Central banks will grab center stage in the week ahead as markets focus on the message from policymakers who are confronting a deteriorating growth outlook, falling inflation expectations and a high bar for a dovish surprise.
Obviously, the Fed is front and center. Analysts are looking for a less enthusiastic assessment on the economy, some of the individual dots to show cuts in 2019 and a removal of the “patient” language from the statement, replaced by some reference to vigilance and a preparedness to act in the face of rampant uncertainty.
With rates markets foaming at the mouth for cuts and stocks still sitting precariously near the highs, it’s entirely possible that Jerome Powell simply can’t deliver “enough”.
“Since the renewed escalation in US-China trade tensions in early May, front-end rates have priced an additional 60bp of easing for H2 19 [and] the market is now more-than-fully pricing a 25bp cut in July, assigning a small probability to a 50bp move, and is fully discounting three 25bp rate cuts by year-end”, Barclays wrote over the weekend, on the way to noting that “such expectations seem fully expected by the equity markets, too, with the belief that bold cuts will prove sufficient to cushion the economy against a significant escalation of trade tensions and continued decline in industrial growth.”
In other words, stocks are priced to perfection at this point, and as the bank goes on to say, that probably explains the “recent conundrum of sharply declining global yields but still-elevated equity prices.”
US stocks managed a second gain last week after the torrid rally that accompanied the rapid pricing in of additional easing as Trump threatened tariffs on Mexico.
You can expect more jawboning from the president right up through Wednesday. He’d like nothing more than to have some monetary policy cover ahead of the G20.
In addition to the Fed, the BoE and the BoJ are up this week. Mixed messaging from the BoE makes for an interesting setup, but the bottom line is that between Brexit uncertainty, deteriorating data and the Fed set to cut rates sooner or later, the bar for a hike is probably higher than hawks want to admit.
“Judging by some recent comments [BoE] has the potential to jar with the growing market narrative of rate cuts. The market is pricing 8bp of rate cuts by next August, but BoE speakers keep talking about rate hikes”, BofA wrote Friday, adding the following useful summary:
Chief Economist Andy Haldane published a very hawkish article in The Sun. Uber-hawk Michael Saunders said the market was under-pricing the risk of hikes, though he did caveat that by saying as long as Brexit was smooth. The same applies to Ben Broadbent and Mark Carney. The rest of the MPC remain blank canvasses given that they have said little on their monetary policy views recently. Given the data have almost universally worsened since May, we believe the BoE’s minutes next week will be less hawkish, but not dovish enough to be justifying rate cuts or even rates on hold for the indefinite future. So the risk is this meeting is a hawkish shock for the market.
Barclays sees scope for some sterling downside. Gertjan Vlieghe’s recent cautious assessment of the outlook marks a rather stark contrast to the hawkish banter mentioned above. “The voting process for the new Conservative leader, too, could add headline risks to sterling, but that appears less likely with betting markets assigning a c.80% likelihood to Boris Johnson being the new PM”, Barclays adds. 19 out of 20 analysts expect a unanimous vote to keep rates unchanged.
As far as the BoJ goes, it’s the same old story. The inflation target is a mile away, the global outlook is obviously shaky and it’s not exactly like Kuroda could lean any semblance of hawkish even if he wanted to, because that would add appreciation pressure to the yen at a time when the currency’s safe haven appeal already risks unwanted FX strength amid proliferating geopolitical risks. Of course, Kuroda doesn’t want to – lean hawkish that is. Earlier this month, he said the BoJ could ease more if they wanted.
On top of that, the ECB will hold its annual Sintra forum this week. The gathering has seen its share of market-moving comments, and this time around, officials are likely to emphasize the dovish message from the June policy meeting. “A materially dovish surprise appears somewhat unlikely, as it would almost certainly prompt markets to price easing in earlier than what the ECB could realistically deliver [but] a potential worsening of the economic outlook, coupled with the clear risk of de-anchoring of EA inflation expectations, currently at all-time lows have significantly raised the likelihood of further easing this year, likely capping the EUR over the medium term”, Barclays notes.
That bit about plunging inflation expectations is obviously important. Although Draghi went out of his way to say that deflation isn’t a risk at the last presser, the fact he talked about a possible restart to QE and mentioned there was some discussion of rate cuts suggests the GC is doubtlessly aware that things might be on the verge of becoming unanchored.
Stateside, you’re reminded that on Friday, U. of Michigan expected change in median prices during the next 5-10 years printed 2.2%, a record low.
Norway will likely remain the odd “man” out. They could well hike. “Given Norges Bank’s signals at the May meeting and the development in the economy there is little doubt that Norges Bank will hike key rates in line with the March path”, Nordea wrote last week, adding that “the rate path will likely be lifted compared to the March path in the short end giving a high probability for a hike again in September and then one or two hikes in 2020.”
In addition to monetary policy, there are no shortage of geopolitical narratives to track.
Obviously, tensions between Washington and Tehran are running especially high after last week’s oil tanker attacks, which the US swears Iran orchestrated. Suffice to say there’s a bull market in false flag rumors and although it’s clear that key members of the Trump administration are angling for regime change (and that Israel and the Saudis are pleased with Washington’s hawkish position), Trump himself is notoriously wary of costly armed conflicts. On top of that, Iran is taking steps to scale back compliance with the nuclear agreement. Throw in the fact that John Bolton and Mike Pompeo are doing everything in their power to push Tehran to the brink, and the Iranians do have a powerful incentive to lash out. Really, though, it doesn’t matter all that much. What matters is what happens next.
As far as oil goes, demand destruction jitters (tied to an expected deceleration in the global economy) and swelling US stockpiles have been enough to blunt the impact on crude prices. Over the weekend, Saudi Crown Prince Mohammed called for a “decisive stand” on the tanker issue. He didn’t say whether bone saws should be involved.
Meanwhile, the Hong Kong protests were back on Sunday, as Carrie Lam’s move to suspend the extradition bill did not placate those calling (loudly) for her resignation.