FEDERAL RESERVE (FED)
• Attention this week will be on the Q&A part of Fed chair Janet Yellen’s semi-annual testimony to Congress (House Financial Services Committee on 12 July and Senate Banking Committee the next day). The Fed’s Monetary Policy Report, released Friday, provided little new information, reiterating gradual hikes, and gradual reduction of the balance sheet when it begins later this year. Indeed, the report largely echoed recent comments from Fed policymakers, as well as the FOMC’s June meeting.
• Yellen’s testimony will likely toe the line, but her Q&A may be more revealing (although we wouldn’t hold our breath: the Fed chair has become increasingly talented at saying a lot without telling us anything new of consequence). Nevertheless, the balance sheet plans, and inflation are the two areas the market would like to hear about.
• On the latter, the June meeting minutes indicated that most policymakers saw the recent softness in inflation as having little impact on the trend on inflation, though several were concerned that it might persist, indicating the divide on the FOMC. “The Minutes showed a Fed hiking on realised activity but forecasted inflation,” UBS says, “taken together, strong activity, tight labour markets, supportive financial conditions, decreased risks from abroad, and a belief in their inflation forecasts were enough reason for them to hike.” (NOTE: US June CPI data is released on Friday, which will be crucial in judging how transitory the recent softness is).
• On the former, the key question is around the sequencing of rate hikes and balance sheet normalisation. There seems to be a consensus building that the Fed will begin to normalise the balance sheet in September, with the next hike coming in December, after the minutes revealed several believed normalisation would be appropriate in the next “couple of months”. Additionally, some insight into the logic behind the cap system would be welcomed, UBS says, arguing that the cap system put forward is anything but straightforward: “The asymmetric treatment of Treasury securities and MBS and the fact that the caps become largely irrelevant after a year make for a bit of a head-scratcher. Sadly, there was no further insight into how they came up with their plan.”
• At the close of business on Friday, the market was pricing in a 71% chance that rates would be held between 100-125bps in the July, September and November meetings, with the chance of a hike pretty much a coin flip in December. It is also worth keeping an ear out for comments about the FOMC’s projection for the long-term Fed Funds Rate, currently 3%; it is clear that the market does not buy into that hike trajectory, pricing in just three more hikes between now and the end of 2019, compared with the FOMC forecast that looks for another seven.
EUROPEAN CENTRAL BANK (ECB)
• Following the dropping of its easing bias at its June meeting, and the apparently hawkish comments of President Mario Draghi at the Sintra conference just a couple of weeks ago, the ECB is clearly uncomfortable with the market’s perception that it would be sending further hawkish signals at its 20 July policy meeting, as suggested by subsequent commentary from officials, as well as other ‘sources’ stories.
• To recap on Draghi’s comments made on 27 June: although he declared ‘all signs now point to a strengthening and broadening recovery in the Eurozone, and deflationary forces have been replaced by inflationary ones’, he reiterated that ‘any policy shift would be gradual, and a considerable amount of accommodation was still required for inflation dynamics to become self-sustaining’ (paraphrased).
• The latter sentiment has been echoed by other officials in wake of Draghi’s comments. ECB chief economist Peter Praet, for instance, argued that “the process of reflation is a long one” and it will take a long time for inflation to come back to target. The normally hawkish Jens Weidmann also said that despite being on the cusp of normalisation, the process would be contingent on inflation, and that process would not mean applying the breaks fully, but instead easing off the accelerator.
• Nevertheless, taking Draghi’s comments at face-value, the tone has shifted over the last month. Analysts at Commerzbank believe that Draghi and the ECB are employing a “taper bluff” that sells tapering as a sign of strength, rather than a function of the legal constraints that will be imposed on the central bank within the next year. Recall, the European Court of Justice ruled that the ECB’s Outright Monetary Transactions are justified so long as the central bank doesn’t becoming the dominant creditor of governments (judged to be one-third of an issuer’s outstanding bonds).
• Commerzbank’s analysis finds that this limit will start getting hit next year, and as ECB’s Yves Mersch has previously noted, may have legal ramifications. The upshot is that the ECB may be scaling back its asset purchases without having obtained its objectives and an exit from these bond-buying might be forced. “If the ECB had to suspend its bond purchases despite not having met its policy targets, it would be left without instruments and defenceless,” Commerz warns, and though unlikely, it says that “market nervousness would rise and, in an extreme scenario, the sovereign debt crisis might flare up again.”
BANK OF JAPAN (BOJ)
• The global bond rout has put the BOJ on the defensive. With 10yr yields 11bps above its 0% target, on Friday it offered to by unlimited quantities to push the yield down towards target.
