Original insights into market moving news

Week in Focus; week commencing 19th August 2019

  • MON: Japanese Trade Balance, EZ CPI,
  • TUE: Swiss Trade Balance, German PPI, Norwegian GDP, Canadian Manufacturing Sales, RBA Minutes
  • WED: Norwegian Unemployment, South African CPI, Canadian CPI, US Existing Home Sales, FOMC Minutes
  • THU: EZ & US Manufacturing, Services and Composite PMIs, Swedish Unemployment, EZ Consumer Confidence, NZ Retail Sales, ECB Minutes
  • FRI: Japanese National CPI, Canadian Retail Sales, US New Home Sales


The theme of the economic symposium at Jackson Hole this year will be ‘Challenges to monetary policy’ (as it was in 1999). More details are awaited, but the theme is broad enough to cover the challenges of bringing inflation to target (policy framework related themes), the challenge of central bank independence, and of course the challenge of administering monetary policy at a time of heightened global trade risks and softening global growth. There are also geopolitical themes that the Fed will need to navigate (US/China is the obvious one, but also Japan and South Korea, while the Fed has noted Brexit risks in the past, which seem to be resurfacing again now). Concerns around these themes are now manifesting themselves in the yield curve, where recent inversions portend recessions ahead, leaving the Fed facing arguments that it is either is behind the curve, or does not have the tool set to tackle the challenges it faces. Given that a cocktail of these issues have been keeping a lid on inflationary pressures, the messaging from Fed officials will set the stage for the 18th September FOMC, where the market is pricing 30bps of easing (implying a cut is fully priced, and there is some probability of a 50bps move). Amid the market turmoil, and dovish actions by many global central banks, the Fed may emphasise that QT is over, and Fed policy is now accommodative; the market may be especially attuned for any insight on the magnitude of a rate cut, while 50bps is still a scenario on some bank desks; some of the dovish elements have dismissed the notion of a single 50bps rate cut in the past (see Bullard, who has not signalled any panic about the risk sell-off/yield curve inversion, preferring to judge the data, while noting it has been coming in decent recently). More generally, it may be an opportunity for central bank officials to calm the market after its recent rout (the full agenda is not released until the day before the event gets underway, however, the event is usually attended by bigwigs from other major central banks too). One criticism the Fed and ECB faced after their respective July policy meetings was the lack of clarity – with the two dissents on the FOMC, and Draghi clearly unable to have the GC unanimously back his views on looser policy made in the run up to the meeting. A thought about attendees: some desks would prefer Fed Vice Chair Clarida and FOMC Vice Chair Williams to attend, both of whose messaging might be less confused than Powell’s was after the July FOMC, and both of those are also able to provide more academic insight than Powell might be capable. There was no ECB representation at last year’s event, however, if anyone attends this year, traders will eye clues on how big of a bazooka the central bank could potentially fire in months ahead (note: Draghi has been dovish in recent times, although he has seemingly been unable to convince the hawkish elements on the GC of his views). If there is BOE representation, it is unclear how much policy insight we will be able to get amid Brexit uncertainty tying officials’ hands.


At its July meeting, the Fed lowered rates by 25bps to 2.00-2.25%, in line with expectations, though some in the market were pricing for 50bps. The Committee also ended balance sheet normalisation two months early, which only some were looking for. The cut was justified as insurance against downside risks presented to inflation from global growth and trade policy uncertainty. The Fed Chair was more upbeat about the state of the US economy, though again expressed concerns around business investment, which has been hit as confidence weakens amid global trade risks. Esther George and Eric Rosengren dissented to the cut – both had expressed scepticism about the need for lower rates in speeches preceding the blackout window; the dissent signals that the Committee is not united in the need for a lower rate path, and served to neutralise some of the dovish elements of the rate cut/balance sheet announcement, while also serving to slightly mitigate the prospects of a follow-up cut. Indeed, guidance in the statement, while retaining its pledge to “act as appropriate to sustain the expansion”, it seems to have eased its alert status, and will now “continue to monitor” incoming information, rather than “closely monitor”. In the press conference, Powell said the cut was a “mid-cycle adjustment to policy”, not the beginning of an easing cycle, since the outlook for the economy remains favourable; but also stated that it is not particularly likely that Fed will return to hiking in this business cycle. With that said, Powell referred to the Fed cuts in 1995 and 1998 – as Bullard, Clarida and Evans did in the lead to the meeting as a potential blueprint for the FOMC’s strategy – in both those episodes, the Fed provided three 25bps cuts for a total of 75bps worth of insurance.


