News & analysis

The sensitivity of central banks to currency appreciation, discussions of the Fed’s new average inflation targeting framework, and Brexit were the main themes that markets latched onto this week. With the Fed potentially announcing the conclusion of its framework review on Wednesday, a suite of central bank policy decisions throughout the week, and the internal markets bill remaining in focus, the themes of this week are likely to spill over to the week ahead.

Under these overarching themes, a few key market dynamics have emerged. It has almost become a market consensus that the dollar will remain weak as the Fed becomes less sensitive to the idea of an inflationary overshoot during the recovery phase. However, the idea of rate normalisation by the US central bank is one for the distant future, with focus on the evolution of QE programmes a more pressing matter for the near-term.

This week’s Fed meeting may give some indication of the type of forward guidance markets are going to see from Jerome Powell and thus how the dollar is likely to trade in the earlier parts of the recovery phase.

Additionally, a combination of Lagarde’s comments and a Bloomberg “sources” story has given the euro the green light to rally again, but will the ECB verbally intervene back up at the 1.20 level? Finally, sterling traders have been sent back to 2019 as markets begin to price in the risk of a no-deal Brexit. The key difference between now and then; the Bank of England. Money markets are now pricing in negative rates from the BoE as soon as February 2020.

Also next week, all eyes will focus on the election of Japan’s new Prime Minister, after Shinzo Abe put an end to its 8-year tenure in office due to health reasons. The Liberal Democratic Party presidential election begins on the 14th, with candidates Fumio Kishida, Shigeru Ishiba and Yoshihide Suga all jostling for the position. Suga is the current favourite but Abe’s successor will be officially announced on Wednesday 16th, just prior to the Bank of Japan’s policy meeting on the 17th.

 

THIS WEEK’S CALENDAR:

Monday 14th: It’s a slow start to what is set to be a busy week, with only eurozone industrial production data for July released at 10:00BST and Canada’s Bloomberg Nanos Confidence index released at 13:00BST. Industrial production data is substantially lagged and will likely play a very minor role in EURUSD price action as investors already received Germany’s underwhelming industrial production data last week (+1.2% vs expectations of 4.5%). The data coming from Canada is likely to be more interesting, with consumer sentiment stalling as of late. The second reading of the controversial Internal Markets Bill in the UK is also scheduled.

Tuesday 15th: Tuesday’s session starts with a bang in Asian markets. Meeting minutes from the Reserve Bank of Australia are due at 02:30BST, where markets are likely to get the rationale behind the RBA’s latest move to increase the accessibility of its Term Funding Facility. With rates set to stay at 0.25% for some time, Governor Lowe announced that the Bank “continues to consider how further monetary measures could support the recovery”. One measure was expanding the Term Funding Facility to allow banks up to 2% of outstanding credit at a fixed rate of 0.25% for three years. The facility now has a capacity of A$200bn, with A$52bn already being accessed. Will this be the last easing action by the RBA? The minutes should give us clarity. At 03:00, retail sales and industrial production data from August are due from China. These will be key metrics for markets to watch given China’s position as the leader of the global economic recovery. Retail sales are expected to grow to just -8.8% YTD, with industrial production set to break into positive territory YTD (0.3%) with a reading of 5.1% YoY expected. This highlights the two-speed recovery underway in China’s economy. The calendar then switches to UK data, with jobless data due at 07:00BST.

Wednesday 16th: Markets can await the official announcement of Shinzo Abe’s successor Wednesday morning, with UK inflation data for August due out at 07:00BST. Low levels of inflation will be a concern for the Bank of England who meet the following day, but the level of inflation won’t be as important as the evolution of the economic growth rebound. The focus will then shift to the eurozone trade balance data released at 10:00BST, ahead of US retail sales data for July at 13:30BST. Retail sales data for the period in which the US economy was embroiled with the outbreak in the Sunbelt region will be a key metric for markets to analyse, with the Federal Reserve due that evening at 19:00BST. Just prior to the Fed, however, ECB member Holzmann is set to speak at 16:00BST at a virtual roundtable event, with ECB speakers in the limelight after last week’s communication blunder over the focus of the euro. Jerome Powell is set to give a post-FOMC press conference at 19:30BST, just prior to the Central Bank of Brazil’s rate announcement later in the evening. Details of the Fed and BCB meeting are below.

