and Philippines will garner most attention this week.  China’s economy is emerging from the Covid crisis in good shape, helped by resilient exports performance, with medical goods and electronics exports performing particularly well.  This is likely to be reflected in China’s PMIs this week, which are set to remain in expansion territory. Meanwhile US government pressure on Chinese technology companies continues to rise, with the US government reportedly sanctioning China’s biggest chipmaker, SMIC.  This may draw a retaliatory response from China, such as adding US companies to China’s “unreliable entities” list.  

India’s Reserve Bank of India (RBI) monetary policy decision is likely to result in an unchanged outcome on Thursday.  While growth has been hit badly due to Covid-19, inflation has also spiked to well above the RBI’s target, leaving the central bank in a difficult position on policy.  Ultimately the RBI will have to ease monetary policy further, but it is unlikely to do so at its meeting on Thursday.  India’s economy is fast heading for a double-digit plunge in growth this year and unfortunately virus cases remain at very high levels.  The rupee has been resilient, however, and is unlikely to weak much further in the short term, even as the economy softens. 

Central Banks Galore

It’s a big week for central banks.  Several central banks globally meet to decide upon monetary policy this week.  The biggest focus will be on the Fed FOMC but this week also sees Norges Bank, Bank of England, Bank of Japan and central banks in Indonesia, Philippines, Taiwan, and Brazil meet.

Markets are already aggressive in pricing in Fed rate cuts.  As US-China trade tensions have worsened markets have intensified their expectations of Fed easing, with around 75bps of easing already priced in.  Given how much is priced in in terms of Fed easing, if the Fed does not validate this with a dovish statement and/or shift in the dot plot there could be a significant risks of disappointment, which could weigh on equities, but leave the USD on a firmer footing.

Admittedly the Bank of Japan is more constrained than the Fed in terms of policy room, but their rhetoric has become more dovish.  I don’t expect easing anytime soon but the BoJ is likely to sound dovish and could offer some enhanced forward guidance.  BoJ governor Kuroda outlined four options in terms of more policy stimulus, with one being a further cut in the deposit rate.  However, BoJ would need to outline how they plan to alleviate the pressure on bank profits from such a move.

Bank of England is unlikely to move.  Data in the UK has been mixed, with softening in Q2 growth but ongoing pressure on inflation given the tightness of the labour market.  It’s also difficult for the BoE given the large amount of Brexit uncertainty. GBP risks remain to the downside over the short term especially given the heightening political noise in the UK.  The Norges Bank is likely to stand out amongst the crowd, with a rate hike expected, its second in just three months.

Elsewhere in Asia I expect no change from Bank Indonesia, BSP in the Philippines, and CBC in Taiwan. Bank Indonesia is edging towards a rate cut amid low inflation and slowing activity, but will likely want to see further signs of IDR stability before pulling the trigger to begin reversing the 175bp of hikes implemented in 2018.

Weaker activity in Taiwan calls for some sort of stimulus but the reality is that a rate cut will do little to alleviate the pain given that much of the problem is due to external factors.  Instead much of the adjustment may take place on the currency front.

I expect the BSP in the Philippines to maintain its overnight borrowing rate at 4.50% at this week’s meeting while signalling more RRR cuts ahead. Although CPI came in above expectations in May, at 3.2% y/y, it remains close to the midpoint of the BSP’s 2-4% band and I don’t expect it to stand in the way of further easing, but think BSP may wait until at least August to move again.

 

 

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