• It was the third occasion the central bank had to step with fixed-rate operations since introducing the yield curve control (YCC) policy in September 2016, and the first time since February. Unlike in February (where it also offered to buy at 0.11%), the operation had no bids offered – as was the case with its operation in November – and accordingly, 10yr yields fell by 2bps to 0.09%.
• “The yen is suffering from a dual personality,” say analysts at Pantheon Macroeconomics. “It receives safe haven-like flows when the world goes risk-off but its central bank is behind the global tightening.” Pantheon believes that, for now, the BOJ will continue to defend its yield curve target, but expects “the BOJ to capitulate to the global reflation game toward the end of the year as a result of downward pressure on the yen,” and subsequently, the consultancy sees the central bank raising its 10yr yield target to 20bp.
• Analysts at IFR argue that the YCC doesn’t have an upper or lower limit, and instead aims to keep 10yr yields at zero. If bonds continue to sell off globally, the BOJ will likely be compelled to intervene again, but IFR says “the aim, however, would likely be to allow 10yr yields to be more volatile as opposed to setting a firm ceiling,” citing the central bank’s recent meeting minutes, where some members thought it was inappropriate for the market to have a perception that there was a ‘band’ between -0.10% and +0.10%.
• “The intention will be to try to keep JGBs stable, waiting for greater clarity on policy from the Fed and ECB later in the year before the BOJ makes any adjustments of its own,” IFR writes. “There is likely to be pressure for the BOJ to also make a shift in communication and this will have a strong impact given.”
BANK OF CANADA (BOC)
• There is a gap between market pricing and analyst forecasts as to whether the BOC will fire the first hike in seven years on 12 July; OIS closed-out the week pricing in an 87% implied probability that rates would be lifted by 25bps to 0.75%, but on the other hand, analysts are split with only 14 of the 31 surveyed by Reuters expecting a hike.
• Expectations have been heightened after hawkish commentary from BOC Governor Stephen Poloz, and Deputy Governors Carolyn Wilkins and Lynn Patterson. The message from this trinity is that two rate cuts in 2015 have served their purpose, the drag from the oil price shock is now in the rear-view mirror, and Canadian economy is gathering momentum. “A consensus appears to have formed around a July hike as there can be little other reason for the timing of the rhetoric shift,” strategists at BMO write. “If they wanted to wait until October to hike, why not signal such a move at the coming meeting instead of a month earlier?”
• Of course, there are still some issues: inflation, for instance, remains a challenge. Poloz has, however, explained to Handelsblatt that if the BOC was solely setting policy on the basis of inflation, it’d never hit its target, and believes price pressures will be on an upward trajectory in the first half of 2018. Business investment levels have also been soft, but again Poloz is sanguine it will pick up. And then there are concerns about house prices in some areas and consumer debt levels, but the BOC Governor believes the economy would be resilient to a house price shock; and on debt levels, the Poloz has noted the rise, but hasn’t expressed a great deal of concern.
• On the timing of the hike, BMO notes that April’s Monetary Policy Report projected that the output gap would close in the first half of 2018: “In the three tightening cycles since 2000, the Bank has started hiking around one year ahead of when the output gap is forecast to close. July fits nicely in that window, while October risks falling a bit behind the curve if the output gap closes in the early part of H1.”
• With a hike almost completely baked into market pricing, BMO believes the key question is not whether the BOC will hike in July, but whether the next move comes in October on January; the bank will also be keeping an eye out for comments indicating how aggressive this hiking cycle will be.
BANK OF ENGLAND (BOE)
• It’s not surprising that the MPC is divided, according to Capital Economics, which argues that the case for tightening is the strongest it has been in some time. These include above target inflation and the jump in unsecured consumer borrowing.
• The case for tighter policy, at best, only offers scope for fine-tuning policy, rather than triggering a new hiking cycle. Inflation is largely due to the sharp drop in the pound in June 2016, which is going to begin falling out of Y/Y data soon, and increasing borrowing costs to stem the build-up in debt might exacerbate pressures in the consumer sector. And that leaves the BOE with scope to remain accommodative. Additionally, business surveys aren’t at levels consistent with tightening policy, and then there is the uncertainty around Brexit.
• “One possible compromise would be for the MPC to act soon just to reverse the additional policy loosening implemented last August,” perhaps as soon as this August’s QIR, CapEco says, “that would acknowledge that the worst Brexit fears have proved to be unfounded, and yet maintain an exceptional degree of policy stimulus,” though the consultancy notes that this risks sending a signal that this were the beginning of a rate hike cycle, not just fine-tuning policy.
