Overview: Ahead of the much-anticipated speech by Federal Reserve Chair Powell, the Fed funds futures are pricing in about a 70% chance of a 75 bp hike next month. The US 10-year yield is up nearly five basis points today to 3.07% and the two-year yield is firm at 3.38%. Asia Pacific equities were mostly higher, with China the main exception among the large markets, after US equities rallied yesterday. Europe’s Stoxx 600 is off about 0.3% to bring this week’s loss to a little over 1%. It would be the first back-to-back weekly loss in two months. US futures are seeing yesterday’s gains pared. Europe’s benchmark 10-year yields are mostly 4-8 bp higher. The greenback is mixed with the European currencies mostly higher, led by the euro, pushing above parity where options for 1.5 bln euros expire today. The dollar bloc and yen are nursing losses. The firmer euro tone appears to be lending support to the central European currencies, while the South African rand and Thai baht are off a little more than 0.5% to pace the declines. Gold set the high for the week yesterday near $1765 and is struggling to stay above $1750 today. October WTI is up 1% today and 3.4% for the week. It posted an outside down day yesterday to fall 2.5% but is consolidating quietly today. Europe’s natgas benchmark is off 0.5% to pare this week’s gain to around 25.2% after rallying 20.3% last week. US natgas is gaining for a third day, up 2.2%. It was nearly flat on the week coming into today. Iron ore rose almost 3% to bring this week’s gain to 5.2%, the strongest weekly advance this month. September copper is up 1.4% after yesterday’s 1.5% advance. December wheat is firm after a four-day rally was snapped yesterday. Poor weather is seen behind the week’s 3% gain.
Asia Pacific
Tokyo's August CPI, which
does a good job of reflecting national forces, rose more than
expected. The
headline rate rose to 2.9% from 2.5%, its highest in 30 years. The core
measure, which excludes fresh food, stands at 2.6%, up from 2.3%. Several
banks are now warning it could surpass 3% in Q4. A little more than half
of Japan's inflation stems from fresh food and energy, with which CPI rose 1.4%
from a year ago, up from 1.2%. The Bank of Japan meets on September 22
and is expected to remain the outlier among the high-income countries and maintain
the current policy setting, with the target rate at -0.10%.
There are three developments
in China to note. First,
after several initiatives, which individually have been played down by
observers as not going far enough, China's high-yield bond market, dominated by
the property sector, have shown some new domestic interest. The
back-to-back gains are the first in four months. Second, there appears to be
some progress in US-China talks about US regulators access to the accounting
records of Chinese companies that list on American exchanges. These
Chinese companies have been instructed to prepare audit working papers to bring
to Hong Kong to be reviewed by US officials. Although mainland equities
have languished this week (CSI 300 is off 1%), Hong Kong stocks have
rallied. The Hang Seng gained 2% this week, half of which came earlier
today. The HK China Enterprise Index (mainland companies that trade in
HK) rose 3% this week. Third, dubbed teapot, the independent oil refiners
in the Shandong province have cut their run-rates to 61.3% this week, the
lowest since May. This seems to reflect the poor state of the economy,
hampered by the extreme weather and shortage of electricity.
Europe
The record of last month's
ECB meeting, where it delivered its first rate hike with a half-point move did
not tell us anything we did not already know. First, the rise in inflation to near 9%
was the catalyst for the rate hike. That there were some who wanted a
quarter-point move is not surprising. The preliminary estimate of this
month’s CPI will be released on August 31. The month-over-month pace is
expected to rise by 0.3% after a 0.1% gain in July. However, the base
effect will translate this in a slightly slower year-over-year rate (8.8%). The
core rate is expected to be steady at 4.0%, though the risk is on the upside.
The market has fully priced in a 50 bp hike at the September 8 meeting, the
swaps market is consistent with around a chance of 75 bp move, which seems a
bit exaggerated. While there is some debate in the US whether inflation
has peaked, in the eurozone this may be a brief respite.
Like the FOMC minutes, the
ECB's record of its meeting should not be understood as an objective report of
the meeting, but another channel by which officials communicate to the
market. In its
record, the ECB insists that the 50 bp rate hike should be seen accelerating
removal of accommodation, what it calls front-loading, rather than raise the terminal
rate. While many press accounts repeated it, the market seems less
sanguine. Consider that on July 1, the swap market had the policy rate at
1.23% in mid-June 2023. Now it is 1.77%. ECB officials were
cognizant that the economies were slowing, and a recession may be near.
However, in what seems to be an innocuous comment observed that governments may
be better positioned to address it. What is striking is that this goes
against ordoliberalism, which Draghi and others said its part of the ECB's
DNA. Ordoliberalism reject Keynesian demand management through fiscal
policy.
