Fed to validate market shifts?

Chris Scicluna
Emily Nicol

Ahead of what could be a pivotal few days for signaling from central banks – with policy announcements due from the Fed (Wednesday), BoJ and BoE (Thursday), RBA meeting minutes to be published (tomorrow) and Mario Draghi speaking publicly (later today) – it was a quiet start to the week in Asian markets, with no significant economic news to influence the mood. In Japan, the Topix closed down 0.45%, but the Nikkei was effectively unchanged. China’s CSI300 was also little change. And despite the weekend demonstrations, Hong Kong’s Hang Seng is currently up about 0.5%. Futures markets currently point to gains in Europe and the US today.

In bond markets, having moved higher in the wake of Friday’s upside surprise to US retail sales, yields on USTs rose further in Asian time today, with 2Y yields about 7bps up from Friday’s low at 1.87% and 10Y yields more than 4bps higher on the same basis above 2.10%. JGB yields also, perhaps unsurprisingly, rose a touch (10Y yields almost 1bp higher at -0.13%). Euro area govvies are mixed this morning, with yields on Bunds little changed but Italian and Spanish bonds firmer (e.g. yields on 10Y BTPs are currently down 5bps below 2.30% while Spanish 10Y yields have inched down to touch a new record low below 0.49%) in the wake of this morning’s publication of a dovish FT interview with ECB Executive Board member Benoît Cœuré. Forex markets are uneventful, with the dollar having locked in Friday’s gain.

While the central bankers will be the main focus this week – with the Fed’s meeting of course the key event and set either to legitimise or raise into serious doubt the current market pricing of significant easing in the second half of the year – some notable data will be released too, including inflation in the UK (Wednesday) and Japan (Friday), trade in the euro area (Tuesday) and Japan (Wednesday) and the euro area’s June flash PMIs (Friday), while housing market the main focus of new releases from the US. However, no top-tier data are due from China.

In Japan, the conclusion of the BoJ’s latest Policy Board meeting on Thursday will be the key event. Like the Fed and BoE, we expect no changes to policy parameters this week – i.e. the -0.1% marginal interest rate on banks’ excess reserves and the 0% target for 10Y JGB yields will be left intact – but Kuroda’s communication will be watched. Of course, the BoJ might feel the need to respond to any change in tone from the Fed the previous day. But while recent data point to a possible contraction in GDP in Q2 and suggest that inflation has now passed its peak, the BoJ is likely to maintain its view that Japan’s economy remains on an expanding trend with rising underlying price pressure. With the BoJ’s forward guidance currently foreseeing extremely low rates maintained only at least through spring 2020, however, it might seem be appropriate this time around to push that date further into the future.

The Japanese data flow this week will provide greater insight into economic activity in the second quarter, with the goods trade report for May due on Wednesday. While the extended Golden Week holiday is likely to have disrupted shipments more than normal in May, the twenty-day trade figures indicated a particularly sharp fall in the value of exports that month (13½%Y/Y), while import values rose 1.3%Y/Y, suggesting that net trade is on track to provide a significant drag on GDP growth in Q2. Thursday’s all industry activity release, meanwhile, is expected to show that overall output in April reversed much of the 0.4%M/M decline recorded in March. And surveys, including the Reuters Tankan (Tuesday) and flash manufacturing PMI (Friday), will provide an update on conditions at the end of the second quarter too.

With respect to prices, Friday will bring national CPI figures for May, which are expected to confirm that inflation passed its peak in April. In particular, the headline inflation measure, as well as the BoJ’s forecast core rate, are forecast to decline 0.2ppt to 0.7%Y/Y, while the BoJ’s preferred core measure (excluding fresh foods and energy) is expected to fall 0.1ppt to 0.5%Y/Y. Final labour earnings figures for April are also due Friday and likely to confirm that headline wage growth remained negative that month, with the preliminary release reporting a decline of 0.1%Y/Y, admittedly a marked improvement from the 1.3%Y/Y drop in March. Finally, in the markets, the MoF will sell 5Y JGBs tomorrow.

Euro area:
While there is no monetary policy meeting for the Governing Council this week, the ECB’s Sintra Forum on Central Banking – its equivalent to the Fed’s Jackson Hole symposium, which has previously been used by Mario Draghi to provide a shift in communication to try to influence the financial markets – will be the principal focus at the start of the week. Indeed, fears of a de-anchoring of inflation expectations will be weighing on Draghi’s mind after market-based measures last week slumped to record lows, with the closely-watched 5Y5Y inflation swap forward rate now sub-1.14%.

In an interview in the FT published this morning, Executive Board member Benoît Cœuré – one possible candidate to succeed Draghi as ECB President – has already set a dovish tone for Sintra, raising concerns about the “very bleak” indications from the bond markets about the health of the global economy and stating that the ECB “might very well be at some point during our next few meetings be facing a situation where risks have materialised”. Draghi’s opening remarks this evening will need to be scrutinised, as will the subsequent contributions, including this evening’s speech from the Peterson Institute’s Olivier Blanchard, who (encouragingly in our view) also now seems to have joined the list of potential Draghi successors.

Data-wise, today will bring only euro area labour costs figures for Q1, with the headline growth rate likely to remain near the top of its range of the past five years but, despite the ongoing drop in unemployment, still down on the pre-GFC rates. These will be followed tomorrow by the final inflation release for May – we expect the data largely to align with the preliminary estimates, with the headline CPI rate down 0.5ppt to 1.2%YY, a thirteen-month low, and core inflation down 0.5ppt to 0.8%Y/Y. Tomorrow will also bring new car registration numbers for May and trade figures for April, while construction output and balance of payments data for April are due on Wednesday.

