Fed, ECB, UK elections In Focus

An event filled week lies ahead.  Several central bank decisions including the Federal Reserve FOMC (11th Dec), European Central Bank (ECB) (12 Dec) and Swiss National Bank (SNB)  (12 Dec) are on the calendar.  All of these major central banks are likely to leave policy unchanged and the meetings should prove to be uneventful.  Fed Chair Powell is likely to reiterate the Fed’s patient stance, with last Friday’s strong US November job report (payrolls rose 266k) effectively sealing the case for no change in policy at this meeting, even as a Phase 1 trade deal remains elusive.

Similarly recently firmer data in Europe have pushed back expectations of further ECB easing, though President Lagarde is likely to sound cautious highlighting her desire to maintain an accommodative monetary policy stance.  The picture is rather different for emerging market central banks this week, with policy easing likely from Turkey (12 Dec), Russia (13 Dec) and Brazil (12 Dec) while Philippines (12 Dec) is likely to keep policy unchanged.

UK general elections on Thursday will be closely watched, with GBP already having rallied above 1.30 vs USD as polls show a strong lead for Boris Johnson’s Conservative Party.  The main question is whether Johnson will have gained enough of a share of the vote to gain a majority, allowing him to push ahead with his Brexit plans, with Parliament voting to leave the European Union by Jan 31.

Polls may not be as accurate as assumed in the past given surprises over recent years including the Brexit vote itself, but the wide margin between the two parties highlights the relatively stronger position of the Conservatives going into the election.  Nonetheless, given that a lot is in the price already, the bigger (negative) reaction in GBP could come from a hung parliament or Labour win.

This week is also crunch time for a decision on the threatened December 15 tariffs on China.  As previously noted there is little sign of any deal on any Phase 1 trade deal.  It appears that issues such as the amount of purchases of US goods by China remain unresolved.  Recent comments by President Trump suggest that he is prepared to delay a deal even as far as past the US elections in November 2020.

Whether this is tactic to force China to agree on a deal or a real desire not to rush a deal is difficult to determine, but it seems as though Phase 1 will deal will not be signed this year given the limited time to do so.  December 15 tariffs could be delayed but this is also not guaranteed.  President Trump’s attention will also partly be on the potential for an impeachement vote in the House this week.

Looking At Central Banks For Direction

This week feels as though its one where markets have gone into limbo waiting for developments on the trade war front, and for direction from central bankers.  So far there has been no indication that a date or even location has been set to finalise details of a Phase 1 deal between the US and China.  While officials on both sides suggest that progress is being made, markets are left wondering if a deal will even be signed this side of the new year.  Despite such uncertainty there does not seem to be too much angst in markets yet, and if anything, risk assets including equities look rather resilient.

Central bankers and central bank minutes will garner plenty of attention over coming days.   Overall it looks as though major central banks led by the Fed are moving into a wait and see mode and this means less direction from these central banks to markets over the next few weeks and likely into year end.

Fed FOMC minutes this week will give more information on the Fed’s thinking when it eased policy in October, and markets will be looking for clues as to what will make them ease again.  In his recent Congressional testimony Fed Chair Powell highlighted that he sees little need to ease policy at the December meeting, strongly suggesting no more easing from the Fed this year.

Reserve Bank of Australia minutes overnight highlighted that the Bank will also now wait to assess past monetary easing measures before cutting rates again while still holding the door open to further cuts if necessary.  While the RBA noted that a case could have been made for easing this month, it doesn’t appear that they are in a rush to move again, with easing now becoming more likely next year than in December.

Another central bank in focus is the ECB, with ECB President Lagarde delivering the keynote address at the European Banking Congress in Frankfurt.  This will be an opportunity for markets to see whether her views are in line with previous ECB President Draghi and also to see how she reacts to criticism of the ECB’s decision from outside and within the governing council, to ease policy further at the September meeting, when it cut the deposit rate to -0.5% and restarted asset purchases.

Another central bank in focus over coming days includes the PBoC in China.  The PBoC cuts its 7-day reverse repo rate by 5bps this week, the first decline in this rate since 2015 in an attempt to lower funding cots to banks.  While the move is small the direction of travel is clearly for lower rates and this is likely to be echoed in the release of the new Loan Prime Rate tomorrow, which could also reveal a small 5bps reduction.  China is likely to maintain this path of incremental easing in the weeks ahead.

Brexit Developments Sharply In Focus

Two major market risks have been sidelined, though admittedly not taken off the table.  Firstly the prospects of an intensification of the US-China trade war appears to have diminished and secondly the risks of the UK crashing out of the EU without a deal have lessened.  This presents a calmer and less volatile backdrop for markets even as global growth continues to remain under pressure.  Separately markets are hoping and expecting for some icing on the cake in the form of Fed easing later this month. As long as US Q3 earnings are not too bad, this suggests a period of calm ahead.

