Drivers for the Week Ahead

Blog icons-DRIVERS

  • Fed chair Yellen speaks at the annual Jackson Hole Symposium on Friday
  • Merkel has to protect both her flanks; flash eurozone PMIs will be reported
  • Markets will be closely listening to BOJ’s Kuroda when he speaks on August 23
  • The Article 50 trigger by the UK may be closer than anticipated
  • EM and “risk” are very vulnerable under a hawkish Yellen scenario

The dollar is broadly firmer against the majors as Fed tightening expectations shift. Sterling is outperforming while the yen and Kiwi are underperforming. EM currencies are broadly weaker. CNY and THB are outperforming while KRW and ZAR are underperforming. MSCI Asia Pacific was down 0.2%, with the Nikkei rising 0.3%. MSCI EM is down 0.5%, with Chinese markets falling 0.8%. Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is flat at 1.58%. Commodity prices are lower, with oil down 2.0-2.5%, copper down 1.2%, and gold down 0.4%.

Fed chair Yellen speaks at the annual Jackson Hole Symposium on Friday, and will be the highlight of the week. Over the weekend, Vice Chair Fischer said that the Fed is nearing its targets, which implied that tightening isn’t far off. To the extent that Yellen shares their assessments of the economy, we would expect her to largely echo the broad sentiments expressed by both Dudley and Fischer. If she delivers a somewhat hawkish message this week, that should give the dollar more traction.

Fed tightening expectations were buffeted last week first by hawkish Dudley comments, then by the more balanced FOMC minutes, and now by the Fischer comments. On net, the markets have adjusted the odds for tightening this year higher, and now stand at the highest odds since the Brexit vote. The US 2-year yield is above 0.75% and is the highest since June 23, while the while 10-year yield is approaching 1.60%. Higher US rates should help the dollar maintain some traction ahead of this Friday’s Yellen speech.

Yet despite the strong jobs data in June and July, odds of a move on September 21 or November 2 are still low, with the December 14 meeting seen as the most likely for the next hike. The implied yield on the December Fed funds futures contract stands at 0.505%, the highest since June 9. If the dovish Fed outlook is chipped away further by Yellen, the dollar may maintain its recent traction.

Merkel has to protect both her flanks. She will be meeting EU leaders ahead of the summit, saying she wants the broadest possible debate about the future of the European Union. At the same time, many observers question whether she can be re-elected in a year’s time. The outcome of the state elections next month will be watched closely. The first one is September 4 in Mecklenburg-Vorpommern.

Flash eurozone PMIs will be reported Tuesday. The record of the recent ECB meeting was not very informative. In addition to playing down shortages of bonds that it must buy under its QE program, there were two points that seemed to be important for what to expect next month. First, there was broad agreement that the downside economic risks had increased, and second, it was noted with concern that the underlying trend of inflation was not rising. The eurozone composite PMI has been unusually steady. It has been between 53.0 and 53.2 since February. The July print was 53.2 but is expected remain within the range in August. Elsewhere, Germany reports Q2 GDP breakdown on Wednesday, and then the August IFO survey on Thursday and September GfK on Friday.

The market remains uncertain what the BOJ will do next month, and will be closely listening to Kuroda when he speaks on August 23. Data overall have come in on the weak side recently, feeding market expectations that greater pressure will be on the BOJ for further easing. If it does not ease more, then dollar/yen will likely move further below 100. At the end of the week, Japan will report July inflation figures. No progress is expected with the national headline and core (excluding fresh food) expected to remain at minus 0.4%. Excluding food and energy, the inflation rate is anticipated to edge down to 0.4% from 0.5% to match its lowest level since May 2015, which itself is the lowest since October 2013. Ahead of the CPI data, Japan’s cabinet releases its monthly economic report for August around mid-week.

The Article 50 trigger by the UK may be closer than anticipated. In the face of the enormity of the challenge and the complexity of the issue many observers have given up on ideas that Article 50, which formally begins the negotiations for the separation of the EU and the UK would be triggered anytime soon. However, comments by two UK officials may be the first indication that the many have misread the intent of the May government. Further clarification will be sought.

UK data this week could also command some attention. CBI reports orders and sales for August, while the first print for Q2 GDP will be reported Friday. Of course, Q2 is old news but it will be important to see what sort of momentum the UK economy had going into the Brexit vote.

EM and “risk” are very vulnerable under a hawkish Yellen scenario. Of note, Turkey’s central bank meets Tuesday and is expected to cut the overnight lending rate 25 bp to 8.5% whilst keeping all other rates steady. CPI rose 8.8% y/y in July, the highest since February and back above the 3-7% target range. Yet the bank will likely come under greater pressure to ease more aggressively, which would spook the markets. Last Friday, Fitch kept Turkey’s BBB- rating but moved the outlook to negative from stable. We felt a downgrade to BB+ was warranted, but the negative outlook keeps that risk alive.