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Week Ahead: Monday 8th – Friday 12th August

Economic Outlook 

Last week the Bank of England (BoE) joined the European Central Bank (ECB), the Bank of Japan (BOJ) and People’s Bank of China (PBOC) as yet another major global central bank to take an outright dovish stance. Amongst smaller, but still significant, economies we have just had a rate cut from the Reserve Bank of Australia (RBA) and are also anticipating one from the Reserve Bank of New Zealand (RBNZ).  As things stand it is only the US Federal Reserve which is anxious to convince investors that it is preparing to tighten monetary policy. This lone hawkishness seems a bit ridiculous given the interconnectedness of major economies in our globalised world. However, the Fed is desperate to persuade investors (and, it would appear, its own members) that the US economy is strong enough to handle a modest 25 basis point rate hike. I’m quite sure it is. Unfortunately, the financial markets aren’t. We saw the negative effects of monetary tightening on bonds and equities earlier in the year soon after the US central bank raised rates for the first time since June 2006. It has become more and more apparent that the Fed, along with other central banks, is scared stiff of the damage that a significant stock market correction would have on the increasingly fragile global financial system. The ups and downs of equity markets should be of no concern to any properly functioning central bank. But decades of politicisation and general meddling have taken us into a precarious situation.

As far as the Bank of England is concerned, last week’s 25 basis point cut which halved its headline Bank Rate to its lowest ever level in the BoE’s 322-year history was no surprise. But the rest of its stimulus package certainly was. It raised its Asset Purchase Facility by £60 billion to £435 billion and chucked in an additional £10 billion to purchase UK corporate bonds. Also, in an effort to counter some of the negative impacts of low rates, the Bank came up with a new Term Funding Scheme worth up to £100 billion.

In his press conference Governor Carney brushed aside concerns about the damage the rate cut will inflict on savers. He said that the Bank had a clear mandate and was more immediately concerned with the prospect of higher unemployment due to lower growth following the UK vote to leave the European Union. He also made it clear that he was against negative rates (as did BOJ Governor Kuroda the week before he adopted them) but the Bank was quite prepared to cut rates further towards zero.

In its Quarterly Inflation Report the Bank delivered a pretty downbeat assessment of the UK’s economic outlook. It downgraded its outlook for UK growth in the biggest revision since 1993. It now predicts a cumulative 2.5% reduction in growth over the next 3 years with next year’s GDP expected to come in at +0.8% - down from its May projection of +2.3%.

Yet despite these projections it seems a bit odd that the Bank would launch such a large stimulus package on the back one month’s worth of poor PMI releases, a weak Retail Sales number and, no doubt, some downbeat assessments from its agents around the UK. So in this regard the fresh stimulus is undoubtedly pre-emptive. After all, the Bank still expects the UK to avoid an outright recession. Granted, the Bank is taking credit for this by saying there would be one without this stimulus – there’s a counterfactual if ever there was one. So here’s another one: would we really be worse off now without the rescue programmes, monetary stimulus and negative interest rates that came as a result of all the intervention following the financial crisis?  

Additionally, the government hasn’t even triggered Article 50 yet to get Brexit negotiations underway. Does that mean we should expect further monetary easing if the UK looks like being stuffed by the EU as it severs ties? Also, what does last week’s monetary stimulus tell us about the prospect of fiscal stimulus being announced at the Chancellor’s Autumn Statement?  Despite these questions the news led to a sharp rally in the FTSE100 as investors saw the bond purchases and weaker dollar as positive for large multinationals. But it’s worth considering how much more upside there is for equities where the outlook for global growth is so uncertain that we have to rely so heavily on central bank stimulus.