Thursday 17th: Another busy Asian session begins with the Australian labour market report due at 02:30BST, with the unemployment rate expected to tick up to 7.7% in August, a likely by-product of the latest lockdown measures. The focus will then shift to the Bank of Japan who are expected to announce their latest policy decision, later than usual in the week due to the leadership election. The Bank of England are then up at their new early time of 07:00BST, with more details below. Just after lunchtime, the South African Reserve Bank will be in focus, with expectations suggesting another 25bps cut is incoming to help the economic recovery as fiscal policy is constrained and lockdown measures remained in play for longer than expected. US jobless claims round off the day’s events at 13:30BST.

Friday 18th: After a busy week, Friday will come as a welcome relief for market participants, but the economic calendar continues at a rapid pace. To start the day, UK retail sales data for August is released at 07:00BST, while the Central Bank of Russia meet at 11:30BST. Economists’ expectations for a rate cut are practically split down the middle, with commentary from the CBR suggesting another rate cut is being discussed but isn’t a certainty. Canadian retail sales data is due at 13:30BST and will round off the week for most. Retail sales in Canada showed explosive growth in June, which is natural due to the re-opening of the economy, but Friday’s data will show if the recovery in consumption can continue. This will be of upmost importance for the Bank of Canada, which signaled this week that monetary policy will start to become more active in the coming months.

 

USD

FOMC TO FILL IN DETAILS OF SWEEPING STRATEGY CHANGES OUTLINED BY POWELL

Jerome Powell’s speech at the virtual Federal Reserve symposium this year made it clear that monetary policy in the US was moving to a structurally more dovish reaction function. The Fed Chair outlined historic changes in a new Statement on Longer-Run Goals and Policy Strategy. Powell announced a switch to average inflation targeting, and a move away from pre-emptive rate hikes as the economy approached estimates of maximum employment. Both of these changes add up to a significantly more dovish Fed, and the dollar has duly remained on the back foot since. The Fed’s ongoing framework review now appears to have been concluded, clearing the way for changes to nearer-term forward guidance issues as part of regular policy statements.

This week’s Fed meeting may therefore see a third major change to the Fed’s policy, and one with more immediate implications for the dollar and US markets, in the form of outcome-based forward guidance:

  • Recent meeting minutes and speeches have made it clear the FOMC is considering a range of possible calendar and outcome-based forward guidance. The likeliest outcome is further formalisation of the Fed’s shift away from viewing maximum employment as a constraint that will lead to rate hikes. Powell’s speech may provide a template for what outcome based guidance could look like. In his speech, the Chair stated “employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation”. In practice, the Fed could link changes in policy to a robust, sustained convergence of inflation to a level that would threaten even the Fed’s looser average inflation target.
  • Further details of how average inflation targeting will be implemented would be nice, but are unlikely to be forthcoming. Some guidance on the length of the averaging period would be particularly interesting, with the Fed’s 3-year forecast horizon the obvious starting point. New member “dot plot” projections will be issued, providing a related insight into members’ opinions. The previous set of projections, from June, showed members’ expectations of rates flat over the forecast horizon, but still relatively unchanged at around 2.5% over the longer run.
  • Asset purchases, which were included in the Fed’s framework review, will also be a topic of interest, although formal changes may not be announced this week. The Fed’s current “whatever it takes” approach to asset purchases gives it great flexibility – this may be changed to a regular monthly pace that is announced ahead of time as the US recovery continues.

 

FOMC member projections glued to lower bound over forecast horizon – what about the longer-run?

 

JPY

BOJ TO MAINTAIN POLICY STANCE WHILE THE CURRENCY CAPTURES ATTENTION

The Bank of Japan is scheduled to meet on September 17th, while markets will also focus attention on the election of the new Prime Minister after Shinzo Abe’s departure. The Bank is set to maintain its current monetary policy stance, with heavy focus on corporate financing. Ample liquidity provision attuned with the government’s financial support program has soothed strains in the corporate sector amid the pandemic. Asset purchases remain relevant for investors, as back-end yields in the JGB bond curve raise concerns of high debt issuance. The increase in Japanese yields underpins the gradual strength in the yen, which has traded above its 50-day moving average over the last month. The currency has also been supported by a recent correction in stocks markets, following doubts on the sustainability of record high valuations in the tech sector and daunting hopes in the vaccine race.

As of now, the BoJ has not rang the alarm bells about the evolution of the currency, but it might soon be forced to face questions about the need to soften the yen’s appreciation –similar to what some ECB official members recently did.

