Ok, so it’s Sunday. And as we’re fond of reminding readers, that means tomorrow will be Monday assuming Trump doesn’t push the button between now and midnight.
So it’s time to get “jacked to the tits!” about the new trading week.
— Walter White (@heisenbergrpt) July 14, 2017
If you didn’t get your fill of hand-wringing over DM central banks last week, then you’re in luck because this week we’ll get the ECB and the BoJ. Oh, and minutes from the RBA and the Riksbank.
As far as the ECB is concerned, BofAML notes that they’ve got to “choose between ‘backtracking’ and ‘assuming’ after the ‘Sintra hiccup.'”
That’s an amusing way to put it. The “Sintra hiccup” (a reference to initial comments from Draghi on June 27 that sent bund yields sharply higher and the subsequent procession of hawkishness that ultimately conspired to trigger a mini DM rates tantrum) can be visualized as follows:
“The action in rates was underpinned by the change in rhetoric from the ECB in recent weeks, where the central bank appeared to have modified its view on the trajectory of its current stimulus measures,” Deutsche Bank wrote on Friday evening, adding that “EU rates have reacted quite strongly, as even such a modest change in language makes a big difference in a world where investors have become accustomed to central bankers finding reasons to maintain stimulative policies.”
“This episode provides a good example of just how difficult the eventual path to policy normalization is going to be,” DB went on to suggest, underscoring a point we made earlier in the week about how unnerving it was that all it took was a little harsh language to trigger a small rates panic.
For their part, BofAML “thinks the ECB will choose to [stay the course] and toughen its language marginally, by removing the easing bias on QE, while insisting on the need for prudence and a ‘persistent’ monetary stimulus.”
Citi agrees. Here’s their take courtesy of Harvinder Sian who, for the record, is pretty damn good at what he does:
The July ECB should see bond markets digest a further evolution in ECB forward guidance and a reinforcement of the (more hawkish) signal sent by the Draghi speech at Sintra. It makes little sense for a dovish turn at the 20th July meeting ahead of a taper announcement in September or October.
The root cause of the ECB shift is the technical need to terminate PSPP in 2018 as the 33% legal limit approaches. It’s not about inflation. If we work backwards from that conclusion, the timing and motivation on why the ECB is now signaling that disinflation headwinds are temporary and that tapering is not really a tightening, becomes much clearer.
In other words, they have to signal an exit – at least from PSPP because they are literally bumping up against supply constraints.
Needless to say, all of this means the ECB statement carries quite a bit of event risk this week.
As for the BoJ, well, there’s no hope of Kuroda hitting his inflation target any time soon (or really, “ever”).
“At its 20 July meeting, we expect the BoJ policy board to keep its short rate unchanged at -0.1% and keep its guidance on QE unchanged,” BofAML writes. “The weakness in YTD inflation means the BoJ board will likely cut its FY17 core CPI forecasts.”
It’s not entirely clear what that will mean for the yen – thanks to YCC it trades almost entirely off US rates, so in that respect last week’s Treasury rally, if it holds, will probably provide a measure of support.
Absent a rates differentials-based reason for the yen to weaken materially, it seems exceedingly unlikely that the BoJ is going to change course – especially in light of their recent move to cap 5Y yields. Here’s Goldman with a bit more color:
We expect the BOJ to maintain current monetary policy at its July 19-20 monetary policy meeting. On July 8, the BOJ offered to buy an unlimited amount of JGBs at the fixed rate of 0.11% in the 10-year zone for the second time since February 3, thus keeping the 10-year rate at 0.1% or lower. We see this as a strong signal from the BOJ that it intends to continue a wait-and-see approach, sitting tight until US rates rise significantly. With the risk of inflation losing momentum again, we maintain our base-case view that the BOJ is likely to leave monetary policy unchanged at least for the remainder of FY2017. One potential risk scenario we see is that if the yen weakens substantially, USD/JPY climbing above 120 and heading toward 125, it could prompt the BOJ to consider raising its 10-year rate target even if inflation is still low at the time.
