Fed indecision to raise sunken cable?
- Most recent FOMC minutes paint a mixed picture
- Record GBP short, USD plunge could boost cable
- Fed paper floats idea of boosting inflation target
By Neil Staines
"First law on holes: when you’re in one, stop digging" – Dennis Healey
The last set of policy meeting minutes from the Federal Open Market Committee, released July 27, painted a mixed macroeconomic picture of the US. They pointed out continued labour market improvements (and even an increase in labour utilisation) amid a moderate pace of economic expansion.
Within that expansion, however, it was noted that household spending was growing strongly, but that business investment remained soft. In that regard, Friday’s weak retail sales print was a concerning development.
Despite the dissent from Kansas City Federal Reserve governor Esther George at the July meeting, the minutes continued to convey at best a modest medium-term rise in inflation (and inflation compensation or expectations), amid diminished risks to the economic outlook.
The threat of inflation, and thus higher US interest rates, continues to abate.
Last week we made the point that “in a world where there is no sign of monetary tightening, and worryingly, where there is little progress in structural reform, ever lower yield curves mean ever higher (forward discounted) equity yield valuations and an ever more distant search for yield.”
"Don’t lower your expectations to meet your performance" – Ralph Marston
The weakness in US retail sales seen in July (read: a contraction in eight of 13 major retail categories) had already led to the market lowering the probability (implied by the OIS yield curve) of a rate hike in 2016 to below 50%.
The release of an academic paper by Fed governor Williams suggesting a broad reassessment of monetary policy in an era of low rates – more specifically suggesting a higher inflation target – is a further lurch to the dovish end of the monetary spectrum from the Fed, and from our perspective is of significant near-term concern for the USD.
Despite economic outperformance against its G10 peers, the search for yield amid the Fed’s “diminished” near-term risks to the economic outlook will put pressure on the continued positional bias of long USD.
This can be further undermined by falling rate expectations and and concerns over the US consumer, as well as policy intentions.
Does a 4% inflation target stretch the definition of price stability?
While the next installment of FOMC minutes arrives this Wednesday, the revelations in Fed thinking from Williams likely mean that the importance of the (retrospective) August FOMC minutes has been gazumped by the (forward-looking) implications for policy from the Jackson Hole summit, and Janet Yellen’s testimony on August 26.
"If you find a path with no obstacles, it probably doesn’t lead anywhere" – Frank A. Clark
This morning we have seen higher-than-expected inflation data in the UK (on rising input costs as GBP drop fuels prices) and sterling has duly appreciated. Against a backdrop of a paradigm shift lower in the equilibrium level of GBP, imported inflation is expected and thus, as the Bank of England has forewarned, is of significantly reduced direct impact on the UK rate path.
Despite that, a forecast-exceeding figure will still likely weigh against the prospect of further monetary accommodation (in part at least), a theme that may be exacerbated by UK retail sales on Thursday if our expectations of outperformance are confirmed.
With GBP positioning at record short levels, and adding in the negative US interest rate connotations of the Williams paper, we see potential for GBPUSD to rise in the near term. A weaker-than-expected inflation print in the US this afternoon will likely add to any momentum.
Watch this space.
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group