Aside from the final readings of Eurozone CPI for the month of July, the main highlight on the data docket for the Eurozone will be Thursday’s August flash PMI release. In terms of expectations for the Eurozone-wide metrics, Manufacturing is forecast to slip to 46.3 from 46.5, whilst Services is expected to decline to 52.7 from 53.2. Ahead of the release, RBC highlights that the July metrics failed to suggest that a potential turnaround in the EZ growth outlook was imminent with Markit noting “The pace of GDP growth looks set to weaken from the 0.2% rate indicated for the second quarter closer to 0.1% in the third quarter”. This time around, RBC suggests that the prospects for any meaningful recovery look slim with the Bank highlighting that last month’s performance for services makes it unlikely that the sector will be able to compensate for the contraction in the manufacturing sector. From a policy perspective, this week’s release will be used as a gauge for markets to assess the extent of next month’s prospective easing measures by the ECB. As it stands, markets fully price in a 10bps cut to the deposit rate with the odds of a deeper cut of 20bps at around 48%. A particularly lacklustre batch of PMIs could see a further shift in market pricing towards a 20bps cut and stoke expectations for imminent supplementary measures such as further bond purchases and a tiered deposit rate system and thus challenge ECB Rehn’s assertion that the Bank needs to come up with an “impactful and significant” stimulus package to “exceed investors’ expectations”.


At the previous meeting, policymakers opted to stand pat on rates and thus refrain from lowering the deposit rate, despite market pricing leaning towards such a move ahead of the meeting (53% chance of a cut, pre-announcement). However, the Bank paved the way for an eventual rate cut by tweaking its forward guidance on rates to include an “or lower” option. In the aftermath of the decision, markets priced in a 93% chance of a 10bps rate cut at the September meeting; this pricing has been further cemented since July, following the FOMC 25bps cut and global growth concerns, with some now looking for a 20bps cut by the ECB. Other dovish elements to the policy statement included the Governing Council tasking the relevant Euro system Committees with examining options, including ways to reinforce its forward guidance on policy rates, the design of a tiered rate system, and options for the size and composition of potential new net asset purchases; any discussion about the extent of the preparation of such measures would be of interest to the market, however, they are broadly deemed to have been at an early stage at the time. During the press conference, Draghi suggested that a rebound in the second half of the year looks “less likely” with the outlook looking “worse and worse”. However, markets proceeded to reverse course from their initial dovish take from the 1245BST announcement as Draghi rebuffed questions regarding the unanimity of today’s policy adjustments. Instead, Draghi suggested there was a broad discussion with "broad convergence" to the decision whilst noting that some board members had reservations about a two-tiered rate system; any specificity of the extent of disagreements in the decision will be pertinent for investors, however, any such objections may be deemed to be slightly stale given the shift in market pricing for ECB action since the prior meeting. It was also revealed that no discussion took place on an imminent rate cut or the size of such a prospective move, but again, the shift in the global rate environment renders this aspect of the release slightly redundant at this stage. Following the release, some analysts concluded that the potential policy 'bazooka' that some in the market had been looking for might not necessarily on its way, with the ECB President keen to stress the optionality in potential policy responses and that there is no order of preference of instruments the Bank could use. However, with markets now pricing in over a 40% chance of a 20bps cut next month, pressure on the ECB to act is significantly greater than it was in July and thus the account from last month’s meeting might carry less weight than historical releases.


