Hawkish Central Banks

It was a soft end to the week for global equities, while the US dollar (USD) rallied further as US Treasury yields pushed higher.  Neither the move in Treasuries or the USD shows any sign of slowing, and if anything, US inflation data will keep the upward pressure on yields and USD intact this week.  Clearly, most currencies, expect notably the Russian rouble are suffering at the hands of a strong USD though Asian currencies have been less pressured of late compared to other currencies. 

The surge in US Treasury yields has been particularly stark and fuelled pressure across many other markets.  The USD (DXY) has been a key beneficiary of the rise in US yields, with the currency propelled to its highest level since May 2020.  USDJPY remains one of the most highly correlated currency pairs to yield differentials and with Japan persisting in its defence of Yield Curve Control (YCC) it looks like USDJPY will continue to move higher, with 130 moving into sight. 

There’s plenty of central bank action this week and much of it likely in a hawkish direction, including in New Zealand (Wed), Canada (Wed), Singapore, Korea, Euro area, and Turkey (all Thu).  Tightening is expected from several of these central banks.  The consensus is expecting a 25-basis point (bp) hike in policy rates in New Zealand, but a significant minority is looking for a 50bp hike

In Korea, the consensus is split between no change and a 25bp hike, with the risks skewed towards the latter amid strong inflation pressures and high household debt, even though the new central bank governor may not be installed at this meeting. Similarly, a hawkish outturn from the Monetary Authority of Singapore is likely, with a steepening, re-centering and possible widening of the Singapore dollar nominal effective exchange rate band expected.  Note that Singapore’s monetary policy is carried out via its exchange rate.

In Canada, a 50bp hike in policy rates is likely, while the Bank may announce balance-sheet run off in a likely hawkish statement in the wake of stronger readings both on the growth and inflation front. Last but not least, the European Central Bank (ECB) may announce an early end to its quantitative easing and prepare markets for rate hikes, possibly as early as June.  In contrast, Turkey is likely to continue to maintain its monetary policy on hold amid some stability in its currency. 

On the data front, US March CPI inflation data will be among the key releases this week.  Another high reading is likely, with the consensus expectation at 8.4% year-on-year, from 7.9% previously.  The data will not make for pleasant reading, with headlines likely to highlight that US inflation is back at over 40- year highs.  While the data will likely keep up the pressure on interest rate markets, I would caution that a lot is in the price.       

Fed Tapering Concerns/Rising COVID Cases In Europe

Equities struggled at the end of last week amid news of rising COVID cases and hints by Federal Reserve officials of a preference for faster tapering though tech stocks benefitted from a rally in US Treasuries.  Oil prices fell further as markets pondered the potential for releases from China, Japan and US strategic oil reserves. Meanwhile, various countries are registering record daily COVID cases in Europe, resulting in partial lockdowns in a few countries. The outlook doesn’t look good heading into the winter flu season, while protests against mobility restrictions are on the rise. 

The US dollar extended gains at the start of this week helped by hawkish comments from Federal Reserve officials.  Conversely, rising COVID cases across Europe and resultant mobility restrictions, have hurt the euro, with the EURUSD exchange rate falling through 1.13 and showing little sign of any reversal.  Worsening sentiment towards the euro has fuelled a collapse in speculative euro positioning, with the market being net short for 6 out of the last 7 weeks (according to the CFTC IMM net non-commercial futures data).  In contrast, China’s authorities are becoming more concerned with the strength of the Chinese renminbi, which is currently around five year highs in trade weighted terms.  Measures to cap renmimbi strength are likely to be forthcoming.

Risk assets could struggle in the wake of speculation/pressure for more aggressive Fed tapering.  Fed Vice Chair Clarida and Governor Waller sounded relatively hawkish on Friday. Clarida said that the FOMC could discuss the pace of tapering at the December FOMC meeting and separately Waller stated that recent data had pushed him toward “favoring a faster pace of tapering and a more rapid removal of accommodation in 2022.”  This implies that the December Fed FOMC meeting will be a live one and could potentially see the announcement of more rapid tapering than the $15bn per month rate that was announced at the last Fed meeting. 

As such, the Fed FOMC minutes (Wed) will be under scrutiny to provide clues to any hint of support for more aggressive tapering though they will likely reveal that most officials see no rush for rate hikes.  On the same day the US core Personal Consumption Expenditure (PCE) report is likely to have registered a strong increase in October keeping inflation concerns at the fore.  Fed nominations are also likely this week, and markets will be especially focused on whether Fed Chair Powell will be reaffirmed for another term.  The overall composition of the FOMC is likely to become a more dovish one next year. 

Several central bank policy decisions are scheduled this week including in China where the Peoples Bank of China (PBoC) unsurprisingly kept its Loan Prime Rate on hold today.  However, in its latest quarterly monetary policy report released on Friday, the PBoC removed some key phrases cited in its previous reports, implying a softer tone to policy ahead. Any such easing would be targeted such as recent support for lenders via a new special relending facility to support the clean use of coal, via loans at special rates.  Additionally, a cut in the reserve ratio (RRR) cannot be ruled out.