The USDJPY real effective exchange rate remains slightly undervalued with respect to its 10-year moving average, but its upward trend could weigh on the BoJ’s assessment of the balance of risks to the inflation outlook in the months to come. The consensus view suggests that a break through the 104/105 level in the USDJPY rate might trigger further monetary easing, as the currency becomes too expensive for foreign customers. The attention on the evolution of the yen might become a stronger point in the BoJ’s agenda under the influence of the soon-to-be Primer Minister Yoshihide Suga, the most likely winner in next week´s LDP presidential elections. Suga is set to build on the Abenomics heritage, centered on combined fiscal and monetary stimulus. In addition, the candidate has also been reportedly linked to the importance of the FX rate as a crisis management tool. Even though the currency value is not a monetary policy target per se, the topic is yet to be exhausted amid pain in the export sector.

 

JPY approaching its 10-year medium real effective cost might rise attention in Japanese institutions

 

GBP

BOE MEETS AS STERLING GETS A WHIFF OF NO-DEAL RISK AND BREXIT APPROACHES ENDGAME

Sterling has been by far the worst performing major currency this week, due to a sudden and dramatic escalation in the risk of no-deal Brexit following the introduction of the Internal Market Bill, which contains clauses that would breach last year’s withdrawal agreement. Sterling has weakened roughly 5% against both the dollar and the euro compared to a couple of weeks ago, with much of the depreciation coming in the last few days. In the wider scheme of things, both these moves, and the absolute levels of GBPUSD and GBPEUR, are not as extreme as during past close brushes with no-deal.

This suggests that market participants are either less concerned about the economic and market impact of the collapse of trade talks, or are taking the possibility less seriously than during previous no-deal scares.

Judging how far sterling may end up falling should both sides walk away from trade talks is difficult. A twitter poll conducted by Monex this week saw more than 60% of 285 respondents say they thought GBPUSD would fall to below 1.20.

 

Two main avenues of uncertainty will be worth watching this week: domestic opposition to the Bill, and bilateral UK-EU relations including both a possible legal challenge to the legislation and ongoing trade talks:

  • Domestic opposition to the Bill escalated at the end of this week. Prominent Conservative member of the House of Lords Norman Lamont called the bill “impossible” to defend. Opposition in the Lords aside, a more practical concern for the Government may be a rebellion in the House of Commons, where Conservative MP Bob Neill has tabled amendments to the Internal Markets bill removing the offending clauses. The Bill will face its second reading in Parliament next week on Monday, with The Times guessing as many as 30 Conservative MPs may be ready to rebel. Given the Government’s comfortable working majority of above 80, this seems like a stretch – particularly when the votes of the Northern Irish DUP are considered. However, the history of Brexit so far should caution against assuming a status-quo outcome.
  • Trade talks will continue with the EU this week, after EU leaders lined up to warn that the passage of the Internal Markets Bill would seriously threaten trade talks, but did not unilaterally withdraw. Instead, the European Commission has given the UK until the end of September to amend or withdraw the legislation, while talks continue. Given the lack of progress this week, a breakthrough on contentious issues such as state aid – the subject of the Internal Markets Bill breaches of the withdrawal agreement – seems unlikely.

 

TOO EARLY FOR BOE TO ENJOY AN “I TOLD-YOU-SO” MOMENT ABOUT RAPID UK RECOVERY

Next week’s MPC meeting will likely be a non-event for markets, given the historic Brexit drama that will likely be playing out. Recent commentary from policymakers has been optimistic, and economic data indicates a robust recovery is underway, consistent with the BoE’s expectations. Several themes will be interesting, even if no policy change is forthcoming:

  • Chief Economist Andy Haldane and Governor Andrew Bailey have both been fairly sanguine about the end of Government furlough schemes. Haldane recently said the Government should end support, saying businesses and consumers had been “incredibly resilient”. Bailey similarly said fiscal policy should “move forward” – meaning to end furlough subsidies. The meeting minutes will shed light on exactly how optimistic the MPC is about the UK labour market and wider economy. The housing market will also be relevant here, with prices hitting all-time highs by some measures in some regions, indicating a recovery in some parts of consumer behaviour.
  • The pace and duration of QE will be the key topic, although little clear guidance on this is likely to be forthcoming. Further asset purchases at a reduced rate remain likely at some point later this year in the UK, depending on the development of the economy, but at this current juncture, no action is likely.
  • Negative rates are becoming a perennial topic for the BoE and may come up. Despite clear guidance from both Andrew Bailey and the August Monetary Policy Report that the measure is not imminent, OIS pricing indicates markets are increasingly anticipating the BoE may cut rates to negative as early as this year. The August MPC said that negative rates were a tool that would most likely be effective during the “upswing” phase of a recovery, when banks were less concerned about balance sheet risks. The recent falls in short-term fixed-income pricing have coincided with the latest round of Brexit angst. This suggests that markets may be anticipating the possibility that an additional drag on the economy from a no-deal scenario will force the BoE to go negative in the coming months.

