Will BOE Ease on May Day?

United Kingdom UK Big Ben and Flag Marc

  • After a nearly three weeks of turmoil following the UK referendum, there is now a sense of order returning to UK politics
  • Today’s focus though is not on Brexit per se, but rather the Bank of England meeting
  • News reports indicate that some key Japanese officials appear to be pushing for bold action that includes both strong monetary and fiscal stimulus
  • The US reports weekly initial jobless claims and PPI
  • Bank of Korea kept rates steady at 1.25%, as expected; Banco de Mexico releases minutes
  • Central banks of Chile and Peru meet, steady rates expected from both

The dollar is mostly softer against the majors. The Swiss franc and sterling are outperforming while the yen and Kiwi are underperforming. EM currencies are mostly firmer. ZAR and RUB are outperforming while CNY and IDR are underperforming. MSCI Asia Pacific was up 0.2%, with the Nikkei rising 1%. MSCI EM is up 0.8%, with Chinese markets down around 0.2%. Euro Stoxx 600 is up 0.9% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is up 2 bp at 1.50%. Commodity prices are mixed, with oil up 1%, copper down 0.3%, and gold down over 1%.

After a nearly three weeks of turmoil following the UK referendum, there is now a sense of order returning to UK politics. Two elements of the new government are particularly relevant. First, May demonstrates strategic prowess by putting those like Johnson and Davis, who campaigned for Brexit, to lead the negotiations with the EU, while putting Tories who favored remaining in the EU in the internal ministries.

The second element that is important is that May represents a different wing of the Tory Party than Cameron and Osborne. Not to put too fine a point on it, but she and at least part of her cabinet are more interested in social justice. That was what her first speech emphasized, not Brexit. She has expressed concern about executive pay and is sympathetic to having workers represented on corporate boards.

Today’s focus though is not on Brexit per se, but rather the Bank of England meeting. The surveys show divided markets. Many of those who don’t think the BOE will cut rates look for a move next month. The mixed view in the market warns of the risk of volatile market response no matter the decision. The Times and City AM run their own shadow MPC exercises, and both favored a rate cut today.

In addition to the price of money, i.e., interest rates, there is some focus on the potential for a new asset purchase plan. If QE is ventured, there are some thoughts that the BOE would focus the operation on corporate bonds. The BOJ and now the ECB are buying corporate bonds, so it is not completely unprecedented for the BOE in the sense that previously they bought a few billion pounds of commercial paper.

Estimates suggest that the UK corporate bond market is roughly GBP435 bln. Most of the corporate bonds, however, would likely not be included for reasons ranging from ratings (below investment grade), issuers (non-UK domiciled business), sectors (banks bonds), and technical reasons (e.g., maturity). Still, when these allowances are made, there may be more than GBP125 bln to “pick from.” Even a small program might be sufficient to revive the UK corporate bond issuance market, which has slowed to about GBP900 mln this year compared with GBP1.6 bln in the same period a year ago.

The BOE is not the only potential source of fresh accommodation that the market is focused on today. The yen is under continued pressure as participants begin appreciating that new bold stimulus is possible from Japan. As we noted yesterday, like the word recession, there is not agreed upon definition of “helicopter money” except to note some blurring of monetary and fiscal policy, which incidentally is what critics claim of QE in the first place.

In any event, news reports indicate that some key Japanese officials appear to be pushing for bold action that includes both strong monetary and fiscal stimulus. A key advisor to Abe (Honda) may have found support for his proposal for the Japanese government to issue non-market perpetual bond (no maturity) which the BOJ buys directly. This would, in effect, free government spending from another restraint.

The implication that investors see is the debasing of the currency. The yen’s has declined 4.8% against the dollar this week (and there have complaints from Japanese officials about the pace of the move). This has the makings of the largest weekly decline in the yen in over a decade, and among the biggest in the floating-rate era.

After the yen today, the New Zealand dollar is the weakest of the majors. It is off about three-quarters of a percent on heightened rate cut speculation following the central bank’s announcement of an unscheduled economic assessment next week. The central bank meets again in the second week of August. The derivatives market now shows around a 60% chance of a rate cut then, up from 40% previously.

The Australian dollar is second only to sterling today. It was helped by a sharp jump in full-time employment (38.4k), which is the strongest since last November. This, coupled with the tick up in consumer inflation expectations, keeps investors from anticipating a near-term RBA cut.

The US reports weekly initial jobless claims and PPI. Neither are typically market movers, especially ahead of tomorrow’s more important retail sales and CPI reports. Three Fed officials speak: Lockhart, George, and Kaplan. Regardless of what they say, the market will not become convinced of a hike later this month. Whether the Fed goes in September, which the market is pricing in less than a 10% chance, is dependent on the next couple months of data.

Bank of Korea kept rates steady at 1.25%, as expected. However, it cut its 2016 growth and inflation forecasts. We do not think that the 25 bp cut in June was “one and done” and so we think rates will be cut again in Q3. Earlier this year, the BOK cut its forecasts at one meeting and then followed up with the June rate cut. Given the BOK’s cautious approach, it’s not surprising that it will wait a month or two before cutting rates again.

Banco de Mexico releases minutes from its June meeting. At that last meeting, it surprised markets with a larger than expected 50 bp cut and so the minutes will be scrutinized for clues on future moves. With the growth outlook worsening, we think another hike will be hard to justify. The next policy meeting is August 11, and that decision will really depend on how the peso is trading then.

Chilean central bank meets and is expected to keep rates steady at 3.5%. CPI rose 4.2% y/y in June, slightly above the 2-4% target range but still converging. We think the tightening cycle has ended, as the economic outlook remains soft along with low copper prices.

Peruvian central bank meets and is expected to keep rates steady at 4.25%. CPI rose 3.3% y/y in June, slightly above the 1-3% target range but still converging. We think the tightening cycle has ended here too. For both these banks, an easing cycle seems unlikely until late this year or early 2017.