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Week Ahead: Monday 5th – Friday 9th September

Economic Outlook 

Last week’s Non-Farm Payrolls took on particular importance as they were the last significant employment release ahead of the Fed’s crucial FOMC meeting in September. The payrolls also followed on from Janet Yellen’s hawkish Jackson Hole speech when she said the case for raising the fed funds rate had strengthened over the last few months.

It now looks as if Friday’s payrolls could prove to be the final nail in the “September rate hike” coffin. The consensus expectation was for payroll growth of 180,000 in August. But the headline number came in at 151,000. There were a couple of revisions to the previous releases. July was revised up to 275,000 from 255,000 but this was offset by June’s downward revision to 271,000 from 292,000. The August Unemployment Rate was unchanged from July’s at 4.9%. However, Average Hourly Earnings rose just 0.1% month-on-month, well below the prior month’s increase of 0.3%.

Now it could be argued by some analysts that, while disappointing, this data isn’t bad enough to fully discount the possibility of a modest rate hike from the Fed after its meeting on 20th/21st September. They may point out that this data series is notoriously volatile and the twelve month average still shows a respectable monthly payroll gain of around 200,000. On top of this they can also highlight the Unemployment Rate which has been at or below 5% since last November. This is near the bottom of the range typically considered to represent “full employment” in the US. As Janet Yellen said in her speech at the Jackson Hole Economic Symposium, the Fed’s employment targets are close to being met.

However, maximising employment is only one half of the US central bank’s dual mandate. The other is maintaining price stability which means pushing inflation up to (or even beyond) the Fed’s 2% target. Unfortunately, August’s decline in Average Hourly Earnings has just made this target harder to hit. This is a particular problem as inflation, as measured by the Fed’s preferred Core PCE Price Index, has been stuck around an annualised rate of 1.5/1.6% for the past two years.

It’s possible then that this payroll data is the best of all worlds for investors. The US employment situation still looks relatively OK suggesting that the economy is humming along quite nicely (even if second quarter GDP was a miserable 1.1% year-on-year). Yet inflationary pressures remain subdued. This gives the Fed the perfect excuse to hold off from tightening monetary policy until December, after the US Presidential Election, or beyond. Consequently, in the absence of any nasty shocks, this should help to support equity and bond prices while keeping a lid on the US dollar. All-in-all, the “Goldilocks” economy lives on.

This week’s major economic releases include:

Monday

USD Closed for Labor Day; G20 meetings in Hangzhou, China; EUR Spanish, Italian, German and Euro zone Services PMIs, Euro zone Retail Sales, Euro zone Sentix Investor Confidence

Tuesday

GBP BRC Retail Sales Monitor; AUD Cash Rate and RBA Rate Statement; EUR German Factory Orders, Euro zone Revised GDP; USD ISM Non-Manufacturing PMI

Wednesday

AUD GDP; EUR German Industrial Production; GBP Manufacturing Production, Industrial Production; CAD BOC Rate Statement; USD JOLTS Job Openings

Thursday

JPY Current Account, Final GDP; AUD Trade Balance; CNY Trade Balance; EUR ECB Minimum Bid Rate and Press Conference; USD Unemployment Claims, Crude Oil Inventories

Friday

CNY CPI & PPI; EUR German Trade Balance, German WPI; GBP Goods Trade Balance, Construction Output, Consumer Inflation Expectations; CAD Unemployment Rate; USD Wholesale Inventories

 Equities Outlook

The Dow Jones Industrials, S&P500 and NASDAQ 100 all hit fresh record highs in August. Despite this, none have managed to make a significant break out of the relatively tight trading ranges that have been in place for the last six weeks.

In one respect equities still seem attractive. The dividend return on the S&P500 is around 2%. This is tempting when government bonds yield so little. Investors continue to search out a return on capital in a low-yield world. This means that many fund managers are increasing their exposure to equities and cutting their holdings of safer financial instruments. On the face of it this is a high risk strategy. However, the actions of central bankers over the past twenty years (and particularly since 2008/9) have convinced investors that there’s now very little risk in holding a diversified portfolio of equities and a smaller percentage of bonds. Who can blame them? After all, there can be little doubt that central banks are making policy decisions with stock markets in mind. Just last week we had this rather telling comment from Federal Reserve Vice Chairman Stanley Fischer. Mr Fischer was asked about the effectiveness of negative interest rates in Europe and Japan. He replied: “We’re in a world where they seem to work,” and they typically “go along with quite decent equity prices.”

“Quite decent equity prices” really shouldn’t be a major concern for the Federal Reserve, or any other central bank. And yet look how investors reacted to Friday’s disappointing jobs report. Despite a Non-Farm Payroll number which came in well below the consensus expectation, investors responded by driving stocks higher. This is despite just having gone through an earnings season which saw earnings register their fifth consecutive quarter of year-on-year declines. This is also after a second quarter GDP report which showed the US growing at just 1.1% annualised. What this means is that (unlike FX players) equity traders now believe there is no chance of a September rate hike. On top of this they are convinced (with good reason) that the US Federal Reserve (along with other major central banks) will do everything in their power to keep the equity market rally going.

Commodity/ FX Outlook

Oil

Crude oil fell sharply last week. By Friday afternoon both WTI and Brent were on course to post their biggest weekly losses since January this year. There were a number of reasons cited for the move, including a sharp build in US inventories, some weak US economic data, the increased prospect of a Fed rate hike which could weigh on economic activity, uncertainty over future global demand growth and an expectation that the much-vaunted production freeze talks scheduled for this month will end in failure, just as they did in April. There was also a “technical” aspect to the sell-off.

