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. 

Powell Keeps The Risk Rally Going

It felt as though markets spent all of last week waiting for the Jackson Hole symposium but in the event Federal Reserve Chair Powell didn’t really tell us anything new.  This was good enough for risk assets, with equities ending the week higher and bonds also rallying, with the US Treasury curve bull steepening, setting up a positive start for equity markets this week.  The US dollar came under pressure as Powell did not repeat the hawkish messages of some recent Fed speakers over recent days.

Overall Powell noted that one of the key criteria for tapering has been met, namely “substantial further progress” for inflation while “clear progress” has been met on the second goal of maximum employment. Powell also disassociated the criteria for rate hikes and tapering, with markets continuing to price in the first hike around March 2023. A tapering announcement is likely this year, but September looks too soon. 

The US dollar is likely to remain under pressure this week in the wake of Powell’s comments which ought to bode well for many emerging market currencies.  The potential for a softer than consensus US August jobs report (non-farm payrolls consensus 750k) at the end of the week also suggests that the USD could struggle to make a short term rebound though US interest rate markets, will likely remain supported. 

All of this bodes well for some consolidation in Asian markets though tomorrow’s Chinese August purchasing managers index (PMI) data will provide further direction.  Further moderation in both manufacturing and services PMIs will likely keep up the pressure on the authorities there to avoid renminbi appreciation as well as loosen liquidity likely via another reserve requirement ratio (RRR) cut. 

Other key data this week includes Q2 GDP releases in Australia (Wed), India (Tue), and Canada (Tue), US ISM surveys (Wed) and (Fri), Eurozone inflation data (Tue), and Polish inflation (Tue).  Also keep an eye on German political developments; the election is less than one month away and recent polling has shown that the SPD has pulled ahead of Merkel’s CDU for the first time in 15 years, raising the possibility of a left wing coalition. 

Geopolitical issues, specifically to do with Afghanistan remain a threat to risk appetite as the US deadline for evacuation approaches.  Separately, oil prices could be impacted by Hurricane Ida, which hit the US Gulf Coast yesterday.   

US Dollar On Top – All Eyes On Jackson Hole

Although risk assets rallied at the end of last week, weaker than expected US July retail sales data and China’s July data slate including industrial production and retail sales, helped to intensify growth concerns.  As it is, many indicators are showing that we are past peak growth. US economic surprises are becoming increasingly negative as reflected in the Citi US economic surprise index, which has fallen to its lowest level since May 2020.  Combined with intensifying Delta virus concerns, worsening supply chain pressures and sharply rising freight rates as reflected in the spike in the Baltic Dry Index to its highest since June 2008, it has led to a marked worsening in investor risk appetite.  This has been compounded by China’s regulatory crackdown and rising geopolitical risks in Afghanistan

The US dollar has been a key beneficiary while safe haven demand for Treasuries has increased and commodity prices have come under growing pressure.  Equity markets wobbled last week after a prolonged run up though the pull back in the S&P 500 looked like a healthy correction rather than anything more sinister at this stage.  The moves in the USD have been sharp, with the USD index (DXY) rising to its highest since November 2020 and EURUSD on its way to testing the 1.16 low.  Some Asian currency pairs broke key levels on Friday, with USDCNH breaking through 6.50.  Safe haven currencies such as CHF and JPY are holding up much better, highlighting that USD demand against other currencies is largely due to a rise in risk aversion while currencies such as CAD appear to be pressured by weakening commodity prices.  

This week attention will turn to the Jackson Hole Symposium (Fri) where markets will look for clues to the contours of Fed tapering.  Fed chair Powell is likely to repeat the message from the July minutes, with QE tapering likely by year-end if the labour data continue to strengthen.  Markets will be on the lookout for any further clues on the timing and shape of tapering. Separately the US July Core Personal Consumption Expenditures (PCE) report is likely to show a high 3.6% y/y increase though this is unlikely to change the Fed’s perspective on transitory inflation pressures.  Monetary policy decisions in Hungary (Tue) and Korea (Thu) will be in focus, with the former likely to hike by 30bps and the latter on hold, albeit in a close decision.  Ongoing US budget talks and European Central Bank minutes (Thu) will also be in focus. Finally, closer to home New Zealand (Tue) and Australia (Fri) retail sales reports are in focus. 

