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.   

What Could Prompt Higher Volatility?

Equities were buoyed last week in the wake of US President Biden’s infrastructure deal and renewed reflation trade optimism amid mixed post Federal Reserve FOMC messages from Fed officials. This resulted in US stocks recording their biggest weekly gain since February.  The prospects of passing the infrastructure deal has improved in the wake of Biden’s decision not to tie it to a much larger spending package that is being pushed through by Democrats but is not supported by Republicans. 

Given heightened sensitivity over inflation, the slightly weaker than expected US Personal Consumption Expenditures (PCE) data on Friday, which increased 0.5% m/m in May, slightly below the 0.6% consensus, added further support to the reflation trade, helping the US Treasury curve to steepen.  Moreover, the University of Michigan 5-10y inflation expectations series came in lower in June compared to the previous month. Fed officials likely put much more emphasis on this long-term series and will view the 2.8% reading as consistent with their “largely transitory” take on the pickup in inflation.

Cross-asset volatility has continued to decline, which bodes well for carry trades and risk assets.  For example, the VIX “fear gauge” index has dropped to pre-COVID level, something that has been echoed in other market volatility measures.  However, it’s hard to ignore the shift in tone from many central banks globally to a more hawkish one while risk asset momentum will likely wane as the strength of recovery slows, suggesting that low volatility may not persist.  It is notable that changes in global excess liquidity and China’s credit impulse have both weakened, implying a downdraft for risk assets and commodity prices and higher volatility. 

If there is anything that could prompt any increase in volatility this week, its the US June jobs report on Friday.  June likely saw another strong (consensus 700k) increase in nonfarm payrolls while the unemployment rate likely dropped to 5.7% from 5.8% previously.  Despite the likely strong gain in hiring, payrolls would still be close to 7 million lower compared to pre-COVID levels, suggesting a long way to go before the US jobs market normalises. The June US Institute for Supply Management (ISM) manufacturing index will also come under scrutiny though little change is expected from the May reading, with a 61.0 outcome likely from 61.2 in May. 

Other data and events of importance this week include the 100th year anniversary of China’s Communist Party (Thu), the release of purchasing managers indices (PMI) data globally including China’s official NBS PMI (Wed) for which a slight moderation is expected.  Eurozone June CPI inflation (Wed) which is likely to edge lower, Sweden’s Riksbank policy decision (Thu) where an unchanged outcome is likely and Bank of England (BoE) Governor Bailey’s Mansion House Speech (Thu), will be among the other key events in focus this week. 

Federal Reserve Speakers In Focus

After a major flattening of the US Treasury curve last week in the wake of the Federal Reserve Federal Open Market Committee (FOMC) meeting, this week will be important to determine how comfortable the Fed is with the market reaction to its shift in stance, with a number of speakers on tap including Fed Chairman Powell who testifies to Congress today.

In summary, the Fed FOMC was much less dovish than expected and acknowledged that they are formally thinking about thinking about tapering. The most obvious shift was in the Fed FOMC dot plot, with the median Fed official now expecting 50bp of tightening by the end of 2023.  

Notably, St. Louis Fed President Bullard was even more hawkish on Friday, highlighting the prospects of a “late 2022” hike in US policy rates.  Moreover, Fed speakers overnight did not walk back from the FOMC statement, with Presidents Bullard, Kaplan and Williams delivering views.  Kaplan favours tapering “sooner rather than later”, while Bullard highlighted upside risks to inflation. 

Nonetheless despite hawkish comments, markets have calmed somewhat following the sharp post FOMC reaction last week, which reeked of a major positioning squeeze.  Longer end US Treasury yields move higher overnight while equities recouped losses and the USD weakened. Today most attention will fall on Fed Chairman Powell’s testimony before the House Select Subcommittee on the Coronavirus Crisis on “The Federal Reserve’s Response to the Coronavirus Pandemic.” 

This week there are also several central bank decisions on hand.  Yesterday, China’s central bank PBoC, left policy on hold for a 14th straight month. China is in no rush to raise its policy rate and will likely focus on liquidity adjustments to fine tune policy. Other central bank policy decisions this week will come from Hungary (today), Thailand (Wed), Czech Republic (Wed), Philippines, UK, and Mexico (all on Thu).  

The NBH in Hungary is expected to hike policy rates, with both the 1 week depo rate and base rate likely to be hiked by 30bps. The Czech National bank is also expected to hike, with a 25bp increase in policy rates expected by consensus.  All the rest are forecast to leave policy on hold.  The key data releases this week will be the US May PCE report on Friday, which will likely reveal another sharp rise in prices.  

Although the USD weakened overnight it still looks positive technically, with the dollar index (DXY) remaining above its 200-day moving and MACD differential remaining positive. The Asian dollar index (ADXY) marks an interesting level for Asian FX as its is verging on a break below its 200-day moving average around 108.2861.  As such, the USD bounce may have a little more to run in the short term.