 

Sterling OIS pricing indicates increasing speculation of negative BoE rates
The dotted line indicates pricing one month ago

 

BRL

BCB TO MAINTAIN STATUS QUO AND KEEP REMAINING POWDER DRY

The Central Bank of Brazil has pretty much exhausted the policy tools that are acceptable from a cost-benefit perspective. The Bank cut rates to the record low of 2%, from the 6.50% level in December last year, with 250 basis points scrapped amid the pandemic-driven recession. The latest Copom minutes highlights the reluctance of the committee to ease further via interest rate cuts, as the group weigh on the effects of overstepping the 2% effective lower bound. Assets purchases, on the other hand, are not a policy tool of the BCB liking either, as the Bank risks the public confidence over an extended debt portfolio. An unusual instrument among emerging markets was also deployed: forward guidance. More often used in developed economies´ central banking, a strengthened forward guidance entails the promise of not rising interest rates until certain goals in the economic outlook are met. This is a plausible commitment considering the subdued current and expected inflation profile, but it is also a bold bet in terms of financial stability and asset markets. BCB´s guidance, however, does not prevent the Bank to further cuts should it becomes handy – a scenario we don´t foresee at the moment. Even though the low level of interest rates might be supportive of a faster economic recovery and a stronger currency in the medium-to-long run, additional easing (or hints of it) might not be welcomed by the forex market any longer. The BRL has coped with increased pressure from both the economic and political fronts and is set to recover from the pandemic-driven recession only gradually. Next week BCB policy review is expected to maintain the current status quo, but the currency does still face a highly volatile outlook on the back of increasing risks.

 

ZAR

SARB SET TO CONTINUE FILLING IN THE HOLES LEFT BY FISCAL SHORTFALL

Despite the monetary policy committee showing increased reluctance to enact further rate cuts over the last few meetings, economists still expect another 25bps from the SARB on Thursday’s meeting. The 50.1% annualised GDP contraction in Q2 dwarfed the 40% contraction anticipated in the SARB’s previous forecasts, suggesting the growth projections are likely to be revised down.

Coupled with inflation hugging the SARB’s lower band and the recovery being riddled with load shedding and prolonged lockdown measures, we expect the Reserve Bank to lower rates to 3.25% along with the median consensus supplied to Bloomberg.

The main question will be over the split. Will the committee split 3-2 in favour of the rate cut as it has in the last two meetings, or will committee members shift to signal a greater consensus towards monetary easing? With the electricity supply gap its greatest on record despite weaker demand, signaling a structural buffer to the recovery and a risk to the level of potential growth, we would argue the SARB may opt to signal a more dovish rate cut than previously.

 

Last week’s Q2 GDP release may make the SARB’s decision easy this week

RUB

RATE CUT BY CBR ISN’T SET IN STONE WITH ECONOMISTS’ EXPECTATIONS SPLIT

The Russian central bank stated it will consider a rate cut next week “thoughtfully and with care” after having already slashed the key rate to a record low of 4.25% earlier this year to help its economy recover from the pandemic and crash in oil prices. Deputy Central Bank Governor Alexei Zabotkin said on Thursday that “the board of directors will consider the necessity of further rate cuts”. However, he acknowledged that the virus adds “noise” to inflationary data that the bank considers in its decision making process. The poisoning of Russian opposition leader Alexei Navalny with a military grade nerve agent heightened the possibility that western countries could slap new sanctions on Russia, delivering a big blow to the ruble. However, Zabotkin earlier stated that the ruble’s plunge will not have a special economic impact, downplaying the fact that the currency has fallen to its weakest since 2016 against the euro. The recent ruble weakness pushed inflation to a higher peak in August, with the rate slowly on course to reach the CBR’s target of 4% by early next year. Headline inflation picked up to 3.6% year-on-year in August, up from 3.4% in July, matching the forecasted median provided by Bloomberg. Zabotkin said that the CBR could cut its key rate below 4% if that is needed to boost consumer inflation back to its 4% target. However, the Deputy’s wording may be perceived as a sign of holding rates at this week’s policy meeting, especially with Rosstat releasing its inflationary data for the first week of September highlighting CPI at 3%, thus reducing deflationary concerns. In addition, the Russian government recently announced a 3% increase in public sector salaries, which may bode well for inflation in the near future and increases chances of inflation reaching the 4% target at the end of the year. Half of the economists surveyed by Bloomberg foresee a 25bp cut on September 18, but the recent commentary by the CBR’s Deputy and the latest rise in inflation data may point to a pause in the CBR’s policy.

 

Authors: 
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, FX Market Analyst

 

 

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