US-China trade developments are likely to take a back seat in the run up to the APEC meeting on 16-17 November in Chile where a ‘Phase 1’ trade deal may be signed by both US and Chinese leaders.  Talks rumbling in the background appear to progressing well, with US Treasury Secretary Mnuchin and Trade Representative Lighthizer scheduled to speak to China’s Vice Premier Liu He this week by phone.  Markets will carefully eye what the prospects are for a delay of the $156bn of US tariffs on China that are due to take effect on December 15.

Brexit developments will move sharply back into focus today, with UK Prime Minister Boris Johnson set to make a fresh attempt at passing a ‘meaningful vote’ today or gaining a majority in a vote on legislation implementing the deal tomorrow.  This follows having to jettison a vote on Saturday and being forced to write to the EU requesting a three-month delay to the Article 50 exit process.  The government thinks it has the number of votes necessary to pass the vote and the fact that GBP has only lost a little ground today (at the time of writing) suggests that markets think the chances are high.

Other than this, the European Central Bank meeting on Thursday will garner attention although President Draghi is unlikely to offer any further changes in policy, having come under criticism from hawks in the ECB governing council who opposed the renewed bond buying from the ECB.  Expect Draghi to maintain a dovish stance at this meeting.  Other central banks in focus this week include Norway, Sweden, Turkey and Indonesia.  The former two are likely to leave policy unchanged while both Turkey and Indonesia are likely to ease policy.

 

Bonds Under Pressure, UK Parliament Rejects Election Again

Market sentiment remains positive as hopes of a US-China trade deal continue to provide a floor under risk sentiment amid hopes that the escalation in tariffs can be reversed.  Weak Chinese trade data over the weekend has largely been ignored and instead markets have focused on further stimulus unleashed by China in the wake of the cut in its banks’ reserve ratios, which freed up around USD 126bn in liquidity to help shore up growth.  Expectations that the European Central Bank (ECB) will this week provide another monetary boost by lowering its deposit rates and embarking on a fresh wave of quantitative easing, are also helping to support risk sentiment though a lot is already in the price in terms of ECB expectations.

One of the casualties of the turn in sentiment has been bonds, with yields rising in G10 bond markets.  For example US 10 year yields have risen by around 18 basis points since their low a week ago.   The US dollar has also come under pressure, losing ground in particular to emerging market currencies over the past week.  Safe haven currencies such as the Japanese yen (JPY) and Swiss franc (CHF) have fared even worse.   As I noted last week I think the bounce in risk appetite will be short-lived, but how long is short?  Clearly markets anticipate positive developments in US-China trade talks, and it seems unlikely that risk appetite will deteriorate ahead of talks, at least until there is some clarity on the discussions.  Of course a tweet here or there could derail markets, but that is hard to predict.

Sterling (GBP) has been another currency that has benefited from USD weakness, but also from growing expectations that the UK will not crash out of the EU without a deal.  Developments overnight have done little to provide much clarity, however.  UK Prime Minister Boris Johnson failed in his bid for an early election on October 15, with MPs voting 293 in favour of an election against 46 opposed;  Johnson required two-thirds or 434 MPs to support the motion.  Johnson is now effectively a hostage in his own government unable to hold an election and legally unable to leave without a deal.  Parliament has been suspended until October 14, with Johnson stating that he will not delay Brexit any further, reiterating that he is prepared to leave the EU without an agreement if necessary.

This would effectively ignore legislation passed into law earlier blocking a no-deal Brexit forcing the PM to seek a delay until 31 Jan 2020. Separately parliament passed a motion by 311 to 302 to compel Downing Street to release various documents related to no-deal Brexit planning, but officials are so far resisting their release.  A lack of progress in talks with Irish PM Varadkar in Dublin on Monday highlights the challenges ahead.  GBP has rallied following firmer than expected Gross Domestic Product data (GDP) yesterday and growing hopes that the UK will be prevented from crashing out of the EU at the end of October, but could the currency could be derailed if there is still no progress towards a deal as the deadline approaches.

 

What To Watch This Week

Market expectations for Fed FOMC interest rate cuts have gyrated back and forth following a recent speech by NY Fed President Williams, one of the key decision makers within the Fed FOMC. He appeared to support a 50bps rate cut at the meeting at the end of the month, but unusually this was clarified later.  If anything, as the clarification may suggest, the bigger probability is that the Fed eases policy by 25bps in an insurance cut.

There will be no Fed speakers in the days ahead but the Fed will assess developments this week in helping to determine the magnitude of easing. Attention will continue to centre on US earnings, with more than a quarter of S&P 500 companies reporting Q2 earnings this week.   On the data front, US Q2 GDP and July durable goods orders will command most attention.  The consensus looks for a slowing in GDP growth to 1.8% q/q in Q1 from 3.1% q/q in Q1 while durable goods orders are expected to increase by 0.7% m/m.

A major central bank in action this week is the European Central Bank on Thursday. While policy easing is unlikely at this meeting, the ECB is likely to set to set the market up for an easing in deposit rates at the September meeting.  ECB President Draghi could do this by strengthening his forward guidance, but as a lot of this is priced in by the market, a dovish sounding Draghi is unlikely to weigh too much on the EUR.