The euro (EUR) will be in focus to see if it breaks below 1.19, with the currency looking vulnerable on a technical basis to further downside. Similarly, the Australian dollar (AUD) is trading just below its 200 day moving average any may struggle to appreciate in the short term.

Watching US Yields

Risk assets struggled to make headway last week, with technology stocks stumbling in particular.  Nonetheless, inflows into equities remain strong as more and more retail money is drawn in (perhaps signs of a near term peak).  Asian stocks started the week in positive mood despite last week’s nervousness, but equity investors will continue to keep one eye on the move in US yields.

US Treasuries continued to remain under pressure and the curve continued to bear steepen.  A combination of US fiscal stimulus hopes/expectations, vaccine progress and reduction in COVID cases, appear to be pressuring bonds. President Biden is likely to pass his $1.9 tn stimulus package in the weeks ahead, with a House vote likely this week, while the Fed continues to dampen down of any tapering talk, helping to push inflation expectations as reflected in break-evens, higher.  Indeed, this will likely be the message from a number of Fed speeches this week including Chair Powell testifying before Congress (Tue and Wed). 

Despite higher US nominal and real yields and visibly more nervous equities, the US dollar (USD) continues to struggle, failing to find a trigger to much covering of the massive short USD position still present.  We note that non-commercial FX futures positioning data (CFTC IMM) revealed only a limited reduction in aggregate USD short positions (as a % of open interest) in the latest week. Antipodean currencies led the way at the end of last week, but pound sterling (GBP) speculative positions have seen the biggest bounce over the last couple of weeks. 

Despite the USDs reluctance to rally lately, the short-term bias could shift to a firmer USD sooner rather than later, including against Asian emerging market currencies.  Indeed, several Asian currencies lost ground last week, with the Philippines peso (PHP) and Indonesian rupiah (IDR) leading the way lower.  The Asia USD index (ADXY) appears to have peaked and looks vulnerable to more short-term downside.

US economic data at the end of last week revealed that the flash estimates for the February purchasing managers indices (PMIs) stayed at fairly strong levels for both the manufacturing and services sectors.  Separately, US existing home sales posted stronger-than-expected numbers for January.

Attention this week will be on progress of passage on US fiscal stimulus as well as a number of central bank decisions beginning with China (today), New Zealand (Wed,) Hungary (Wed), and South Korea (Fri).  No policy changes from these central banks are likely.  Also of interest will be the UK’s announcement on exit plans from the current lockdown (today) and Germany’s Feb IFO survey, which is forecast to edge higher. 

US Elections Take Yet More Twists & Turns

Amidst mixed messages from the White House about President’s Trump’s health and a growing circle of US administration officials and Senate Republicans infected with Covid-19, markets will kick of this week with many questions about the running of government, prospects for fresh fiscal stimulus and the nomination of the new Supreme Court Justice. President Trump pushed for stimulus in tweet while in hospital but obstacles in the Senate remain, including the fact that the Senate has adjourned until Oct 19, a factor that will also delay the Supreme Court confirmation process. 

In what was already an election fraught with various issues, President Trump’s Covid infection has added another layer of uncertainty.  The fact that several of his campaign aides have tested positive also complicates his ability to campaign to try to close the gap with ex- VP Biden.  There is also the question of whether the President will be well enough to take part in the second Presidential debate scheduled for October 15.  Markets initial sharp negative reaction to the news that Trump had contracted the virus, on Friday was tempered by the end of the session suggesting some calm.  However, every piece of news on Trump’s health will be closely scrutinized in the days ahead.  

The US dollar ended last week firm and this trend is likely to continue given the uncertainty about events in the weeks ahead, which despite the fact that much of this uncertainty is US led, will still likely lead to some safe haven dollar demand. 

A weaker than consensus US September jobs report didn’t help markets at the end of last week, with non-farm payrolls coming at 661k (consensus 859k) while a 0.5% drop in the unemployment rate was due a drop in the participation rate.  US non-farm payrolls are still down 10.7 million from the levels seen in February, highlighting the still significant pressure on the US labour market despite the job gains over recent months. 

Attention this week will focus on Federal Reserve Chair Powell’s speech on Tuesday and Fed FOMC minutes on Wednesday, which will be scrutinised for details on how the Fed will implement average inflation targeting.  Also on tap is the US Vice Presidential debate on Wed between Mike Pence and Senator Kamala Harris, which hopefully will not be a fractious as the debate between President Trump and ex-Vice President Biden.  

Monetary Policy rate decisions in Australia (consensus 0.25%) on Tuesday and in Poland (consensus 0.1%) on Wednesday as well as the Australian Federal budget on Tuesday will also garner attention this week. 

%d bloggers like this: