All eyes will turn to the Fed this week, as Jerome Powell attempts to navigate treacherous waters.
Officials have done a decent job of making the case for an “insurance” cut, but the risk is that putting too much emphasis on the preventative character of the cut leads the market to believe that this isn’t the start of an easing cycle – that the commitment to accommodation isn’t sufficiently open-ended. On the other side, coming across as too dovish risks the usual charges of overt politicization in the face of withering criticism from the White House.
It’s a delicate balancing act to be sure. 25bp is a virtual guarantee, and 50bp seems far-fetched. It’s all about the statement and the press conference.
Read our full July FOMC preview
US equities are coming off a good week. Stocks posted a sixth weekly gain in eight, and the May rout is now a distant memory. The dollar is sitting at its strongest in nearly two months, as speculation builds around a possible intervention by Steve Mnuchin and the administration struggles to keep its story straight.
Although the Fed’s dovish pivot hasn’t been enough to pull the rug from beneath the dollar, the greenback’s correlation with near-term Fed pricing has risen.
It’s not all about the Fed in the US this week. There’s a raft of key data on deck including, of course, July payrolls. Jerome Powell and other Fed officials were keen on emphasizing that the strong June jobs report wasn’t something that would deter them when it comes to an insurance cut at the July meeting, but another blockbuster report might well cast doubt on an assumed follow-up cut in September.
ISM is up this week too. A rebound in the Empire and Philly gauges suggests the US may skirt the kind of factory slump underway in Germany and parts of Asia, but the jury is still out. Consensus is looking for 166k on July payrolls. Any indication that ISM has turned down or is poised to enter contraction territory would be worrisome, even as it would underpin expectations for more Fed cuts. A fresh read on the Chicago PMI is due this week – look for that to rebound back into expansion territory after last month’s contractionary print.
“Overall, US data remain broadly resilient, and upside surprises could offer additional support for the USD amid a potentially not-so-dovish Fed”, Barclays wrote over the weekend, although the bank also noted that “month-end flows could bring modest downside pressures to the USD this week [as] a preliminary run of month-end models points to moderate USD selling vs. all majors”.
Trade data, ECI and PCE are all up this week stateside as well.
After last week’s ECB meeting and a series of dour indicators that suggest the German economy is headed towards a recession, it’s hard to be optimistic about the data due out of Europe. GDP and flash inflation are on the docket, with consensus looking for a 0.2% print on the former and a 1% read on core CPI. Suffice to say the risks for the eurozone remain skewed to the downside.
The BoE and the BoJ are up to bat, rounding out two weeks’ worth of big central bank meetings.
“The BoE’s August meeting is likely to gain traction with the publication of the QIR [and] while policy is widely expected to remain unchanged, markets will be looking for any shift in rhetoric with recent MPC communication turning more balanced by perceived hawks (Saunders), while other members (Carney, Haldane, Vlieghe and Tenreyro) have acknowledged a weakened outlook”, Barclays said Sunday. In other words: Expect a wait-and-see approach with a dovish slant.
BofA agrees. “We see the BoE continuing to shift in a dovish direction, with next week’s QIR likely to mark a shift in communication strategy from here”, the bank said Friday, noting that “after conditioning their forecasts on 100% chance of a smooth Brexit, the MPC have been struggling recently with the divergence between this stance and reality”. You couldn’t put it any better than that. Boris Johnson has injected considerably more uncertainty into an already fraught situation.
As far as the BoJ goes, they’re still in a very tough spot, and it always comes back to the same old quandary. There’s not much left in the toolkit (Kuroda’s protestations notwithstanding) but saying and doing nothing while the Fed and the ECB pivot, risks yen appreciation which could further undermine the inflation targeting effort. Any risk-off episode would also tend to strengthen the currency, complicating the situation.
“About a third of economists in a survey published last week said they expect policy makers to strengthen their pledge to maintain rock-bottom interest rates rather than do nothing and risk a sharp appreciation of the yen should the Fed cut rates”, Bloomberg said Sunday, underscoring the point. “Still, some officials see little to be gained from such a tweak, according to people familiar with the matter”.
“In the event that financial conditions tighten due to JPY appreciation/equity selling, we believe the BoJ would opt to ease in the form of deeper negative interest rates rather than through an expansion of its already-stretched QE program or an extreme policy such as helicopter money”, Barclays muses, before referencing one of their previous efforts to analyze the effect of further rate cuts on the yen. Specifically, the bank says the yen should weaken around 1.3% on an additional 10bp rate cut and 2.4% in the event the BoJ cut rates by another 20bp. Of course, there would be side effects, and as Barclays also notes, “the sustainability of any JPY depreciation effects would likely depend on the easing of other central banks and global risk sentiment”.
Trade talks between the US and China will resume in Shanghai this week, and expectations are understandably muted. Beijing has ratcheted up the rhetoric on some fronts (e.g., further accusations against FedEx) while toning things down on others (the nationalist drumbeat has dissipated a bit, and, as Reuters reports citing Chinese state media, “the US has shipped several million tonnes of soybeans to China since the two countries’ leaders met in June”).
Still, Chinese imports of US soybeans in H1 totaled around 6 million tons, which looks like the lowest for any first half going back to 2005.
China’s manufacturing PMI for July is due this week. That will be watched closely for signs of stabilization and viewed in light of upbeat activity data released earlier this month.
Full calendar via BofA