We had thought there was a
quid pro quo at the July ECB meeting, which allowed for the larger rate hike in
exchange for the new Transmission Protection Instrument. However, if this was case, the hawks have
the advantage. There appear to be so many hurdles to its use that, like
the Outright Market Transactions (announced with Draghi's "whatever it
takes") it may never be used. The ECB's record indicated that the
Governing Council would take into account analysis by the EC, the European
Stability Mechanism, the IMF, "and other institutions", alongside the
ECB's own analysis, with no ranking provided. Unlike the OMT, which was
to be triggered at a country's request, the TPI is done at the ECB's
discretion.
America
Fed Chair Powell's
long-awaited speech at Jackson Hole is a few hours away, and the market is
pricing in about a 70% chance that the Fed hikes 75 bp next month. Of course, there is important data
due before the FOMC meeting concludes on September 21 including the jobs report
next Friday and CPI on September 13. Still, it is unlikely that either
report changes that overall assessment that the labor market remains strong,
even if job growth slows a bit from the unexpectedly sharp 528k jump in July
nonfarm payrolls, and that price pressures are far too high, even if the pace
eases a little. Those who insist on reading Powell dovishly seem to be
focusing on the line in the recent FOMC minutes, which noted that many members
recognized the risk that the Fed could overdo it. However, what these
observers seem to under-appreciate is that the observation was in the context
of a general assessment of the risks and the minutes recognized an even greater
risk that inflation expectations get embedded. Indeed, in recent weeks
there have been numerous essays claiming that the era of low inflation is over,
due to various structural factors, including the re-shoring and pullback from
globalization, the integration of large populations in central Europe and Asia,
and the costs of sustainable development.
We do not think Powell is as
dovish as the many pundits argue, and despite this era for forward guidance, we
think it best to focus on what the Fed does rather than what it says in this
context. Among
the high-income countries, no central bank has been as aggressive as the
Federal Reserve, even if some like the Bank of England began normalizing policy
earlier. In addition, starting in a few days, the pace that the Fed will
shrink its balance sheet will double to $95 bln a month. If dovish and hawkish
are to signify anything of importance, they cannot be understood in the
abstract, but placed in a context. By the Fed's own history, and in
comparison, to other high income central banks, several of whom have higher
inflation than the US, it has acted expeditiously this year and knows that it
is not done. Many of those who criticize the Fed for not being even more
aggressive are also among those that have the most pessimistic economic
outlooks. It is an easy space to occupy if one is not held accountable.
For whom do they speak? Even the hawks at the Bundesbank are not hawkish enough
for many of these critics.
Play the player or play the
game? What
Powell actually says may not means as much in the short run as to how the
market responds. Consider the FOMC minutes again. When they were
initially reported, the pundits said it was dovish and the December Fed funds
futures made new session highs on August 17 and follow-through buying the next
day. We insisted that a dovish reading was a mistake, and although the
subsequent economic data have mostly been weaker than expected, the December
Fed fund futures have sold off and the implied yield rose to new highs for the
month (~3.54%) yesterday. Similarly, since those "dovish minutes"
were released, the implied yield of the October Fed funds futures contract (no
FOMC meeting in October, so arguably a cleaner read than the September
contract) has risen by 5.5 bp, reflecting perceptions of heightened. Rather than
focusing on Powell's exact words, we suspect it may be more fruitful to focus
on the market's penchant for reacting as if the Fed were dovish.
Ahead of Powell, the US
reports a bevy of data, which include the advanced estimate of US merchandise
July trade figures, and inventory, and personal income and consumption
data. Given
the importance attributed to Powell's speech, the data is likely to be more
important for economists as they work on their Q3 GDP forecasts than market
participants. The PCE headline deflator, which the Fed official targets are
expected to slip toward 6.4% from 6.8%. The core deflator is projected to tick
lower to 4.7% from 4.8%. The CPI, which comes out first, and is based on
different methodology, has stolen the deflators thunder and was cited by Powell
in explaining the larger-than-signaled hike in June. Mexico also reports
July trade figures today. Mexico's trade balance is deteriorating
sharply. The Q2 monthly average deficit was $2.69 bln. In Q2 21, it
was in surplus by $927 mln. This has been blunted a little by surging
worker remittances, and the July report is next week. Worker remittances
averaged $5.01 bln in a month in Q2 22 (vs. $4.3 bln in Q2 21).
The US dollar set a five-day
low yesterday, slightly below CAD1.2900. It was probing the CAD1.3060 area in the first two sessions
this week. It is near CAD1.2935 in the Europe, and it needs to resurface
above CAD1.2960-80 to open the upside again. If the yen takes its cues
from US yields, the Canadian dollar takes its from the general risk appetite
reflected in the US S&P 500. Initial support is seen now near
CAD1.2920. The US dollar slipped to seven-day lows against the
Mexican peso yesterday (~MXN19.85) and recovered through the North American
session to MXN19.98. It is trading sideways today above
MXN19.92. The intraday momentum readings seem to favor the dollar's
upside today provided that the MXN19.90 area holds.
Disclaimer
Reviewed by Marc Chandler
on
August 26, 2022
Rating:
