September Begins with a Bang

The summer lull is surely over. In the week ahead no fewer than six G10 central banks meet and a host of important economic data is slated for release. The US employment data at the end of the week is seen by many as critical for the one major central bank that is not meeting, the Federal Reserve.

None of the central banks meeting, which includes Australia, Canada, Japan, Sweden, England and the ECB, are expected to alter their monetary policy stances. And the economic data are unlikely to alter market perceptions that China is stabilizing, Europe reflating, even if unevenly and the Japanese economy is sufficiently strong to allow for the implementation of the controversial retail sales tax hike next April, although with likely additional fiscal support.

Barring a significant surprise, the US jobs report is unlikely to spur any one to change their outlook for Fed policy.  Although weekly initial jobs claims seem to reflect improvement in the labor market, the more authoritative monthly employment report shows nothing of the kind.  

The six month average net private sector employment gain stands at 200k, but only because of the out sized gain in February and this will be dropped out of the six-month average with the August jobs report at the end of the week.  Moreover, February was the only month this year that the private sector grew 200k or more jobs.  Even if the August figures comes in at 200k, which would be above the consensus,  the 6-month average will fall to levels not seen since late last year.  The 3-month average has been trending lower since March and has been below 200k since May. Nor has there been much improvement in other measures, like hourly earnings or the work week.   

Many people say that the Fed's decision to taper is highly data dependent, but precisely what this means is rarely addressed.  The decision to taper is most certainly not a technocrat response to some predetermined set of economic variables.  Indeed, a dispassionate review finds that the Fed has over-estimated growth and price pressures.  

The pace of improvement in the US labor market remains painfully slow and does not appear to have accelerated in any meaningful way.  At the same time, the Fed's preferred inflation measure is low (closer to 1% on the monthly calculus than 2%, while the GDP measure is below 1%) and has not shown any predilection of moving back towards the Fed's target.   Meanwhile, even with the upward revision in Q2 GDP figures, the Fed's forecast for growth still seems high and could be trimmed as early at this month's FOMC meeting when many expect the tapering decision to be made.  

While we don't think that central bank meetings nor the economic data will challenge the generally held views, there are a six items we would highlight:  In particular, we note that politics may trump economics in the week ahead.  

First, Japan's corporate spending report on Monday.  It is important because it will help shape the revision to Q2 GDP (Sept 9).  This in turn will be used in the debate over the retail sales tax.  It may help shape the discussion of the supplemental budget,or other measures, that may mitigate some of the short-run impact.

Second, on Tuesday the Reserve Bank of Australia is likely to keep its cash rate at the record low 2.5%. We expect the RBA's statement to keep the door ajar for an additional rate cut, but not necessarily October. The RBA meeting is ironically small beer ahead of the September 7 national election.  The polls point to a Liberal-National victory over the Labour Party, which has suffered many self-inflicted injuries.  The next prime minister is likely to be Tony Abbott, who has promised, among other things, to abolish the controversial carbon and mining tax.   This has the potential to alter the investment calculus.  

Third, the stronger the UK economic data, the less credible the Bank of England's forward guidance is likely to be perceived, though it is difficult to imagine the UK economy accelerating more from its current pace. Unlike the US and the euro area, where inflation is low in what may be economic acceleration, the UK's headline rate did not get very low during the stagnation phase, so the recovery is commencing with relatively firm price pressures.  It is not clear whether Carney will make a post-meeting statement.  Under King, when the BOE did nothing, it said nothing besides confirming the continuation of the policy.  This will be Carney's third meeting  He spoke after the first, but not the second.  

Barring significantly worse than expected data, the economy may be eclipsed by UK politics.  The defeat last week by the government over Syria may have been some payback for Blair's Iraq decision, in some bizarre way, but the ramifications for the Tory-led government are serious.  It could produce a shake-up in the government, especially with the parliamentary team.  It appears to have been a poorly worded motion and most importantly, poorly executed, but the damage is done.  

Ultimately, the road Cameron is leading the UK down is arguably one of marginalization, as the non-binding parliament vote, neuters its voice in the UN Security Council.  And this is even before, the referendum promised by Cameron (after the next election, in the run-up to which Carney has conditionally promised to keep rates low) on whether the UK should remain an EU member.   

Fourth, Draghi's press conference will be more important than the ECB meeting, which is unlikely to take fresh action.  The region's economy is recovering as the ECB expected, but it seems too early to conclude that the two-part forward guidance (rates will remain at current levels or lower for an extended period) is no longer needed or that the ECB is about to move away from "or lower" part of the construction.    