The back end of the week will bring flash sentiment surveys for June. In particular, the Commission’s preliminary consumer confidence indicator (Thursday) is expected to show that household sentiment improved slightly in June, rising to its highest level in seven months, albeit still not far from the bottom of the recent range. Business confidence, meanwhile, is likely to show little improvement at the end of the second quarter, with manufacturing conditions likely impacted again by the ongoing US trade wars. As such, the headline manufacturing PMI is expected to remain firmly in contractionary territory. And the services PMI is expected to move broadly sideways, leaving the composite PMI little changed from the 51.8 reading in May and therefore consistent with a moderation in GDP growth in Q2.

In the markets, Germany will sell longer-dated bonds on Wednesday, while Spain and France will sell bonds of various maturities on Thursday.

This week’s main event is obviously the FOMC meeting, which concludes on Wednesday. While the Fed Funds Rate target range looks set to be left unchanged at 2.25-2.50%, the updated forecasts, dot-plots, statement and press conference will be watched for clues as to the likelihood of a near-term rate cut. The status of previous language stating that the FOMC intends to be “patient as it determines what future adjustments…may be appropriate” will be key. As noted by Daiwa America Chief Economist Mike Moran, if officials retain “patient” to describe their expected pace of action, we would view this as a strong effort to dissuade market participants of the view that the Fed will be easing policy aggressively. While Mike suspects that the wording will be changed to open a door to a possible ease, he thinks the wording will fall well shy of suggesting that a rate cut is imminent.

Of course, the dot plots will also be scrutinized, and at a minimum we would expect to see some downward adjustment to the members’ expectations for the fed fund rate. While the median participant in March forecast no change to policy in 2019, six members were still forecasting a rate hike this year and no members were forecasting a rate cut. Meanwhile, the median forecast called for one hike in 2020.

With respect to the US data, this week will be dominated by the housing market, including the NAHB index for June (today), housing starts for May (tomorrow) and existing home sales for May (Friday). Sentiment surveys for June due will include the Empire Manufacturing indicator (today), Philly Fed index (Thursday) and the flash PMIs (Friday). Thursday will also bring the usual weekly jobless claims figures and balance of payments data for Q1. In the markets, the US Treasury will sell 5Y TIPS on Thursday.

There will be several noteworthy events in the UK this week too. While much focus will be on the BoE’s MPC announcement on Thursday, there will be no surprises in terms of the main policy parameters, with Bank Rate expected to remain unchanged at 0.75% by unanimous vote. The post-meeting statement and minutes will be closely watched for any amendments to the Committee’s guidance on future policy that previously stated “were the economy to develop broadly in line with [the] Inflation Report projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate”.

Certainly, since the MPC’s last policy-setting meeting at the start of May, there has been a significant transformation in the mood in global financial markets, not least associated with rising expectations of a near-term shift in Fed policy. Geopolitical tensions have intensified the downside risks to the global outlook, domestic economic data strongly suggest much weaker UK GDP growth in Q2 – with our expectation for a contraction in output – and the political backdrop (including a largely moronic Conservative leadership campaign) has further heightened the uncertainties surrounding Brexit. As such, market pricing now suggests that the next move in rates will be down rather than up. But while that might suggest that some adjustment to the MPC’s forward guidance would be appropriate, data released last week suggest that the labour market remains tight and so, on balance, we expect no change of tack this week.

The data calendar will also bring several UK releases of note, with Wednesday’s CPI report likely to show that inflationary pressures remain contained. In particular, the headline inflation rate is expected to fall back to 2.0%Y/Y in May as the impact of Easter-related boost to services inflation wears off and energy inflation eases somewhat. And so core CPI inflation is also expected to take a further small step down in May, by 0.1ppt to 1.7%Y/Y, which would be the lowest rate since the start of 2017. Retail sales figures for May (due Thursday) will also provide further insight into GDP growth in the current quarter, with expectations that spending declined last month. Other releases due include the latest ONS house price index and CBI industrial trends survey (tomorrow) and public finance figures (Friday). In addition, the DMO will sell 10Y Gilts on Tuesday.

Turning to politics, further Conservative Party ballots this week will determine the final two candidates to be subjected to the decisive poll among the party’s rank and file members. Last Thursday’s first-round vote suggests that the populist Brexiteer Boris Johnson already has sufficient support to qualify as one of this pair. Following Friday’s withdrawal of Health Secretary Matt Hancock, the remaining six candidates will each require a minimum of 33 votes in tomorrow’s ballot. Should that threshold be achieved by all candidates, the one with the least votes will be eliminated. Further ballots will be held on Wednesday and Thursday if required. Following last night’s first televised debate, which saw no-one shine, the candidates will today face questioning by journalists, while tomorrow’s second televised debate will be the first to include front-runner Johnson.

After a quiet start to the week, focus tomorrow will be on the minutes from the RBA’s latest policy meeting, when the cash rate was cut by 25bps to a record low 1.252%, for further insights into discussions on the near-term policy outlook. Tomorrow will also bring the ABS’s latest quarterly home price indices for Q1, which are expected to hint at some stabilisation of prices following sharp decline over the past year. Wednesday’s releases include the Westpac leading index and skilled vacancy figures for May, while the flash CBA manufacturing and services PMIs for June are due on Friday.

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