- Central banks trying to 'have their cake and eat it too'
- Can they normalise policy without spooking nervous markets?
- Risk rally continues as markets shrug off hawkish ECB, BoE, BoC remarks
Central banks are preparing for battle with risk-taking markets as they seek
to tighten conditions without spooking investors. Photo: Shutterstock
By John J Hardy
Yesterday’s market action confounded the narrative built just the day before: that the slow but persistent withdrawal of the global central bank policy "punch bowl" signaled that it is time to reassess current widespread complacency.
That narrative was driven by the hawkish tilt from European Central Bank president Draghi on Tuesday that seemed to provide the spark for an ugly, global risk-off move that saw the rare combination of a sharp down day in both bonds and stocks.
Yesterday’s action, however, did little to bolster that narrative as we soon saw new hawkish developments from both the Bank of England, where governor Mark Carney talked up a rate hike under the right set of circumstances a mere week after a very dovish broadside, and the Bank of Canada where special adviser Lynn Patterson adding to the din with hawkish comments that are rapidly raising the odds of a hike at the July 12 meeting.
Despite all this, global equity markets brushed off the Tuesday narrative and risky assets rallied hard to almost unchanged from early this week.
If we’re to cobble together some kind of narrative, it would be this: the market has rallied again on the "Goldilocks trade" – the idea that central banks want to have their cake and eat it too. More specifically, the idea holds that they wish to make a ponderous shift away from excessively accommodative policy without spooking the markets that are so reliant on the central bank punch bowl remaining at its current, full-to-the-brim level.
This sets up an increasingly high-stakes game of chicken as central banks will constantly need to "increase the dosage" if they want to tighten financial conditions enough for the market to understand that they mean business. In the end, there will be no “just right” and this will end in a very ugly fashion, but what is the time scale?
Let’s watch the G20 meeting next week for clues...
Beyond the G20, we await the US commerce department’s omnibus report on the US trade deficit with great interest today, but have seen no coverage of its release. There could be strong implications for the world’s big exporters wtihin, particularly China, Korea, Japan, and possibly Germany.
EURGBP looks capped after yesterday’s reversal if it can remain below the 0.8850 area. The odds of an August rate hike from the BoE back to 0.50% have moved up from a virtual nil to about 25% after Carney’s rhetoric yesterday.
Technically, we have a solid if unconfirmed bearish reversal with 0.8850 the key line in the sand to the upside, while a dip through perhaps 0.8725 suggests that a large consolidation lower may be in the offing.
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Source: Saxo Bank
The G-10 rundown
USD – the USD is the punching bag of the Goldilocks trade, only outdone on the weak side by the yen, as the Federal Reserve is seen as extremely gradualist in tightening policy from here, likely launching QT at the September meeting and so afraid of its own shadow that it is unwilling to go beyond this for now. Only a recession can save the Fed from the embarrassment of having been far too cautious in unwinding policy.
EUR – the euro spike has continued into a key resistance zone and descending trend-line around 1.1425-plus. The highest weekly close since early 2015 was near 1.1450.
JPY – the market is making a strong assumption that the Bank of Japan will maintain its YCC policy and the return of strong risk appetite and yields pulling back higher is the most potent combination for a weaker JPY.
GBP – a reassessment of sterling with the more hawkish turn from Carney – will it lead to follow-through lower for EURGBP? And can GBPUSD take out 1.3000-plus resistance on this? Data will be important for sterling if the market willing to ignore UK politics/Brexit for now.
CHF – if we can continue to see the combination of higher rates and strong risk appetite, the franc may have some weakening to do. EURCHF has risen to new multi-week highs and the next interesting level is not far away now just ahead of 1.1000.
AUD – the market is busying reassessing the potential or more hawkish central banks everywhere, and the Reserve Bank of Australia is no exception after an ex-board member said that the RBA could raise rates 200 basis points over the next two year. AUDUSD is ploughing higher into the last bits of the two-year range as the longer-term chart tries to get interesting for an upside break.
CAD – odds are strongly in favour now of a 25 basis point rate hike at the July 12 meeting after the latest hawkish rhetoric from Patterson. 1.3000 is the hurdle for further progress lower in USDCAD.
NZD – the kiwi easing lower versus some of its commodity peers, but the Goldilocks comeback is very supportive for the currency versus the USD and JPY if the theme extends.
SEK – the upbeat equity markets and Goldilocks theme are more supportive of SEK and EURSEK has executed a sharp reversal. We may finally at least test the lower bound of the persistent range around 9.70.
NOK – oil prices are trying to offer a glimmer of hope that EURNOK won’t continue to follow through to the upside on the latest rally in prices after the US supply data.
Upcoming Economic Calendar Highlights (all times GMT)
- 1200 – Germany Jun. Flash CPI
- 1230 – US Weekly Initial Jobless Claims
- 1230 – US Q1 GDP Revision
- 1700 – US Fed’s Bullard (FOMC non-voter) to speak
— Edited by Michael McKenna
John J Hardy is head of FX strategy at Saxo Bank