Drivers for the Week Ahead

Blog icons-DRIVERS

  • NY Fed President Dudley suggested before the weekend that the two hurricane’s that have ravaged parts of Texas and Florida may impact the timing of the Fed’s next rate hike
  • BOE and SNB hold policy making meetings in the days ahead, and Norway goes to the polls
  • US retail sales are unlikely to have repeated July’s 0.6% rise
  • The US has reportedly notified the respective parties that it will seek new sanctions against North Korea by the UN at the start of the week

The dollar is mostly firmer against the majors as the new week begins. Loonie and Kiwi are outperforming, while the yen and Nokkie are underperforming. EM currencies are mostly softer. TRY and RUB are outperforming, while CNY and KRW are underperforming. MSCI Asia Pacific was up 0.6%, with the Nikkei rising 1.4%. MSCI EM is up 0.4%, with the Shanghai Composite rising 0.3%. Euro Stoxx 600 is up 1% near midday, while S&P futures are pointing to a higher open. The 10-year US yield is up 3 bp at 2.09%. Commodity prices are mixed, with oil narrowly mixed, copper up 0.4%, and gold down 0.7%.

There are some anomalies about the dollar’s accelerated decline. Even though the market does not expect the Fed to hike rates, it is convinced that the Fed will begin allowing its balance sheet to shrink starting in Q4. It begins slowly to be sure, and it will take place with the sales of a single instrument. It simply won’t reinvest the full amount that is maturing.

The ECB made it clear last week that it is no hurry to exit its extraordinary policies. It is not convinced that inflation has yet to enter a sustainable and durable path. This suggests that the ECB’s balance sheet is likely to expand by more and for longer than may be appreciated by market participants, many of whom are concerned that the ECB will run out of assets it can buy under the current self-imposed rules.

If the ECB were to cut its purchases in half to 30 bln euros in the first half of next year, the balance sheet would expand by another 180 bln euro by the end of June 2018. This after expanding by 180 bln euros in Q4 17. If the Fed begins its balance sheet operations in October, by the end of June 2018, its balance sheet would shrink by $180 bln. The ECB also reiterated that it will not raise rate (deposit rate at minus 40 bp and refi rate is at zero) until after its asset purchases are complete.

NY Fed President Dudley suggested before the weekend that the two hurricane’s that have ravaged parts of Texas and Florida may impact the timing of the Fed’s next rate hike. He had recently suggested could take place before the end of the year, provided the economy evolved as the Fed expected. However, the market had already reduced the chances of a December rate hike to about a 25% chance, down from a little more than 40% the previous week.

While the tighter financial conditions in the EMU are thought to make for a cautious ECB, investors are not nearly as convinced that the easing of US financial conditions will spur the Fed into action. We suggest that this is partly because many participants do not think the Fed places the same amount of weight to the financial stability mandate as they do to the short-hand talk of a dual mandate. We think this is a mistake. Also, given the cautiousness expressed by several Fed presidents and Governor Brainard, as well as the coming personnel changes, many expect easy money to prevail.

The Bank of England and the Swiss National Bank hold policy making meetings in the days ahead, and Norway goes to the polls. Neither central bank is likely to alter policy and Norway’s election will likely confirm the status quo.

Before the Bank of England meets, it will see the August inflation report. It is likely to have risen, largely as a result of depreciation of sterling after the June 2016 referendum. Still, there is good reason to expect the peak in inflation in the coming months, even if CPI gets closer to 3% first. The UK labor market continues to absorb slack and the risk to the unemployment rate is on the downside, even though it has already fallen to 4.4% from 4.8% at the end of last year.   However, earnings growth is slipping further behind the inflation, and this is likely to squeeze discretionary consumption over time.

Sir Ramsden has assumed his role as the new Deputy Governor for the Bank of England. It is now fully staffed with nine members. Two of whom are likely to continue to dissent in favor of a hike, but they have been unable to convince their colleagues.

The Swiss deposit rate will remain unchanged at minus 75 bp. The OECD still regards the Swiss franc as the most over-valued currency in its universe (~23.5%). The SNB seems content to lag well behind the ECB and Fed in the monetary cycle. It may repeat it warning that it is prepared to intervene in the foreign exchange market if needed.

We argue that one of the key drags on the dollar is coming from the drop in interest rates. Data due out in the coming days are unlikely to change sentiment. Specifically, there is risk that the core measure of CPI continued to decline last month. It peaked this year in January at 2.3%. It has been stuck at 1.7% for three months through July. The risk is that it slipped to 1.6% in August, which would be the lowest since January 2015.

US retail sales are unlikely to have repeated July’s 0.6% rise. Auto sales will be a major drag on the headline. The components that feed into GDP are likely to have risen around 0.3%, which is about the average so far, this year. Similarly, industrial output growth likely slowed in August after a meager 0.2% increase in July which matches this year’s average. The jobs growth in manufacturing suggest that output in that sector likely fared better than over all industrial output. However, there is nothing in these data points that suggests the US economy has accelerating.

The US has reportedly notified the respective parties that it will seek new sanctions against North Korea by the UN at the start of the week. In addition to a ban on oil exports, reports suggest the US will also seek an embargo on textile trade, accepting guest workers from North Korea, and freezing Kim’s assets. The cost of the such proposal would likely weigh heaviest on China, but the US does not appear to be offering China anything to offset this cost. It’s worth noting that North Korea did not test a missile over the weekend, as had been feared.

China cannot accept precipitating a crisis that would lead to regime change and the risk that US interests dominate the peninsula. At the same, time, China seems to recognize that North Korea’s six nuclear bomb tests, and even more missile tests, encourage the further deployment of missile defense systems in South Korea and Japan immediately, which could also ostensibly be used against it. A friendly vote from China would be to abstain, while the US course risks a veto unless it can be amenable to compromise. The failure of the UN to agree on more sanctions could further encourage North Korea and discourage risk taking.