State of the union
- Opposing views in the Fed reduce chance of September hike
- Inaction likely to be default setting for various central banks in week ahead
- Volatility likely to remain very high
So do we need more union in Europe or less? Photo: iStock
By Neil Staines
“European Union still does not have enough union” — Jean-Claude Juncker
In the period since our last post, there have been several macroeconomic and geopolitical events worthy of note. However, such developments have failed to produce any clarity at global or even national level as far as economic progression or perhaps more pertinently the progression of global monetary policy.
Last week saw three major central bank meetings: the Bank of Canada surprised on the dovish side, the European Central Bank surprised on the hawkish (or at least less dovish) side and the Reserve Bank of Australia surprised by leaving the statement largely unchanged from the previous month. What is the real state of the union?
“Experts often possess more data than judgement” — Colin Powell
On the data front, the US economic recovery ebbed, with notable weakness in surveys of manufacturing and service sector activity, and a more moderate pace of payroll growth (still comfortably strong enough to see continued tightening of the labour market). In the UK, the backdrop was the polar opposite, as surveyed activity rebounded strongly. While we remain positive on the UK economy relative to both expectations and its peers, we would caution against extrapolating the recent rebound, however, as a significant proportion of the rebound is likely to have been delayed activity from the pre Referendum uncertainty period.
Sticking with the UK and US, the monetary policy progression has been equally uncertain. Prior to the recent, more pedestrian US data, it appeared that September was increasingly likely. In fact comments from Boston Fed Governor (non-voter) Eric Rosengren last week, suggesting that current low rates increased the risk of the Fed being behind the curve going forward, highlighted the sensitivity of both stocks and bonds to the prospect of eventual monetary normalisation.
Lael Brainard (voter), however, swiftly gave the opposing view, that the risks of raising rates too soon were greater than those posed should inflation surprise to the topside. Market expectations of a rate rise next week from the Federal Open Market Committee are now around 25%. We would expect that such low market expectations (with the blackout period removing the option to ‘talk up’ expectations) preclude a rate hike, particularly in light of the price action in equity and bond markets on Friday.
In the UK, with the Bank of England having acted swiftly and aggressively in the aftermath of the UK vote to leave the EU, expectations of further monetary accommodation at this week’s meeting have waned with the rebound in the data (admittedly survey or sentiment based data).
We view the chances of further accommodation from the BoE this week as very low indeed, given the potential difficulties in longer dated gilt purchases under the new QE programme and the proximity of the Bank Rate to the self proclaimed lower bound. We would anticipate an unchanged verdict from the BoE, at least until the Inflation Report (and new projections) in November, while the macroeconomic backdrop remains significantly more stable than many had feared.
Indeed, with currency depreciation pushing up import prices, money supply (M4) growth trending higher, and wage growth (albeit modestly) picking up, a case could be made that the next move in rates is in fact up. That is not to say that in the near term governor Mark Carney et al. won’t play down the rebound in economic activity measures and play up the medium term risks of Brexit, as its implications become better understood.
“I love argument. I love debate” — Margaret Thatcher
In a broader global context, while the intellectual debate seems to be moving away from ever deeper reliance on (non-standard) monetary accommodation, market focus and volatility remain acutely correlated to monetary expectations.
Bloomberg posted a story overnight reporting that a professor of psychology at Waseda University in Tokyo (focussing on decision theory) is recommending encouraging younger consumers to spend more, by providing them a “financial and emotional cushion”. While this is a different expression of radical policy (and one which we expect to have very limited attention applied to it) it highlights the current policy debate.
As fears of secular stagnation germinate, the arguments over the real neutral rate of interest continue (R-star in terminology as recently discussed by Fed Williams). Against this backdrop, the Bill Gross comment that “capitalism does not work at zero interest rates” is likely increasingly weighing on policy makers’ minds.
By the end of next week, we will be furnished with a BoE decision, a Fed decision (and statement) and the Bank of Japan report of the efficacy of its cumulative monetary policy actions - in our view all are likely to leave policy unchanged. In the meantime we expect volatility to remain high and for equity (and bond) markets to continue building a medium term top - at least until we gain a better understanding of the true state (and perhaps more importantly policy makers view of the true state) of the union!
They'll be keeping their eye on the BoE decision. Photo: iStock
— Edited by Martin O'Rourke
Neil Staines is head of trading at ECU Group