This week’s major economic releases include:

Monday

JPY Current Account, BOJ Summary of Opinions; AUD ANZ Job Advertisements; EUR German Industrial Production, Sentix Investor Confidence; CHF CPI; CAD Building Permits; USD Mortgage Delinquencies, Labour Market Conditions Index

Tuesday

AUD NAB Business Confidence; CNY CPI, PPI; CHF Unemployment Rate; EUR German Trade Balance, French Gov Budget Balance; GBP Manufacturing Production, Goods Trade Balance, Industrial Production; USD NFIB Small Business Index, Prelim Nonfarm Productivity, Prelim Unit Labour Costs, IBD/TIPP Economic Optimism, Wholesale Inventories

Wednesday

JPY Core Machinery Orders, PPI, Tertiary Industry Activity; EUR French Industrial Production; USD JOLTS Job Openings, Crude Oil Inventories, Federal Budget Balance; NZD RBNZ Rate Statement

Thursday

JPY Bank Holiday; GBP RICS House Price Balance; EUR German WPI, French Final CPI, Italian Trade Balance; USD Unemployment Claims, Import Prices; NZD Retail Sales

Friday

CNY Industrial Production, Fixed Asset Investment, Retail Sales; EUR German Prelim GDP, German Final CPI, French Prelim Non-Farm Payrolls, Italian Prelim GDP, Flash GDP, Industrial Production; USD Retail Sales, PPI, Consumer Sentiment, Inflation Expectations, Business Inventories.

Non-Farm Payrolls

Friday saw the release of US Non-Farm Payrolls for July. The Bureau of Labor Statistics reported a rise in payrolls of 255,000 while revising up June’s figure by 5,000. For the second consecutive month the headline number blast above the consensus expectation for an increase of around 180,000 which would have been in line with the six month average of 182,000. The dollar soared on the news as did US and European stock indices.  Meanwhile precious metals slumped.

Currently, every major central bank is actively moving to loosen monetary policy with one notable exception.

The US Federal Reserve is the only major central bank which isn’t actively loosening monetary policy. The Fed ended its monthly bond purchase programme in October 2014 and raised rates by 0.25% in December last year. Despite this the Fed has made it clear that it will maintain the size of its balance sheet, replacing any maturing debt with fresh purchases. In addition, while the Fed hike rates in December by 25 basis points its headline Fed Funds rate is still extraordinarily accommodative, fluctuating within a band between 0.25 and 0.50%.

The Fed is desperate to talk up the outlook for the US economy. Friday’s payroll numbers plays into this and traders have responded by hoovering up risk assets and dumping safe haven plays like gold and silver. Yet despite the better data, the Fed’s FOMC cannot bring itself to raise rates again as it is terrified of triggering another stock market meltdown like the one we had in January. It certainly wouldn’t want to risk such an upset so close to the US Presidential Election. This is why the market, in the form of the fed fund futures, assigns just an 18% probability of a hike this September. Seen this way the rally in equities makes perfect sense: the data shows improvement in the US economy, but the Fed’s hands are tied when it comes to raising rates – a perfect Goldilocks environment.

But the dollar is also rallying as investors rush into US assets. This hurts dollar-denominated commodities, including oil, which increases the risk of corporate bond defaults. It also means that China’s yuan (which is pegged to the dollar) is strengthening. This makes China less competitive and the risk is that policymakers there decide to devalue the yuan, which would be deflationary for everyone else. China devalued this time last year and again in January with disastrous results. Investors should be hoping that the dollar rally soon runs out of puff.

               

Commodity/ FX Outlook

Oil

The seemingly relentless sell-off in crude came to a screaming halt last week with a fierce short-covering bounce. Both WTI and Brent reversed direction sharply on Wednesday following the latest update on US inventories from the Energy Information Administration (EIA). The headline number showed a build in crude of 1.4 million barrels against an expectation of a drawdown of 1.6 million. This was undoubtedly market negative. However, the resulting sell-off ended as quickly as it began as investors focused on a large drawdown in gasoline stocks along with reports of a slowdown in US production for the preceding week. Logically, the fall in gasoline stockpiles shouldn’t have come as a big surprise. After all, there’s been a succession of increases in US gasoline inventories despite this being peak driving season. But the slowdown in production was unexpected given the steady rise in the total US rig count since the middle of June. Data aside, the turnaround probably had just as much to do with the chart set-up as fundamental supply issues. Both WTI and Brent had pulled back around 20% from the $50-plus highs hit back at the beginning of June. Chart-wise, the sell-off represented a near 50% retracement of the Feb-March rally in WTI. As far as Brent was concerned, the contract bounced off $42 – a level which acted as resistance back in March this year. On top of this, we’ve seen a concentration of short-side speculative positioning over the last month. Consequently, there was always a danger that many of these leveraged sellers would rush to cover their positions should the market turn against them. If this assessment is accurate then this upside correction should soon run its course and the sell-off will resume. However, while technical factors are important over the short-term, the longer-term direction of oil prices depends on fundamentals. So the outlook for global growth and demand, together with future production will be the major factors influencing prices going forward.

