Powell confirms Tbill purchase plans

Emily Nicol
Chris Scicluna

Overview:
US stocks ended yesterday in retreat, with a late-session sell-off leaving the S&P500 down 1.6% on the day. A trigger was the decision of the US authorities to impose visa restrictions on Chinese officials accused of involvement in mass detentions of Uighurs in Xinjiang province, fueling concerns that the high-level trade talks, set to resume tomorrow, will go nowhere fast. Against that backdrop, however, on a relatively quiet day for economic news from the region, the performance of the main bourses in the Asia-Pacific region today might have been significantly worse. Indeed, China’s markets on the whole made gains, although the CSI300 closed up just 0.1%. With the yen having given up some of its appreciation of yesterday, now easing back above ¥107/$, Japan’s Topix closed down just 0.3%. Following a surprisingly weak Aussie consumer confidence survey (see below), however, the ASX 200 fell a larger 0.7%.

Bond markets, meanwhile, had to digest yesterday’s speech in Denver by Fed Chair Jay Powell. Most notably, Powell confirmed that the Fed will shortly respond to recent stresses in wholesale funding markets by announcing measures to add to the supply of banking system reserves, in particular by increasing its securities holdings via the purchase of Treasury bills. Powell was at pains to emphasise that this should not be interpreted as a return to the large-scale asset purchases deployed after the crisis. Indeed, the measure should not be considered as represented monetary easing (quantitative or otherwise) at all. Instead, just as was the norm before the Global Financial Crisis, the Fed’s balance sheet will be allowed to increase organically in order to keep the fed funds rate in line with the FOMC’s chosen monetary stance, thus avoiding the tightening of financial conditions that might otherwise (as in recent months) occur. Nevertheless, the comments unsurprisingly gave support to short-dated paper.

In terms of the likely outcome from the Fed’s policy meeting at the end of the month, however, Powell was relatively noncommittal, emphasising that decisions will be data dependent. But in his speech he gave reasons to believe that there might well be further slack in the labour market and scope for accelerated gains in productivity. And by repeating concerns about economic risks from global developments, and restating that the Fed will act as appropriate to support continued economic growth and a strong jobs market, he gave no reason to believe that the FOMC won’t vote again to ease policy on 30 October. The probability of a further 25bps cut in the fed funds rate at the end of this month, as implied by fed funds futures, remains a touch above 80% and yields on USTs across the curve remain some way down from yesterday (e.g. 10Y yields are close to 1.54% about 5bps below yesterday’s peak).

The steadier showing in Chinese markets today, meanwhile, has fed through to a moderately positive tone to European markets at the open, with equities higher and most govvie bond markets a touch weaker (10Y Bund yields up to -0.58%). The mood has not been harmed by a satisfactory business survey from the Bank of France, which pointed to ongoing steady growth in the euro area’s second-largest economy (more on this below too).

Finally, after yesterday saw the Brexit negotiations appear to teeter on the brink of collapse, a cease-fire seems to have been reached in the increasingly poisonous rhetorical battle that had sought to apportion blame for failure to one side or the other. The news that talks will be held tomorrow between Irish Taoiseach Varadkar and UK PM Johnson, in a last-ditch attempt to keep open the door to a deal at next week’s EU summit, appears to have given modest support to sterling after yesterday’s weakening. Given the numerous flaws and omissions in Johnson’s proposals, however, we strongly doubt that a breakthrough will be reached tomorrow. So, our baseline assumption remains an extension to the Article 50 deadline at the end of the month. We note, in addition, a new initiative within the House of Commons among the opposition parties and certain Conservative rebels to push to a vote in the chamber that would allow for a second Brexit referendum within the next six months and before a general election.

Japan:
With consumption-related figures showing evidence of front-loading of spending ahead of last week’s consumption tax hike, a dip in Japan’s GDP growth seems to have avoided last quarter despite ongoing challenges in the external environment. The JCER’s latest monthly survey of professional forecasters released today showed the average forecast for GDP growth in Q3 at 0.68%Q/Q annualised. This is expected to be followed by a relatively steep decline in Q4 (2.78%Q/Q ann.) as the consumption tax bites. But today’s survey also suggested that economists on the whole anticipate Japan to avoid a technical recession this time around, forecasting a return to positive growth in Q120. Our colleagues in Tokyo forecast minimal growth of just 0.1%Q/Q ann. in Q3 followed by a modest contraction of 0.6%Q/Q ann. in Q4 and modestly positive growth of 0.5%Q/Q ann. in Q1.

Against this backdrop, in line with the Daiwa house view, the majority of analysts (more than 80% of a sample of 36) surveyed by JCER expect the BoJ to leave its short-term policy rate unchanged this year (and next) at -0.1%. That, of course, contrasts markedly with market-implied probabilities, which suggest that a 10bp cut in the short-term policy rate to -0.20% will be forthcoming at the BoJ’s end-October policy meeting.

Australia:
Despite recent monetary policy easing in Australia, which saw the RBA last week cut its target cash rate to a record low 0.75%, the latest Westpac consumer confidence index signalled a significant deterioration in sentiment at the start of Q4, with the headline index declining 5.5pts on the month to 92.8, the third month out of the past four that pessimists have outweighed optimists and a four-year low. The weakness in the detail was broad based. The most notable drops reflected expectations about the near-term economic outlook – the component reflecting perceptions of economic conditions over the coming twelve months fell 6pts to 87.1, a drop of more than 15pts from a year ago. And with households more downbeat about their current and expected financial situation, the survey’s component measuring their willingness to make major purchases declined to the lowest in four years. As such, with household consumption growth having slowed significantly in the first half of the year – and growth in consumption per capita having slipped into negative territory – today’s surveys offers little optimism about the outlook for spending over coming months and further supports the view that further monetary easing will be required in due course.

Europe:
Consistent with the September PMIs, today’s Bank of France business sentiment survey signalled a loss of momentum at the end of the third quarter, particularly in the manufacturing sector. Indeed, the headline index fell 3pts to 96, reflecting a drop in production that month, particularly in the manufacturing of machinery and electronic equipment. Nevertheless, with order books having improved slightly manufacturers anticipated a pickup in production in October. And on average over the third quarter as a whole, the manufacturing sentiment index was only ½pt lower than the Q2 average. In the survey, services firms also suggested that activity slowed slightly in September, although the headline index at 99 remained close to the long-run average and still left the quarterly index unchanged from Q2 at 100. And construction firms were a touch more upbeat about recent conditions in the sector, with the respective headline index rising 1pt to 105, a four-month high.

Overall, today’s survey aligned with the messages from the INSEE and PMIs, that there was neither substantive improvement nor notable deterioration in economic conditions in Q3. As such, the Bank of France continued to assess the survey to be consistent with GDP growth of 0.3%Q/Q in Q3, which would be unchanged from growth in the first two quarters of the year and is fully in line with our own forecast.

US:
Further clues about the path ahead for Fed policy might emerge from the minutes of last month’s FOMC meeting, due later today. Before then, Powell will be speaking publicly again, this time at a ‘Fed Listens’ event in Kansas City. Today’s dataflow from the major economies is also concentrated in the US, where the August JOLTS jobs numbers as well as wholesale trade and inventories figures, as well as the September Fed monthly budget statement are due.

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