What summer lull?
This week’s calendar is a blockbuster, jam-packed with potentially market-moving events, starting with the closely-watched Bank of Japan meeting.
BoJ pow wows are usually “nothing to see here, move along” affairs, save for Kuroda soundbites, which are entertaining to the extent you’re impressed by his commitment to keeping a “positive attitude” amid overwhelming evidence that his “very powerful” easing is whatever the opposite of “very powerful” is when it comes to engineering a sustainable rise in domestic inflation.
But this time is different (so to speak). Or if it doesn’t turn out to be different in terms of actual policy tweaks, it’s at least different in how market participants are approaching it. 10Y yields in Japan surged last Monday following reports that the BoJ is considering how to go about mitigating some of the negative side effects of its yield curve control program, side effects which include shrinking net interest margins at banks and liquidity vacuums in the JGB market, which has basically ceased to function.
This is a tedious exercise for Kuroda and co. The yen is hypersensitive to perceptions of policy changes from the BoJ and Donald Trump’s express desire for a weaker dollar amid the trade wars only complicates matters as it gives USDJPY an extra excuse to sell off in the event a policy tweak gets the ball rolling. Yen appreciation is obviously not great news for risk assets.
You’ll also want to watch the U.S. curve (and other developed market bond curves) for signs of steepening. The 2s10s saw its largest two-day steepening since February in and around the BoJ “rumors” last Monday and the previous Friday.
Although consensus still assumes no material change from Kuroda, this is easily the most anticipated BoJ meeting in recent memory. For their part, BNP assigns the following probabilities to what the bank says are Kuroda’s four options for Tuesday:
- Option 1: Do nothing for now (30% probability)
- Option 2: Instruct BoJ staff to draw up measures to reduce policy side effects by the next MPM (40% probability)
- Option 3: Announce flexibility in the 10-year rate, while keeping the target at 0% (20% probability)
- Option 4: Hike the target for the 10-year rate (10% probability).
Sooner or later, the BoJ will have to make a move, because what they’re doing isn’t sustainable. The problem, as ever, is guarding against yen appreciation and also maintaining a healthy respect for the possibility that a sharp repricing in JGBs could spill over, causing a tantrum across other developed market bond curves.
“Now it has run for five years, so it might be only natural that the side effects are piling up and hopes are waning that continuation of the same policy will generate additional easing effects”, BofAML wrote last week, adding that “the BoJ is expected to make a gradual course adjustment from unprecedented easing to normal easing, and to aim for a more sustainable policy [and] in that case, there is no reason to wait for a long time.”
You’ve got to love this: “…from unprecedented easing to normal easing.”
For their part, Goldman isn’t necessarily buying the idea that any kind of change is feasible, let alone advisable at this juncture. Here’s a brief excerpt from a longer note out Sunday evening:
We expect the BOJ to maintain current measures at its next meeting on July 30-31. Specifically, we expect it to keep its target 10-year interest rates at 0% and maintain its guideline for long-term JGB purchases (around ¥80 tn a year). Recently, various media outlets have reported that the BOJ is considering policy fine-tuning to lessen the cumulative side effects from prolonged easing. If anything, minor adjustment to permit wider deviation of the 10-year yield from its 0% target looks the most likely candidate. However, even minor tweaks could prove challenging as they would carry risk of triggering yen appreciation if implemented without sufficient communication between the BOJ and the market. Hence we think the Policy Board is unlikely to reach definite conclusions at the upcoming MPM, and carry on the discussion in future meetings.
Barclays notes that while their baseline scenario is for no major policy change (considering lackluster inflation and a likely downgrade to the forecast along with the possibly violent market reaction to any tweak), Kuroda could conceivably try and talk about the deleterious side effects of its various easing programs or even explicitly indicate that there’s a review going on. “In that scenario, JPY appreciation and JGB bear-steepening pressures are likely to continue, perhaps after a temporary pop due to policy inaction, as markets will focus on the prospect for policy changes at later meetings, potentially as early as October after the LDP presidential election on 20 September”, Barclays reckons.
Once that’s out of the way, we’ll get the Fed. Obviously they won’t move at this meeting and there’s no press conference or SEP update, but thanks to Donald Trump’s recent comments about hawkish Fed policy serving to help America’s trade partners weather the tariff storm, the statement will be parsed even more closely than usual for just how upbeat the committee dares to be when it comes to economic conditions in the U.S.
The ultimate irony here is that Trump spent Friday bragging about how his tariffs and tax cuts are ushering in a veritable economic renaissance, but it is in fact the prospect of an overheating economy and tariff-related price pressures that has the Fed leaning so hawkish. This is just another example of Trump’s policies tripping over themselves, but whatever the case, the statement will be important, even if changes are minor.
“On the policy statement, we only look for modest changes marking the language to the latest data such as the rise in the unemployment rate, though we expect the Committee will note that it remains at low levels”, BofAML writes, in their preview. Goldman largely echoes that assessment:
Reflecting the upbeat growth picture, we expect the post-meeting statement to retain most of the positive characterizations from the June meeting, referring to growth as “solid,” job gains and business investment as “strong,” and consumer spending growth as having “picked up.” While we expect a nod to the higher June unemployment rate, the tweaks are likely to be relatively minor (to “has stayed low” from “has declined”), particularly because wage growth measures have been stable-to-higher in recent months.
Despite Trump’s weak dollar rhetoric, USD net long positions jumped for a sixth week in a row to nearly $22 billion overall through last Tuesday. That’s the highest level since January.
Later in the week, Trump will get yet another opportunity to brag about the economy when the July jobs report hits. The June report was another solid print, although earnings growth remains subdued and the unemployment rate ticked higher. Considering what he said ahead of last week’s GDP data (comments delivered in Illinois on Thursday seem to suggest the President is going to make a habit out of tipping these top-tier data points ahead of time) expect Trump to give hints on Thursday if the numbers look good.
Barclays is at 175k on the headline (notably, the bank thinks employers might be spooked by “increasing concerns over protectionism”). BofAML is more optimistic, projecting 225k. Goldman is at 205k.
That’s hardly the end of it on the data front in the U.S. There’s ECI, PCE, and ISM manufacturing, too. In other words, this week will give markets a fresh read on wage growth, inflation, the health of the industrial sector and the overall jobs market. Clearly, all of this has the potential to reinforce the U.S.-centric growth narrative, which would in turn likely point to a September Fed hike, Trump’s protestations notwithstanding. And see, this is where the Erdogan comparisons come in. Trump is simultaneously rooting for further evidence that the economy is overheating on the back of fiscal stimulus while also hoping he can convince the Fed to ignore that overheating on the way to leaning dovish.
Complicating all of this further is the distinct possibility that trade headlines will be the main driver of the greenback this week, despite the myriad fundamental drivers listed above.
Also on deck is the Bank of England. Mercifully, nothing much is expected on the Brexit front this week which I guess means GBP will be free to trade based on whatever folks can glean from the vote split. A hike is obviously expected, but this is a notable milestone. “The likely 25bp hike in interest rates at the Monetary Policy Committee meeting on 2 August would not be the first in this cycle, but it would be the first time that Bank Rate has been lifted above the ‘emergency low’ 0.50% level introduced in March 2009”, BNP notes, adding that “in that sense, it would signal the beginning of a tightening cycle in earnest.”
Not everyone seems convinced that a hike is warranted right now. BofAML, for instance, apparently sees the bank remaining on hold out of respect for Brexit tail risks. To wit, from a note out Friday:
The BoE assumes a 100% probability of a smooth transition. This didn’t make sense to us before recent events. We expect a deal too, but nothing in life is certain. The assumption makes less sense now we think. Equally, why risk it if there is no pressing need to hike? Inflation is falling faster than the BoE expected, wage growth has slowed, the unemployment rate has stopped falling and GDP growth is the weakest in 6 years. The BoE sounds like they might risk it with an August hike (we assumed they do not hike). But that makes the market right to question more hikes: even if the BoE doesn’t price tail risks the market has to.
That’s pretty interesting, if you ask me. To say the situation remains “fluid” around Brexit is to laughably understate the case, so it’s not clear that anyone would blame the BoE if they decided to take a cautious approach. Whatever the case, you’ve got to wonder if the setup doesn’t play GBP negative one way or another.
In EM watch for the BCB, the RBI and especially for inflation data out of Turkey. The threat of U.S. sanctions in connection with the Brunson debacle only adds to the country’s problems amid extreme market consternation about the future path of monetary policy under Erdogan. There’s more on that here.