Jerome Powell gets an opportunity to atone for his latest “sins” in Jackson Hole this week.
The market is convinced the Fed is behind the curve and if Powell doesn’t say something to disabuse everyone of that notion, long-end yields could continue to fall amid worries the Fed isn’t prepared to do what’s necessary to guard against growth spillovers and the potential for an abrupt deceleration in the US economy tied to ongoing trade uncertainty. The latest read on consumer confidence suggests that ongoing strength exhibited in, for instance, five consecutive months of solid retail sales, may have been paradoxically undermined by the Fed cut.
10-year yields dipped below 1.50% in the US last week, and the 30-year fell below 2% for the first time. Term premia spillovers and the residual effects of negative rates abroad are also pushing down long-end yields stateside, as are hedging flows.
Read more: ‘We Have Not Been Bullish Enough’
Powell can take some of the bull flattening pressure off if he chooses, but if he persists in the “mid-cycle adjustment” narrative, recent bond market behavior could be perpetuated. Stocks are riding a three-week losing streak.
“Pressure from President Trump, weak global industrial production, and yield curve concerns [are] pushing the Fed toward further cuts, but stable US inflation and a strong jobs market suggest that the aggressive easing implied by market pricing is excessive”, Credit Suisse said Friday.
Ahead of Powell’s remarks in Jackson Hole, the market will get to digest the July Fed minutes. These will obviously be stale considering the meeting occurred prior to the latest trade escalation, market volatility and also before the 2s10s inversion.
Still, the potential exists for the minutes to rattle investors if they betray a sharply divided committee or indicate there was broad consensus around the idea that a full-on easing cycle isn’t necessary.
“The FOMC minutes, although not taking into account events in August, will provide insights into the Fed’s view on ‘mid-cycle adjustment’ and balance of opinions within the committee, given two dissenting votes at the July meeting”, Barclays notes. Given that, and considering market pricing of more than one “full” cut for next month, and in excess of 100bp of easing over the next year, the bank sees some scope for the minutes to disappoint, “leaving risks skewed for USD strength this week”.
Dollar strength may (or may not) be amplified by the ECB minutes and PMIs out of Europe. Recent comments from ECB officials suggest the Governing Council is prepared to clear the bar for a dovish surprise next month. The July statement set the stage for the imminent delivery of a new easing package, although Draghi’s presser underwhelmed markets, while simultaneously underscoring the darkening outlook.
Eurozone PMIs will likely point to further weakness in the industrial sector and markets will be keen to divine whether the manufacturing slump is spilling over into services.
Italian politics will take center stage on Tuesday, when Prime Minister Giuseppe Conte will address lawmakers in Rome. He’ll call a no confidence vote, he’ll lose and the door will be open for Matteo Salvini to move towards the end game of new elections, which he’ll almost surely win.
Read more about the situation in Italy
All of that could keep pressure on the common currency relative to the dollar and certainly the yen. CPI data is due in Japan this week.
“Despite the fall in US yields and aggressive Fed easing expectations, the dollar has remained firm [and] we expect this to continue”, Credit Suisse said, in the same Friday note cited above. “Helped by a robust US economy, especially compared to Europe, the dollar appears set for further strength”.
Just to drive the point home about the how dour the outlook really is for Europe, consider this latest assessment from BofA:
Long story short, we cut our Euro area GDP forecasts to 1.1% for this year (-10bp) and to 1.0% for next (-20bp). We still don’t assume auto tariffs or no-deal Brexit, although conviction on these assumptions is low. Core inflation will be lower, too, averaging 1.0% and 1.2% (-10bp per year). We think the negativity in data signals and persistence in uncertainty is likely a concern for the ECB — next week’s minutes from the last policy meeting will be a guide — and thereby probably enough to push the central bank into more than just a 20bp depo rate cut (plus tiering) in September. After long reluctance, we pencil in a small QE programme — EUR30bn per month for 9-12 months, between a quarter and a third of the size and duration of the first QE from 2015. To be clear: we still question its success and, hence, economic rationale.