The Riksbank minutes are interesting considering recent events which include not only the bank removing its easing bias (they had to, given that their monetary policy is effectively beholden to Draghi) but also given last week’s hot inflation print and attendant krona rally:
So while the minutes of course don’t capture opinions on the latest data, it will nevertheless be instructive to hear what everyone was mulling when they removed the easing bias.
For those interested in still more color, find Barclays “Thoughts For The Week Ahead” below along with a handy calendar from BofAML…
Since late June, many DM central banks have turned hawkish on the back of solid growth and rising concerns about financial stability despite still-low core inflation. As the Fed delivered another hike in June, the ECB, BoE, and BoC joined the chorus of stimulus withdrawal. EGB and UST term premia have corrected sharply on the back of this hawkish pivot, causing long-term rates to sell off, while the BoJ’s Yield Curve Control (YCC) kept JGB yields anchored, causing JPY depreciation to accelerate. However, the term premia corrections are now showing signs of stabilizing, and our global rates team has turned neutral on 10y Bunds and UST duration. Reversal of some hawkish rhetoric, such as ECB speakers apparently playing down ECB President Draghi’s comments at the ECB Forum or lack of hawkishness in Fed Chair Yellen’s testimony, are causing markets to question these central banks’ determination to follow through on their recent hawkish shift. In this light, various central bank meetings this week, including the ECB, BoJ and various EM central banks (e.g., South Africa and Indonesia), will be keenly watched for their latest stance.
The ECB is widely expected to leave its policy settings unchanged on Thursday, but the statement language represents asymmetric risk to the EUR, in our view. A confirmation of the hawkish language introduced by President Draghi during the Forum in Portugal should result in only a limited sell-off in short-end interest rates, with very modest upside risks for EURUSD. The rates market, for example, already implies almost 10bp of deposit rate hikes over the next year versus less than 3bp prior to President Draghi’s speech, and throughout this time EURUSD has appreciated about 2.5%. Dovish language, on the other hand, could see a more marked retracement as investors reassess expectations of both deposit rate hikes and the pace of asset purchases.
Unchanged BoJ policy and likely negative revisions to its inflation forecasts appear to be well priced by the market, limiting the prospect of further JPY depreciation, in our view. The BoJ is seen as the least-likely G4 central bank to signal a hawkish pivot despite its closing output gap. The JPY has depreciated sharply since late June, due to an unexpected hawkish pivot by other central banks and the BoJ’s commitment to YCC via recent fixed-rate operations. Although the monetary policy divergence story could support USDJPY around 110-115 for longer than we expected, upside above 115 is likely limited, given that our rates team believes overseas term premia corrections have already come a long way (as mentioned above) and we expect 10y UST to end the year at only 2.4%. To the contrary, further reversal of recent hawkishness by other central banks could drive JPY appreciation. Greater caution toward foreign asset investment by Japanese investors this fiscal year is not providing much support for the pair either.
Solid global growth momentum may have provided some central banks more confidence to turn more hawkish since late June. Barclays’ global manufacturing confidence index has risen sharply in June and exceeded its peak earlier in the year, supporting risk asset rallies and higher long-term yields (Figure 2). In our view, the recent JPY weakness reflects not only the renewed expectations of policy divergence but also the rebound in global sentiment, with which the yen has greatest negative correlation, in our view. In this light, this week’s July sentiment indices from major DM (such as US Empire/Philadelphia Fed indices and the German ZEW index) as well as China’s activity data (Q2 GDP and June monthly data) will be closely examined to assess the global growth picture. Continued recovery could support their hawkish stance.
While global growth momentum may continue to support central bank confidence, inflationary pressures are lacking to fully justify actual tightening cycle to ensue. In fact, “missingflation” seems to be striking back across the world after short-lived reflationary expectations earlier in the year. Indeed, major markets’ breakevens have mostly reversed the optimism of earlier in the year (Figure 3). Hence, this week’s inflation data in the UK (June CPI and RPI), Canada (June CPI), euro area (final June HICP), New Zealand (Q2 CPI) and the US (June import prices) will be important in assessing medium-term monetary policy outlook.
Here’s hoping you have a profitable week.
“Billions and billions and billions and ….”
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— VICE News (@vicenews) July 15, 2017