Next up will be the Reserve Bank of New Zealand (RBNZ) (Wed), with a 25bp hike likely and risks of an even bigger 50bp hike. The Bank of Korea is also likely to hike, with a 25bp increase in policy rates likely (Thu) given rising inflation pressures and concerns about financial imbalances. The Riksbank in Sweden (Thu) is likely to keep policy unchanged though an upgrade in their forecasts is expected. 

Setting Up For A More Volatile Q4

After a disappointing September for risk assets, markets at least found some relief at the end of last week, with the S&P 500 ending up over a 1% while US Treasury yields fell and the US dollar also lost ground.  However, sentiment in Asia to kick of the week has been poor, with Evergrande concerns coming back to the forefront.

There was positive news on the US data front, with the Institute of Supply Management (ISM) manufacturing index surprising to the upside in September, rising modestly to 61.1 from an already strong level at 59.9 in August (consensus: 59.5) though the details were less positive.  In particular, the rise in supplier delivery times and prices paid reflects a re-emergence of supply chain issues. 

Separately, the infrastructure can was kicked down the road as infighting within the Democratic party on the passage of the bipartisan $1.2 trillion infrastructure bill and larger $3.5tn package, led to a further delay of up to one more month. It is likely that the eventual size of the proposed $3.5tn spending plan will end up being smaller, but there still seems to be some distance between the progressives in the Democratic party want and what the moderates want. Separately, the debt ceiling issue is likely to go down to the wire too.

China’s Evergrande remains in focus, with the company reportedly suspended from trading in Hong Kong pending “information on a major transaction”. According to China’s Cailian news platform another developer plans to acquire a 51% stake in the property services unit. The sale is likely a further step towards restructuring the entity and preventing a wider contagion to China’s property sector and economy.

Over the rest of the week attention will turn to the US September jobs report, which will as usual likely be closely eyed by Federal Reserve policymakers.   A pickup in hiring relative to the 235,000 rise in August is expected, with the consensus looking for a 470,000 increase. It would likely take a very poor outcome to derail the Federal Reserve’s tapering plans in my view.  

Several central banks including in Australia (Tue), New Zealand (Wed), Poland (Wed) and India (Fri) will deliberate on policy.  Among these the most eventful will likely be the RBNZ, with a 25 basis points rate hike likely while the others are all set to remain on hold.  Other data includes the European Central bank (ECB) meeting accounts of the September meeting (Thu), US ISM Sep services index (Tue) and Turkey September CPI (today). 

Overall, going into the fourth quarter investors will have to contend with host of concerns including weakening global activity especially in the US and China, supply chain pressures, persistent inflation risks, Evergrande contagion and related China property developer woes, China’s regulatory crackdown, raising the debt ceiling, difficulties in passing the US infrastructure bills, Fed tapering, and ongoing COVID concerns.  This may set up for a much rockier and more volatile quarter ahead for markets especially amid a growing wave of more hawkish G10 central banks.

Inflation Angst

US equities fell for a fifth straight day on Friday enduring their worst week since June.  Asian markets faced a tough start to the week after US losses and amid further Chinese regulatory measures, with Alipay in focus as regulators are reportedly (FT) looking to break it up while the Biden administration is reported to be looking at starting a new probe into Chinese industrial subsidies.  Worries about the persistent impact of the Delta variant on the services and tourism sector globally are adding to the sense of malaise in markets. 

Data wise, US Aug Producer Price Index (PPI) data dented confidence following a bigger than expected 0.7% m/m, 8.3% y/y increase, with yet more evidence of the impact of supply pressures impacting the data even as the core measure slowed.  It is worth noting that China’s outsized increase in PPI inflation in August released last week sent a similar message.  Such fears may have been attributable to the move in bonds, with US Treasury yields rising on Friday, giving back the gains in the wake of the strong 30- year auction, despite the fall in equities. 

Following the US PPI, there will be a number of other releases this week which could potentially add to nervousness over lingering inflation pressures.  The plethora of inflation data kicks off with India’s August consumer price index (CPI) today for which a 5.6% y/y increase is expected, a level which will likely continue to make India’s central bank (RBI) uncomfortable.  US August CPI scheduled for tomorrow is likely to show another strong rise in food and energy prices though core CPI likely rose at its slowest pace since February.  Canada August CPI (Wed) is likely to drift higher while UK August inflation (Wed) is likely to reveal a jump after a sharp decline last month.  On balance, the inflation releases this week will do little to calm market’s inflation fears.

Other key data this week will likely show weakening activity.  The slate includes US August retail sales (Thu). The data is likely to add to evidence that the boost to goods spending in the US from fiscal stimulus has peaked.  China activity data including August retail sales and industrial production (Wed) will likely show further moderation especially to retail sales which was likely impacted by lockdowns in various provinces.  Australia employment data (Thu) is likely to have revealed a decline while NZ GDP (Thu) is likely to show firmer economic momentum than the RBNZ’s forecast.

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. 

%d bloggers like this: