Drivers Wanted: Full Week Ahead Preview

If you’re looking for drivers in the week ahead, you can probably point to the dollar and headline risk around Italy.

On Sunday, Reuters reported that the European Commission is likely to reject Italy’s draft budget on Tuesday, an outcome that was largely expected, but which could nonetheless serve to offset some of the relief that might have materialized in BTPs after the Moody’s review produced the best possible outcome under the circumstances.

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European Commission To Reject Italy’s Draft Budget On Tuesday

This will be set against the October ECB meeting which of course won’t bring any actual policy tweaks, but could provide something in the way of confirmation that the central bank cannot backstop Italy in the absence of a bailout request. Markets are still waiting on details around how the ECB will handle reinvestments, but at least according to BofAML, that discussion “may need to wait until December.”

Draghi’s move to usher in state-and-date dependent forward guidance back in June effectively means there’s little to say about rates at this point. “One side-effect of strong forward guidance is that it makes for dull central bank communication for a while”, BofAML writes, in the same noted cited above, adding that “the decision on policy rates has been pushed to a relatively distant future, whatever ‘through the summer’ precisely means.” Obviously, Draghi’s “summer” forward guidance is ambiguous on purpose – that was the beauty of it.

“The ECB rhetoric is unlikely to provide much support to the EUR”, Barclays wrote over the weekend, before noting that while the central bank “is expected to retain the same policy message of the September meeting, it will likely signal growing concerns about negative risks ahead, mainly related to weak external demand, supply-side oil pressures and Italy.”

As far as Draghi’s stance on Italy is concerned, BofAML thinks maybe he’s not getting through to the populists and could use Thursday as an opportunity to drive home the message. “It seems that the message needs to be made loud(er) and clear(er) that QE is part of the monetary policy framework and cannot be used to help individual national governments facing a tightening in financial conditions that they to a large extent triggered themselves”, the bank says.

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Ruh-Roh! ECB Won’t Rescue Italy, May Force Populists Into E.U. Bailout

It’s also worth keeping in mind that we’re starting to see some signs of contagion from Italy, with Spain’s spreads to bunds blowing out considerably.

(Bloomberg)

Stateside, we’ll get GDP this week, which will be another opportunity for Donald Trump to insist that he’s ushered in an economic renaissance in America. Here’s hoping for another absurd press conference on the White House lawn.

The irony, of course, is that the stronger the data, the more reason the Fed has to stick to the hiking path, which means Trump is effectively causing the very hawkish lean he recently characterized as “loco“. Consensus for the initial Q3 GDP read is 3.4% (QoQ saar).

For their part, Goldman sees a modest upside surprise. “We estimate a +3.5% increase in the first vintage of Q3 GDP [and] expect the composition of the report to reflect solid growth in personal consumption (+3.4%) and business fixed investment (+2.9%) alongside a significant boost from federal government spending (+5.0%).” Barclays also expects a beat, reflecting “solid momentum in domestic activity” thanks to “ongoing fiscal stimulus”. There again, it is Trump’s own policies that are driving the hawkish Fed lean.

The GDP print (and a raft of other data in the U.S.) will be set against the September Fed minutes, which tipped support for creating restrictive policy. Here’s Barclays:

Fed communication since the September meeting has raised market concerns about the Fed hiking rates too fast, too far. Last week’s minutes confirmed Fed’s intention to continue gradually hiking rates as the economic outlook remains strong, and to likely overshoot the long-term neutral rate temporarily. As there is uncertainty about the level of the neutral rate (and hence the terminal rate), the Fed is likely to lean toward a balance-of-risks framework from a more model-based approach. Chair Powell has highlighted the importance of risk management in the conduct of monetary policy, and data dependency is likely to increase as the Fed nears a neutral stance.

It’s worth noting that Trump’s “very tight” assessment notwithstanding, financial conditions are actually still pretty loose, although the recent equity selloff has tightened things up a bit. Here’s Goldman’s FCI (RHS inverted) plotted with the S&P and as you can see, financial conditions are still far looser than they were at the beginning of 2016, for instance:

(Bloomberg)

As far as positioning in the dollar goes, specs maintained their longs in the week through last Tuesday (i.e., in the week that included the sharp selloff on Wall Street).

(Goldman)

This is also a BoC week. They’ll hike (probably) despite recent weakness on headline inflation. Core is on target, the economy is strong, the labor market is tight and trade uncertainty has faded following the “successful” (scare quotes are there for a reason) conclusion of a new trilateral deal with the U.S. and Mexico. Last week’s Business Outlook Survey is likely to add to the case for further rate hikes. That said, they’ll likely put a dovish spin on this one, emphasizing a “gradual” pace.

The Riksbank and the Norges Bank are also on deck. We’ll get a new MPR from Sweden which I guess could be notable. As far as Norway goes, this is an interim meeting and they hiked for the first time in seven years last month, so without even looking, I’m going to go ahead and say this week’s meeting will be a non-event.

In EM, Indonesia, Turkey and Russia will all hold policy meetings, and that’s notable as  CBT, BI and CBR have all hiked rates recently in the face of immense pressure on EM FX. Despite the recent turmoil in U.S. equity markets and spillover to other locales, EM currencies have actually held up fairly well, with MSCI’s gauge rising for two straight weeks.

Here’s a bit of color from Credit Suisse on this:

Good news from the EM world contributed [to relative resilience]. The result of the first round of the presidential election in Brazil lent a helping hand to holders of Brazilian assets, and EM assets more broadly. The result sharply raised the likelihood that Jair Bolsonaro (the more market-friendly of the two top candidates) would end up as Brazil’s new president. Developments in Turkey also helped. Gradually strengthening signs (ultimately confirmed last Friday) that Turkish courts would release Pastor Brunson raised expectations of a general thaw in Turkey’s relationship with the US. Both of these factors remain supportive influences on EM asset prices in the current week, as they remove some of Brazil’s and Turkey’s tail-risk, and as the investor community is only gradually adjusting its positioning to this new reality.

Given all of that, Turkey, Russia and Indonesia can “afford” to stay on hold – I suppose.

But don’t forget that exactly nothing is solved in Turkey just because Andrew Brunson was released. Although Erdogan’s decision to let Brunson return to the U.S. sets the stage for constructive talks between Washington and Ankara, we’ll have to see how that plays out. Meanwhile, Indonesia has been extremely aggressive in hiking since May, and largely to no avail for the rupiah. If they stay on hold, it will come with a hawkish bias. As far as Russia is concerned, relations with the Trump administration continue to deteriorate (on the surface anyway), but given last month’s hike was a surprise (see “CBR” link above for more on that), they’ll wait and see.

Finally, the Jamal Khashoggi story will remain front page news as an extremely skeptical international community presses the Saudis for a more convincing explanation about just what happened earlier this month inside the Kingdom’s consulate in Turkey. Over the weekend, Erdogan promised to deliver answers on Tuesday and he seems intent on not allowing Crown Prince bin Salman to orchestrate a cover up.

Oh, and don’t forget about the caravan – Trump is furious about that.

Full calendar via BofAML