Italian PM Conte will appear before the Senate on Tuesday 20th August to respond to the political crisis the country is facing, after Deputy PM/League Leader Salvini put forth a vote of no-confidence against the government. If the no-confidence motion passes (widely expected as the League and PD are likely to back it), President Mattarella will hold formal consultation to see if an alternative coalition can be formed. If not, a technocratic government could be appointed with the goal of passing the Autumn 2020 budget (October 20th) to avoid a 3% VAT tax hike. The failure of negotiations to form a government could see a general election, in October or November. Earlier in the week, Salvini proposed accepting 5SM's demand for a parliamentary reform in return for quick elections, a measure seen as an olive branch to progress proceedings; the proposal will see the number of MPs in both houses cut from 945 to 600; this has been approved by parliament on three occasions, with the fourth vote due in September. HSBC says that completing this reform would mean elections could not take place for another five to six months at least, due to the need to allow a possible referendum to be called, and to re-draw the electoral boundaries. On the flip side, If the confidence motion is rejected on Tuesday, Conte will retain his position, and the parties who voted against the no-confidence motion will be asked to form a new coalition. Analysts at ING believe that elections remain the most likely option: “The possibility of new elections and the threat of an extended period of political uncertainty continues to hint at downside risks for the Euro, alongside the possible dampening effect of the ECB's easing package to be delivered in September”, it said.


At the meeting in August, the RBA kept its Cash Rate unchanged at the record low of 1.00%. The release is largely expected to be side-lined given that Governor Lowe gave his semi-annual testimony alongside the release of the SoMP shortly after the meeting. Additionally, US/China relations have further deteriorated, with China stating that it will have to take countermeasures on US tariffs, whilst President Trump noted that a deal has to be done on US terms. Moreover, the Aussie labour market report this week showed a surge in employment at +41.1k; full-time employment drove most of the gains (+34.5k), albeit the unemployment rate remained at 5.2%. ING noted that the overall solid data signals for a pause in the RBA’s easing cycle; “[the] strong labour data suggest that the Fed is more likely to be easing before the RBA moves again”. Finally, RBA’s Assistant Governor Kent this week said that the Central Bank’s policy does not target unemployment rate but interestingly noted that unconventional policies are possible, although Australia is unlikely to need negative interest rates. Amid all the above, CBA, HSBC and Citi are betting that the RBA will cut rates deeper than previously thought, on the basis of rising global tensions.

45TH G7 SUMMIT (24-26 AUG):

NOTE: a full preview will be published in next week’s Week in Focus note. There is some speculation that the meeting could be a pre-cursor to a co-ordinated round of monetary easing in September, according to ECU Group. Accordingly, it is worth watching the tone of G7 leaders – Canada, France, Germany, Italy, Japan, UK, US, EU, Spain (invited), Australia (invited), India (invited) – in the run-up to next weekend’s events.


Headline CPI is seen -0.2% M/M, but unchanged at 2.0% Y/Y. Canadian bank RBC sees a +0.4% M/M rise, however, driven by airfares and gasoline prices. Those gains might be offset slightly by seasonal declines in clothing and autos prices, the bank says. With that said, an average of the three BOC core measures of inflation might slip from the 2.0% level, RBC warns, but the current inflationary landscape might still provide a positive narrative for the BOC. “Of course, as a forward-looking central bank, the BOC will remain attuned to signs of a weakening outlook that would portend an undershoot in the future,” RBC says.

Meanwhile, RBC sees retail sales roughly flat in June for the third straight month (there is no market consensus yet). The bank argues that the c.5% seasonally adjusted decline in gasoline prices in the month provides downward pressure, while core sales (ex-autos and gas) are pencilled in at +0.3%. “Overall volumes are expected to edge up 0.2% M/M after two consecutive monthly declines, leaving them roughly flat for Q2 as a whole,” RBC writes, “going forward, lower consumer interest rates should provide some boost to the category.”