Weaker China data and Delta Concerns

The same old discussion continues to afflict equity investors as lofty valuations balance against a wall of liquidity.  So far liquidity is winning out as US equity indices are trading around record highs despite a surprise 13.5% plunge in August US consumer confidence released last Friday, which marked one of the largest declines ever in the University of Michigan series. In fact confidence fell to a level even below the COVID low, likely due to Delta variant concerns. 

The confidence data fuelled a bull flattening in US Treasuries and USD sell off.  As reflected in the confidence data, the Delta variant is increasingly threatening recovery and evidence of sharply rising virus cases even in highly vaccinated countries sends a worrying sign of what to expect going forward. 

Geopolitics will be in focus after the Taliban effectively took over Afghanistan after marching into Kabul yesterday.  This will have major repercussions in South Asia and the rest of the region.  Separately, Canada’s PM Trudeau has called a snap election on Sep 20 while Malaysia’s PM Yassin has resigned today.  Geopolitics, weak US confidence data, China’s regulatory crackdown and ongoing Delta variant concerns, with Philippines and Thailand registering record virus cases in Asia led to a cautious start to the week for Asia. 

Further direction came from China’s July data slate released today.  The data revealed weaker than expected outcomes across the board, with industrial production and retail sales alongside other data revealing further softening.  The releases provided more evidence that Chinese consumer caution has intensified in the wake of targeted lockdown measures in several provinces while industrial activity is being hampered by supply constraints and weakening demand for exports.

The Chinese data will likely provide more support to expectations of further easing in liquidity from the central bank (PBOC) and even policy rate cuts. Separately, China’s regulatory crackdown has extended further, weighing on Chinese and regional assets, but there is little sign that officials are looking to step back.   More broadly, weaker Chinese data will likely contribute to a near term tone of risk aversion afflicting global market sentiment amidst worsening Delta variant concerns, rising growth worries and geopolitical risks.

Over the rest of the week Fed FOMC minutes (Wed), in particular views on the shape of quantitative easing tapering, as well as central bank decisions in New Zealand (Wed), Indonesia (Thu) and Norway (Thu) are in focus.  The RBNZ is likely to be the most eventful among these, with a 25bp hike in its policy rate (OCR) expected amid firming data and rising inflation pressures.  Key data this week includes US July retail sales (Tue), with falls in both the headline and control group readings likely as the boost to spending from stimulus and reopening fades. 

Market Cross-Currents

There are many cross currents afflicting markets at present.  Equity valuations look high but US earnings have been strong so far, with close to 90% of S&P 500 earnings coming in above expectations. This has helped to buoy equity markets despite concerns over the spreading of the Delta COVID variant and its negative impact on recovery.  Yet the market doesn’t appear entirely convinced on the recovery trade, with small caps continuing to lag mega caps. 

The USD index (DXY) remained supported at the end of last week even as US yields remain capped, but the USD does appear to be losing momentum. Positioning has now turned long according to the CFTC IMM data indicating that the short covering rally is largely exhausted; aggregate net USD positioning vs. major currencies (EUR, JPY, GBP, AUD, NZD, CAD & CHF as a percent of open interest) turned positive for the first time in over a year. 

Inflation fears have not dissipated especially after recent above consensus consumer price index (CPI) readings, for example in the US and UK.  Reflecting such uncertainty, interest rate market volatility remains high as seen in the ICE BofA MOVE index while inflation gauges such as 5y5y swaps have pushed higher in July.  There was some better news on the inflationary front at the end of last week, with the Markit US July purchasing managers indices (PMIs) revealing an easing in both input and selling prices for a second straight month, albeit remaining at an elevated level. 

This week we will get more information on inflation trends, with the June Personal Consumption Expenditures (PCE) report in the US (Fri), Eurozone July CPI (Fri), Australia Q2 CPI (Wed) and Canada June CPI (Wed), on tap this week.  We will also get to see whether the Fed is more concerned about inflation risks at the Federal Open Markets Committee (FOMC) meeting (Wed).  The Fed is likely to continue to downplay the surge in inflation, arguing that it is transitory, while the standard of “substantial further progress” remains a “ways off”.   Nonetheless, it may not be long before the Fed is more explicit in announcing that is formally moving towards tapering. 

An emerging markets central bank policy decision in focus this week is the National Bank of Hungary (NBH) where a 15bp hike in the base rate is expected.  Central banks in emerging markets are taking differing stances, with for example Russia hiking interest rates by 100 basis points at the end of the week while China left its Loan Prime Rate unchanged.  The July German IFO business climate survey later today will be in focus too (consensus 102.5).  Overall, amid thinner summer trading conditions market activity is likely to be light this week.

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