Gold/Silver

Gold was trading happily above $1,360 at the end of last week and back within spitting distance of the 28-month high of $1,375 hit just under a month ago. Silver was faring even better having hit a two-year high close to $21 at the beginning of the week. Investors piled into the two precious metals as Japan announced further monetary and fiscal stimulus. While the overall package fell somewhat short of market expectations, the takeaway is that Japan remains committed to keeping the stimulus taps open and that more could be forthcoming from the central bank later in September.

On Thursday the Bank of England cut its headline Bank Rate by 25 basis points taking it to a fresh all-time low of 0.25%. This was pretty much priced in. However, the central bank also announced a £60 billion addition to its Asset Purchase Facility, an additional £10 billion fund to purchase corporate bonds and a new Term Funding Scheme for banks worth up to £100 billion. This package of took investors by surprise and the loosening of monetary conditions encouraged investors to increase their exposure to precious metals. A low interest rate environment is supportive for gold and silver as it reduces the lost opportunity costs of holding non-yielding monetary assets.

However, both precious metals slumped on Friday following the release of a strong US jobs number. Non-Farm Payrolls for July came in at 255,000 – well above the 180,000 expected. Investors saw this as increasing the likelihood of a Fed rate hike, with the next meeting on 20th/21st September once again becoming “live”. This could keep a lid on gold and silver for the next six weeks, unless we see a downturn in other US data releases. However, with other global central banks determined to keep monetary conditions loose for the foreseeable future, the downside could also be limited.

Forex

The British pound fell sharply on Thursday following the Bank of England’s decision to unleash a fresh wave of monetary stimulus. The Bank’s Monetary Policy Committee (MPC) surprised few observers when it cut its headline interest rate by 25 basis points. However, it followed this up by adding £70 billion to its Asset Purchase Facility (£60 billion in gilts and £10 billion in corporate bonds). It also set up a new Term Funding Scheme worth up to £100 billion to protect bank margins. The Bank revised down sharply its forecasts for future economic growth and said that it expects a pick-up in unemployment. It said it was prepared to cut rates further towards the zero-bound if required.

Sterling steadied somewhat on Friday morning but then took another lurch downwards following the release of a strong US Non-Farm Payroll number. The better-than-expected jobs data led to a surge in the dollar as investors speculated that the Fed may look to hike rates again at its next meeting in September. This seems unlikely to me as this meeting is dangerously close to the US Presidential Election. There can be little doubt that the Fed is keeping a close eye on stock market movements (despite these being outside its remit) and it will be mindful of the sell-off which followed its 25 basis point rate hike last December. In addition, while the employment outlook is one of the bright spots in the US economy, inflation (as measured by the PCE – currently 1.6% annualised) is still someway short of the Fed’s 2% target. Some analysts believe the Fed would like to see inflation well above 2% before pulling the trigger on another rate hike. But for now investors are piling into the dollar and hoovering up dollar assets. Meanwhile, sterling looks in danger of retesting its post-Brexit lows, particularly given the BoE’s downbeat assessment of the UK’s economic outlook.

The Japanese yen rallied sharply on Tuesday after Prime Minister Shinzo Abe provided more details on his government’s planned 28 trillion yen fiscal stimulus. The yen was already on the rise after the Bank of Japan (BOJ) disappointed investors in the prior week. The BOJ kept its key interest rate unchanged, increased its ETF purchase programme to 6 trillion yen from 3.3 trillion per annum and doubled its lending program for local companies. Mr Abe’s fiscal stimulus plans were also underwhelming and it wasn’t long before the USDJPY broke below 101.00. However, the pair stabilised as dollar shorts booked profits. On Friday the payroll-inspired dollar rally helped to weaken the yen and take it further away from 100. Japanese policymakers will be hoping that the yen continues to weaken and so remove the risk of them having to intervene unilaterally, and so causing ructions with fellow G20 members.

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

Category: Weekly Bulletin


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