Last Tuesday the American Petroleum Institute (API) reported an increase in distillate inventories of 3 million barrels – well above the 275,000 barrel build expected. Then on Wednesday the Energy Information Administration (EIA) released its own US inventory update. As with the API’s data, this showed an unexpectedly large build in distillates. In addition, The EIA reported that crude inventories rose by 2.3 million barrels which was well above the 1.1 million barrels expected.

On Thursday the US ISM Manufacturing PMI for August came in at 49.4 - well below the consensus expectation of 52 and July’s reading of 52.6. This showed contraction in this vital sector of the US economy which was another reason for oil to sell off, particularly as it added to concerns about the global economic outlook. However, Friday’s disappointing Non-Farm Payroll release wasn’t disappointing enough to weigh on crude. Quite the contrary, as it suggested the US economy was continuing to improve, but not fast enough to warrant a September rate hike.

Last week’s sell-off in crude suggested that traders don’t feel there’s much chance of oil producers agreeing to freeze output when they meet in Algeria later this month. It looks as if Saudi Arabia may now support production stabilization at the meeting. However, at the end of last week Russian Energy Minister Alexander Novak dampened down the prospect any production freeze talks taking place at all. Meanwhile, it’s possible that Iran will boycott the talks just as it did with the Doha meeting back in April. The country wants to be excluded from any agreement to freeze production as it continues to ramp up output since sanctions were lifted earlier this year. Also, many analysts have pointed out that an output freeze at current production levels will do nothing to reduce global stockpiles. The International Energy Agency estimates that the world is currently oversupplied by around 300,000 barrels per day, so it would take a cut rather than a freeze to make any significant difference.

Gold/Silver

Gold had a torrid time for most of last week. In contrast, silver lost ground midweek but managed to side-step the selling pressure that afflicted the gold price. The reason behind gold’s sell-off was exceedingly prosaic. All last week’s fluctuations could be put down to movements in the US dollar. Gold fell whenever the greenback rallied, and rallied whenever the greenback fell. For most of last week investors were hoovering up dollars following Fed Chairman Janet Yellen’s speech at Jackson Hole on 26th August. The speech was considered to be hawkish as Dr Yellen said that the case for raising rates had strengthened over the last few months. She also said that the US economy continued to expand and was nearing the Fed’s targets for maximum employment and price stability. Investors took this to imply that the US Federal Reserve may look to raise rates as soon as their September meeting. This saw the Dollar Index rally around 2% from its low before Dr Yellen’s speech to its high on Wednesday. The USDJPY rallied around 4% over the same period.

Gold’s sell-off continued for most of last week and on Thursday morning gold came within a whisker of $1,300 for a high-low sell-off of just under 3%. However, it spiked higher following the release of the US ISM Manufacturing PMI on Thursday. This came in at its lowest level since the beginning of this year, registering contraction in the sector for the first time in six months. The unexpected news led to a sharp sell-off in the dollar as investors dialled back their expectations for a rate hike from the US Federal Reserve when it meets later this month. The prospect of higher US interest rates increases the lost-opportunity costs of owning gold as investors can get a “risk-free” return on interest-bearing assets.

The on Friday gold and silver shot higher following the release of a disappointing Non-Farm Payroll number. This appeared to be weak enough to knock out any possibility of a September rate hike from the US Federal Reserve. This should help to push precious metals higher. Unless, of course, the US dollar continues to rally for reasons all of its own.

Forex

The US dollar flew higher following Janet Yellen’s speech at the Jackson Hole Economic Symposium just over a week ago. To recap: Dr Yellen stated that the case for a rate hike had strengthened in recent months. She said that the US economy continued to expand and was nearing the central bank’s targets for employment and inflation – the two elements of the Fed’s dual mandate (their apparent obsession with ensuring the stock market never has a significant downside correction is not part of the mandate).

But it’s worth remembering that ahead of Jackson Hole, the dollar was trading at the lower end of an 18-month trading range. The Dollar Index was hovering around 94.00, the USDJPY was close to 100 and the EURUSD had rallied to 1.1340. So it could be argued that a hint of Fed hawkishness was all that was needed to send the dollar back up towards the middle of this trading range.

Then on Friday the greenback took a tumble following the release of August Non-Farm Payrolls. The headline number came in at 151,000 - well below the 180,000 consensus expectation. In addition, Average Hourly Earnings rose just 0.1% month-on-month. This suggested that the Fed’s 2% inflation target was going to be harder to hit. Bear in mind that the Fed’s preferred inflation measure, Core PCE, has been hovering around 1.5/1.6% annualised for the best part of two years now. As this excludes food and energy, this “weakness” can’t wholly be blamed on lower crude prices.

These numbers suggested that the Fed was unlikely to raise rates later this month. After all, the FOMC has shown that it is in no hurry to “normalise” interest rates having ducked the opportunity to move on a number of occasions over the last couple of years. Additionally, minutes from the Fed’s July meeting showed that just one voting member of the FOMC was in favour of tightening monetary policy. It seems unlikely that the data since then has been strong enough to sway another five members towards a hike to make it a majority decision. This was certainly the view of equity traders who jumped in to push stocks higher. However, the initial dollar sell-off was reversed quickly. The view amongst currency traders appears to be that a September hike remains a possibility.

In other news, there’s a G20 meeting taking place today (Monday) in Hangzhou, China. It’s worth remembering how the dollar turned lower soon after the G20 meeting in Shanghai earlier this year.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin Weekly

Category: Weekly Bulletin


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