With money supply growth slowing and private sector lending contracting at an accelerated speed (June and July have seen the biggest contractions in EMU's short history), there is not reason to encourage a rise in interest rates, which is what would likely happen if the ECB so signaled.  In addition, the excess liquidity in the system is gradually falling as banks payback their ECB borrowings.  EONIA may face upward pressure in the months ahead.  

Separately, the ECB looks to be close to allowing minutes from its meeting to be published, as many other central banks do.  The minutes are expected to be similar to FOMC minutes, where individual names are associated with particular comments, for fear to curtailing a forthright discussion.  Nevertheless, the central bank minutes should be understood as a channel of communication more than a precise record.  Under current conditions of forward guidance, central bank communication is arguably more important than ever.  It makes no sense for the ECB to deny itself a useful channel. 

Fifth, at the end of next week, China has signaled it will re-open its bond futures market, which has been closed since a three-year experiment ended in 1995.  Initially, the futures on the 3% 5-year note, will be limited in its movement to 2% on either side of the previous day's settlement.  This is an important step in China's financial liberalization and follows the July move to abolish the floor on borrowing costs which had been previously set at 30% below the benchmark.

Foreign investors are increasingly able to access China's bond market through its Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) programs.   Chinese officials have expanded the quotas under QFII and have expanded the RQFII program to allow all qualified asset managers incorporated in Hong Kong to participate.

We note that China' official manufacturing PMI was released over the weekend.  It rose from 50.3 in July to 51.0 in August.  The consensus had expected an increase to only 50.6, perhaps restrained by the preliminary HSBC/Markit measures that showed improvement to 50.1.   The final report will be released early Monday in Beijing.

Economists had previously cut their growth forecasts for China and now news reports suggest several are raising their forecasts.  The PMI report forward looking components, new orders and new export orders rose impressively.  At 52.4, new orders are at their high reading since April 2012.  New export orders rose above 50 for the first time since March.  The HSBC/Markit preliminary measure had shown a decline in export orders.

Incidentally, though perhaps not unrelated, over the weekend South Korea reported its August exports rose twice what economists had expected (7.7% vs 3.8%).  This is the biggest increase since January. Separately, we note that Taiwan's export growth is expected to have accelerated.  It reports its August trade figures on September 9.   Hong Kong imports and exports accelerated markedly in July.   These developments would lend credence to the official PMI data.  The convergence between the two measures is for the HSCB/Markit measure to move toward the official one, rather than the other way around.   

Sixth, the G20 meeting begins Thursday.  The debate over Syria is likely to over shadow economic issues. Still, efforts on to curb some forms of tax evasion will continue to make slow progress.     The OECD's interim economic assessment of the G7 countries and China (to be published Tuesday) will provide a backdrop.   Representative from the emerging markets are likely to press their case to the major economies, especially that the US, should take their interests into account when conducting monetary policy.

Emerging markets have been hit by several shocks this year, and concern about retaliation against Syria is only the latest.  The depreciation of the yen exposed many emerging market countries, especially in Asia, balance of payments weakness, especially in the context of a slowdown in China.  Speculation of tapering by the Fed has exposed the vulnerability of many emerging markets to a reversal of portfolio flows.

It is not coincidental that US Treasuries just finished their fourth consecutive month lower, the longest losing streak since 1996, while Asian equities (MSCI Asia-Pacific Index) finished their fourth consecutive month down.  August was the sixth consecutive month that the JP Morgan EMBI premium over Treasuries rose.

The only thing more disruptive than being inundated with capital inflows for many emerging market countries is seeing the capital leave.  The industrialization of the US, Europe and Japan occurred under a regime of restricted capital movement.  In recent years, even the IMF has warmed to the idea of targeted capital controls under certain circumstances.

There has been some discussion, spurred by a paper discussed at Jackson Hole, that many countries can pursue independent monetary policies if and only if their capital account is managed directly or indirectly.  If a country manages its capital account and the flow of international capital is driven in good measure by the monetary policies of another country (or countries), say QE in the US and Japan, it is not clear how independent of a monetary policy it can pursue.  While recognizing the symbols of monetary independence, we suspect that on closer examination, monetary independence is not quite what it pretends to be.

Part of the rationale for the massive expansion of central bank reserves since the emerging market debt crisis, beginning in mid-1990s in Mexico and culminating the Asian Financial Crisis 1997-1998,was to serve as a type of self-insurance--to help smooth the adjustment process.  Investment capital primarily lent to emerging markets during a period of strong commodity prices, and unusually weak growth and low interest rates among the high income economies.   That period appears to be coming to an end.