• Governor Mark Carney seems to be holding out for signs that real wages are growing, and business investment is picking up before he nails his colours to the hawkish mast, and until that point, the BOE is likely to remain accommodative, assuming Carney can maintain his influence over the MPC.
RESERVE BANK OF AUSTRALIA (RBA)
• As expected, the RBA held its cash rate target at 1.50%, and the policy statement was similar to its previous one. But with that said, there were a few tweaks that should be noted: the RBA still expects a gradual strengthening in the economy, however, it dropped its reference to seeing GDP expansion of over 3% in the next couple of years, and this raises risks that the central bank will trim its growth projections when it updates its forecasts in August.
• Westpac sees Australian growth around 2.5% in 2018 – 0.75ppts beneath the RBA’s current view – and expects the central bank to lower its growth profile in August. “However, with inflation expected to track broadly in line with the RBA’s forecast gradual return to target, and financial stability risks still likely to be factoring into the Bank’s thinking, we suspect this weaker trajectory will not be weak enough to draw further rate cuts”, the bank writes, arguing that rates are likely to remain on hold in 2017 and 2018.
RESERVE BANK OF NEW ZEALAND (RBNZ)
• The NZIER’s quarterly business survey, closely watched by the RBNZ, showed business confidence was steady in the June quarter. However, the RBNZ will have noted the softening in firms’ demand in their own businesses both in the current quarter and the over the coming quarter; additionally, sentiment in the business sector seems to have fallen sharply.
• But businesses continue to remain optimistic about planning for future expansion, and companies intend to invest in new plant and machinery to try and boost output amid the shortages in labour.
• “Capacity pressures and pricing intentions eased in the June quarter,” NZIER said, “although we continue to expect that underlying inflation will lift over the next two years, these recent developments add to the case that there is little urgency for the Reserve Bank to begin lifting interest rates,” with the consultancy looking for the next hike to come after the middle of next year.
SWISS NATIONAL BANK (SNB)
• Swiss inflation data fell short of expectations at -0.1% M/M versus an expected 0.0% and easing from 0.2% previously, and 0.2% Y/Y versus an expected 0.3% and easing from 0.5% previously, presenting very little to suggest that the SNB was – like some of its major global peers – on the cusp of tightening policy.
• The headline inflation measures were on the back of lower energy prices, rather than currency effects, but core inflation was unchanged at a meagre 0.2%.
• “The SNB will be disappointed by the data,” says Capital Economics, given the hopes that low unemployment and an uptick in some data prints would feed through into inflationary pressures. “What’s more, after five years of deflation, there is a risk that low inflation expectations have become entrenched – indeed, consumers’ inflation expectations point to core inflation of little more than zero.” Accordingly, CapEco says the SNB’s approach will remain cautious, and the consultancy believes the central bank won’t be adjusting rates until at least the middle of 2019.
• The Riksbank kept rates unchanged at -50bps, also keeping the particulars of the QE programme unchanged. However, it mirrored the recent move by the ECB to drop its easing bias, highlighting the conditional nature of the Swedish central bank’s policy with that of its largest trading partner.
• The 3bps downside bias to Swedish rates, therefore, has been abandoned on the back of firmer than expected inflation and the stability in the global outlook. It also means that the central bank has not got an easing bias for the first time since 2015.
• Nordea argues, however, that any tightening remains far off, perhaps only after October 2018: “The ECB is important for the Riksbank and any major turn-around in monetary policy stance from ECB still seems remote. In addition, the Riksbank wants to see inflation stabilising ‘more lastingly’ around 2%, while we fear that inflation will decline later this year when the effects on inflation of the weak SEK fade,” and adds that “the SEK is still crucial and the Riksbank clearly states that it will not allow any sharp appreciation.”
• Rabobank makes the case that the Norges Bank may have more scope to lag other global central banks in adopting a tighter policy bias. While some central banks are concerned that the impact of low rates could begin to have detrimental effects within the economy, these concerns seems less acute in Norway.
• House price inflation is easing (due to macroprudential measures rather than direct monetary policy) while inflation runs below target (and is likely to remain so in the quarters ahead), means that the Norges Bank is not likely to have as large concerns for consumer debt levels as some other central banks might.
• Admittedly, economic fundamentals are improving, but nevertheless, Rabo argues that it is too early for the Norges Bank to step back from easy policy, particularly with benign inflationary pressures. Indeed, with these pressures muted and the impact of low rates not causing too many concerns in other parts of the economy, the central bank has the luxury of remaining patient.
Write to Yogesh Chandarana