Note the bank warns that although auto tariffs from Trump and a no-deal Brexit aren’t the base case, they are by no means far-fetched outcomes.
There’s rampant speculation that Germany will ultimately relent on their “black zero” fiscal policy in the interest of stimulating the economy during a downturn by running a deficit. Last week, data showed the German economic machine decelerated, with the economy shrinking for a second quarter in four.
RBA minutes are up this week as well. 10-year Aussie yields fell to record lows last week in sympathy with the bond rally in New Zealand, where manufacturing contracted for the first time in seven years.
“The bar for central banks to ‘out-dove’ the market’s easing expectations is high [and] the market will be on the lookout for commentary on near-term monetary policy, including any hints on the length and depth of rate cuts”, Barclays remarked on Sunday, in the course of (again) warning that with “the front end of the US yield curve pricing almost three cuts before year end, the Fed is unlikely to surprise on the dovish side”.
Markets will of course be subjected to the usual headline hockey around the trade war. Last week’s announcement that tariffs on key consumer goods will be delayed until December 15 was good enough to placate investors for one session, but economic concerns quickly took precedence the following day. Trump continues to send mixed messages and Beijing has indicated that they will respond to US tariffs which will go into effect on the now smaller list September 1.
Finally, note that the Commerce department is likely to extend a temporary reprieve that allows Huawei to access critical supplies it needs to service its existing customer base.
Full calendar via BofA
The Fed will have to communicate a full dovish surprise to go with their full dovish pivot. If they cut 50 bps without using the soothing adverbs, the market will go nuts and price in further cuts. If they cut 50 bps the right way, the market will give the Fed the space they need to communicate to the markets further cuts.
Seeing as Powell needs the market to be down prior to making a significant move (rates or narrative) to have any pretext of independence, I find it unlikely we hear much different from this week. I expect Powell is fully aware that he needs to be more dovish to meet the market’s expectations. He will purposely not meet those expectations such that a 10%+ move down in risk assets prior to a Sept “live” meeting has the pretext needed for a 50 bps cut and likely narrative adjustment.
At least that’s how I’m reading the situation.
Powell could offer a relaxed and laid back theory that their newest model adjustment gave a false positive and that caused the Fed to make a few policy mistakes … but, but, we have adjusted the model and want to assure global markets that we now have our shit together and things will in fact be super cool going forward, so relax!
Here’s a summation of the model tweek and obviously all they have to do is reverse engineer what actually happened, then take credit for finding “the” mistake (what ever that is — and perhaps fire one of their 4000 economics gurus as an offering to Mr. Market):
==> A highly hedged warning: Buried on page 7 of the new study is a warning that the probability of a recession had increased significantly since the original study was done about a year ago: “As of the end of the sample period in early 2019 (and the time of this writing), the near term forward spreads forecast a substantially elevated probability of a recession.”
Indeed, Figure 3 in the study clearly shows that recession risk jumped to 50% (based on first-quarter 2019 data available only through January). Interestingly, this important update wasn’t mentioned in the summary paragraph at the beginning of the study. However, the charts in the paper show that the odds of a recession increase most significantly when the near-term forward spread is markedly below zero, which it was not as of the most recent analysis.
“The most prominent false positive during our sample came with the anticipated easing triggered by the spread of the Asian financial crises in 1998, which did not result in a recession in the U.S. It is not hard to imagine that similar scenarios could generate additional false positives in the future. The near-inversion of the near term forward spread at the end of 2018 seems to have been associated with market perceptions of significant risks to the global economic outlook, including the threat of escalating trade disputes. Whether those risks manifest in a recession remains to be seen.”
https://www.marketwatch.com/story/this-is-the-real-reason-why-the-us-economy-isnt-in-recession-danger-now-2019-04-01