The one data point of note since our last piece was the US employment report for June, and it is important to note that the main pillar of strength in the US economy – the labour market – put in another impressive month. July marked the second consecutive payrolls gain above 200,000 and another incremental reduction in the unemployment rate to just 4.3%. What continues to fall absent, however, is inflation in both wages and, more broadly, in prices.
From a financial market perspective, while inflation remains absent, monetary policy normalisation in the US likely remains a glacial iterative process. Against this backdrop, and in conjunction with a modest recovery in global economic activity (one where downside risks have diminished), the resultant hunt for yield has driven demand for bonds, equities and emerging markets. In turn this has pushed yield curves lower and flatter (arguably further denting inflation expectations), boosting the attractiveness of equities.
In FX terms, given the low volatility, risk positive, low inflation, low (but positive) growth backdrop it is likely that the USD remains on the back foot. In fact, in order for this to change or for the USD to make gains in FX, it would likely require a negative exogenous risk event, a sharp pickup in US growth or a notable pickup in US inflation.
“Recent data question if inflation returning to target” — James Bullard
In that regard, it is interesting to note the testimony of Messrs Bullard and Kashkari last night, neither of whom hold much hope for a resurgence of inflationary pressure anytime soon. Indeed, James Bullard, while advocating the activation of the balance sheet unwind process, provided little explanation or hope for a reversal of ingrained low inflation in the US, concluding that the “best policy would be to leave rates where they are”.
Federal Open Market Committee voting member (and dissenter to the June rate rise) Neel Kashkari reiterated his view that “it matters that inflation has been coming up short”, a sentiment that contributed to keeping US yields subdued and yield curves flat.
“...but some animals are more equal than others” — George Orwell, Animal Farm
In the Eurozone, however, there have been some interesting monetary policy developments. We have noted on a number of occasions that one of the motivating factors for the ECB in considering its path towards monetary normalisation is the increasing scarcity of German debt to purchase (in line with the policy equality of the capital key, accounting for the relative sizes of economies, and thus capital markets, within the eurozone).
The most recent data clearly show that the ECB purchases of German bonds were for amounts below that implied by the capital key for the fourth consecutive month. Furthermore, the German shortfall appears to be increasingly utilised to buy Italian debt.
This process of favouring one member state over another (if sustained) raises significant questions about the Eurozone construct and the equality of the transmission mechanism for monetary policy. We would expect to expand further on this topic over coming months; suffice it to say that if this is a conscious policy target, then its connotations are (perhaps much) less positive for the EUR.
In the near term, and despite the summer lull in data, activity and participation, we would expect the USD's decline to remain the dominant force. With US CPI the next significant macro data point, eyes will be focused on that. Until then, the IAAF Athletics World Championships perhaps offers a welcome distraction?
— Edited by Michael McKenna