Marking Time

The US dollar remains in a consolidative mode as participants await fresh incentives.  The bulls have been denied fresh excuses to push the trend that has carried the US Dollar Index higher for an unprecedented ten consecutive weeks. 

NY Fed's Dudley, like Yellen played down the Fed's own forecasts, arguing that the confidence around the longer-term forecasts were so low as not to avail themselves as very useful guidance. We identified another reason not to put much weight on the dot plot.  Namely that by including all the Fed regional presidents, not just the voting members,  dilutes the policy signal. 

The unexpected decline in existing house sales, which had been one of the bright spots in an otherwise disappointing housing market reported yesterday, coupled with Dudley's dovish talk has kept the bulls cautious.  Not only are existing house sales lower than a year ago in August, but the amount of time needed to sell has increased (53 days from 43 days last August) and the unsold inventory has risen (4.5% year-over-year).  

Separately, the Chicago Fed's National Activity Index collapsed to -21 in August from downwardly revised 26 in July.  It is the first negative reading since January.   Our warning that the US labor market may be losing some momentum may be more broadly applicable to the US economy.  It appears to have lost some momentum as Q3 wound down.  While Q2 growth is widely expected to be revised higher later this week (4.6%+ from 4.2%), this pace is unsustainable.  The economy is expected to slow by more than one percentage point in Q3, and Q4 may be a bit lower still.  

Many investors have moved on from simply focusing on the timing of the first Fed hike to considering the pace of the tightening and the terminal rate of Fed funds.  A CNBC poll before Jackson Hole found consensus expectations for a peak in Fed funds rate of 3.15% in 2017.  The August 2017 Fed funds futures contract, which admitted is not actively traded,  implies an effective average Fed funds rate of about 2.40%.  

That the Fed funds rate has a lower peak in this business cycle than the previous one is not surprising nor unique.  The Bank of Canada indicated similar considerations.  Yesterday it reduced its estimate for the "neutral interest rate," which is consistent with full capacity utilization and stable prices, from 4.5%-5.5% to 3.0%-4.0%.

There are two main pieces of economic news today.  The first is HSBC's flash manufacturing PMI for China.  It was a bit firmer than expected at 50.5, up from 50.3 in August.  Many expected a small decline.  Forward looking indicators, like new orders and new export orders increased. Disappointingly, employment and prices fell.  The news, coupled with reports that China's large banks are poised to ease mortgage policies, helped lift the equity market.  The Shanghai Composite advanced 0.8% and held above the 20-day moving average.  It has not closed traded below this average since the very start of the month.  

The second piece of economic news today is the flash eurozone PMI readings.   Germany's readings continue to disappoint, putting the final touches on what appears to be a poor quarter, after contracting in Q2.  The manufacturing PMI fell to 50.3 from 52.0.  The consensus was for 51.4.  The service sector fared a bit better than expected, but rising from 54.9  in August.  The 55.4 reported in September compares with 54.6 consensus expectations.  It was sufficient to lift the composite to 54.0 form 53.7

Whatever glimmer of hope generated from the French manufacturing PMI rising to 48.8 from 46.5 in August was dashed by the first sub-50 reading from the service PMI since June.  The 49.4 headline compares with 51.1 in August and consensus expectations of 50.4.  The composite slumped further to 49.1 from 49.5.

Some of the pressure seen on the yen has been thought to come from Japanese accounts.  With Japanese markets closed today the yen offers appear to have evaporated, leaving the yen as the strongest of the major currencies, gaining about 0.4% against the greenback.   We have noted that the risk-reward for short-term speculators shifts as the JPY110 area is was approached, and there have been cautionary signals from Japanese corporates, the junior coalition member, and a former BOJ official.

Sterling is trading heavily, having been turned back from $1.6400.  It is off about 0.3% against the greenback in the European morning.  Some profit-taking is seen on the crosses, against both the euro and yen.  Against the dollar, initial support is seen near $1.6285 and then $1.6230-40.   It has not been helped by the continued softness of interest rates.  The discount to the 10-year yield has grown and the March 2015 short-sterling contract implies an 86 bp yield, matching a two-week low.