Trying To End Doublespeak

A recap of actions last week
Shows Draghi maintains his mystique
While Powell, Jerome
Seems much more at home
In trying to end doublespeak

It is a remarkably dull session this morning, with both the dollar and most major government bond markets little changed. Market participants are still coming to grips with last week’s three central bank actions, and their ramifications going forward.

In essence, we learned that the Fed will not be deterred in its efforts to normalize monetary policy as the US growth story remains quite robust, and more importantly, both inflation and unemployment, the Fed’s two key metrics, are now at levels that represent an economy with the potential to overheat soon. And while there are a growing number of voices that are concerned that the Fed’s ongoing balance sheet reduction is having a particularly severe impact on certain emerging market economies, the Fed, thus far, remains unconcerned.

We also learned that the ECB is still highly uncertain over the future, but is dealing with a great deal of internal turmoil due to the two-speed economy they oversee. Northern Europe continues to significantly outperform the southern periphery and has seen its economic metrics improve to the point where a more normal monetary policy stance is appropriate. However, the PIGS are still wallowing in their domestic-led problems, with slower growth, much higher unemployment and almost no inflationary pulse. Ongoing easy money is critical in keeping any growth momentum alive there. Thus Draghi continues to walk a fine line to keep both sides happy. Many lauded his efforts Thursday, but the biggest concern remains that the ECB is going to find itself with no ammunition to fight the next broad economic downturn if they don’t get policy normalized soon. And Draghi just promised to keep interest rates negative at least until 2020. Even optimists feel that a recession is likely by then.

Finally, Kuroda-san has no choice but to continue QE and keep targeting a 0.0% yield on 10-year JGB yields. While unemployment remains quite low there, Q1’s sharp decline in GDP growth and the continued lack of inflation argue that there is no reason to look for a change in policy here anytime soon.

Keeping all that in mind, here’s what we can expect looking ahead. This week, perhaps the biggest story is the BOE meeting on Thursday, although it seems highly unlikely that they will change policy. Earlier expectations for a rate hike have been all but eliminated, and the probability for an August move continues to fall as well. The Brexit story remains the dominant theme there, and nothing has occurred on that front which implies a solution is any nearer. I continue to believe that the BOE will not adjust rates again before Brexit has occurred, and that the next move will be taken by Governor Carney’s successor.

Trade discussions will continue to be an important part of the market narrative, especially given that we have seen the imposition of the first round of tariffs by both the US and China. Equity markets are clearly unhappy with this, and there is no question that the chance for escalating trade issues has put a cloud over the global economy. We have already seen both MXN and CAD underperform pretty significantly as the NAFTA negotiations drag on, with trade issues the unambiguous driver there. Interestingly, this morning CNY is weaker by 0.3% and is actually back to its weakest level since mid-January. I have maintained all year that I expected a weaker yuan as the currency remains one of the most likely release valves for pressures in the Chinese economy. As the PBOC continues to squeeze over-leverage out of the market while supporting slowing economic growth, a weaker currency is an important tool in the process. Look for this trend to continue.

The data calendar this week is sparse:

Tuesday Housing Starts 1.31M
  Building Permits 1.35M
Wednesday Existing Home Sales 5.50M
Thursday Initial Claims 220K
  Philly Fed 20.0

Quite frankly, none of these seem likely to change opinions much. However, we do hear from six Fed speakers, including Chairman Powell on Wednesday. Now, given that we just heard from them, it seems unlikely that there will be much new news, but it is possible that there will be an attempt to fine-tune some of the thoughts. Thursday, as well as the BOE, is also the ECB’s answer to Jackson Hole with their Sintra, Portugal conference. Last year, Signor Draghi shook up the markets with what was a quite hawkish view, and the euro did rally in the wake of the comments. However, this year, given what we have just heard from all the major central banks, my sense is that there will be much less impact on markets. In fact, I expect the whole week to be pretty dull, with modest movement anywhere.

Good luck