In the UK this week it’s all about politics. Boris Johnson is widely expected to be announced as the new Prime Minister.  GBPUSD has clung onto the 1.25 handle, as worries about a no deal Brexit continue to impact sentiment towards the currency.  Once Johnson is sworn in he and the government could face a no confidence motion, which could gain support should it be seen as an alternative to the UK crashing out of the EU.

National elections in Japan yesterday resulted in a victory according to Japanese press for Shinzo Abe’s coalition, its sixth straight victory, with the governing LDP winning over half the 124 seats. The results were no surprise, and unlikely to have a significant market impact, but notably Abe suffered a setback by not gaining a supermajority. He therefore cannot change the country’s pacifist constitution.

In emerging markets, both Russia and Turkey are likely to cut interest rates this week, with Russia predicted to cut its key rate by 25bp and Turkey to cut by at least 200bps if not more.  Elsewhere geopolitical tensions will remain a major focus for markets, as tensions between the UK and Iran intensify.

US/China Tensions Escalate

Risk appetite starts the week in poor form. The shock announcement of 5% tariffs on all Mexican exports (from June 10) to the US and an intensification of tensions with China, have fuelled growing expectations of a worsening in the global growth outlook. Safe haven assets such as JPY and CHF are likely to remain in demand while core bond yields are likely to continue to move lower, with markets continuing to raise bets on Fed rate cuts this year.  Indeed the 10y US Treasury yield has dropped by 1.1% since 8 November last year, with the fall in yields accelerating over recent weeks.

US/China tensions escalated over the weekend, with the deputy head of China’s negotiating team, Wang Shouwen, accusing the US of “resorting to intimidation and coercion”.  This coincides with the increase in US tariffs on $200bn of Chinese goods coming into effect over the weekend as Chinese shipments reached US shores, while earlier on Saturday Chinese tariffs on $60bn of US exports came into effect.  There is also growing speculation that China may curb exports of rare earth exports to the US.

Wang accused the US of abusing export controls and persisting with “exorbitant” demands and insisting on “mandatory requirements that infringe on China’s sovereign affairs”.   Meanwhile China’s defence minister Wei Fenghe, said that China will “fight to the end” on trade if needed.  China is also starting to investigate foreign companies who have violated Chinese law.  Soon after Chinese state media reported that the government was investigating FedEx for allegedly “undermining the legitimate rights and interest” of its Chinese clients.

Attention this week will be on several central bank decisions including the ECB (6th June), RBA (4th June) and RBI (6th June).  The market is fully priced in for an RBA rate cut to 1.25% this week.  The ECB is unlikely to surprise, with no change in policy likely.  Attention will be on terms of the TLTRO III while ECB President Draghi is likely to sound dovish in his press conference.  RBI is set to cut policy rates again, with Friday’s release of weaker than expected Q1 GDP adding to pressure on the Reserve Bank to boost growth amid low inflation.

ECB meeting, Brexit, Fed minutes, China trade, India elections in focus

This week there a number of key events to focus attention on including European Central Bank (ECB) policy meeting, Federal Reserve FOMC March minutes, the commencement of India’s general elections, China data, and further Brexit developments as UK Prime Minister May tries to gain a further short extension to the Brexit deadline, until June 30.

The better than expected US March jobs report, revealing a bigger than expected 196k increase in jobs, with a softer than expected 0.1% monthly increase in hourly earnings, which effectively revealed a firm jobs market, without major wage pressures, helped US markets close off the week on a positive note. The data adds to further evidence that the Fed may not need to hike policy rates further.

The European Central Bank decision is likely to prove uneventful though recent comments by ECB President Draghi have fuelled speculation that the central bank will introduce a tiered deposit system to alleviate the impact of negative rates on banks.   EUR is unlikely to benefit from this.  Separately Fed FOMC minutes will be scrutinised to ascertain how dovish the Fed has become as the markets shift towards pricing in rate cuts, but it is unlikely that the minutes provide further fuel to interest rate doves.

Friday is the deadline to agree on an extension with the EU to prevent a hard Brexit.  Meanwhile PM May is set to restart talks with opposition Labour Party leader Corbyn to thrash out a cross party agreement on Brexit terms ahead of an EU summit on Wednesday that will look at her request for a Brexit extension until June 30.  GBP has lost momentum lately and investors appear to be fatigued with the daily Brexit news gyrations.

Meanwhile, US-China trade talks appear to be edging towards some sort of a deal while Chinese data this week is also likely to be supportive for risk assets.   As China eases financing conditions, evidence of a pick up in the credit impulse will be evident in March aggregate financing, new loans and money supply data this week.   Meanwhile China’s March trade data is likely to look better or at least less negative than over recent months. This suggests that risk assets will likely fare well this week.

India will be in the spotlight as India’s multi stage elections kick off on Thursday.  Prime Minister Modi is in good stead to ahead of elections, boosted by his government’s reaction to recent terrorist attacks on Indian paramilitary in Kashmir.   Concerns that Modi’s ruling BJP would lose a significant amount of seats in the wake of state election losses towards the end of last year have receded.  Nonetheless, election uncertainties may keep the INR on the backfoot this week.

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