Three of the four G5 central banks meet in the week ahead: the
Federal Reserve, the Bank of England and the Bank of Japan. Only the Fed is expected to change policy, and investors
are as sure that a 25 bp hike will be delivered
as they can be.
Our calculations, based on
assumptions where Fed funds will effectively trade (weighted average) for the
second half of the month and where it may trade on the last day of the month
(quarter end), suggested that fair value on a 25 bp hike would have the June contract
imply a yield of 1.04%. Before the weekend it closed at
1.0325%. Bloomberg, which recently changed its methodology, suggests the
market has discounted a 97.8% chance of a hike, while the CME is even higher at
99.6%.
Ironically, the third hike
since the US election last November is so greatly assumed, that it is not the most
important element of the FOMC meeting, though if it is not delivered, that would indeed overshadow everything else.
The simple, even if
unpleasant, truth is that the economy's rebound from the typical Q1 weakness is
disappointing, and more, to the point, the preferred core PCE deflator has
drifted lower for three consecutive months. The Atlanta Fed's GDP tracker
for Q2 has fallen from a little more than 4.0% to 3.0%. It has converged
with the median in Bloomberg's survey, but the risk is that it is too high
still. Our own thinking is more in
line with the NY Fed's tracker that puts it
at 2.25%. The NY Fed's model is not optimistic about Q3, for which it
puts GDP at 1.8%.
The most important part of
the outcome of the FOMC meeting is what it reveals about how officials see
these challenges. The market is not convinced that
there will be another rate hike this year (Bloomberg and CME calculations show
about a 42% chance that Fed funds target will be at 1.25%-1.50% before the end
of the year). Some officials, like Governor Brainard, have already
expressed some concerns. Are those shared? What about the reduced
expectations for fiscal support this year? The economic projections (dot
plot) may take on heightened significance.
There has been much
discussion that financial conditions eased in
the face of the Fed's gradual effort to remove accommodation. There are several different measures, but they agree
that financial conditions, which take into account various interest rates,
equity prices and exchange rates, are at two or three-year lows. This is a powerful argument in favor of additional Fed efforts. It
judges that level of monetary accommodation that the economy needs. It
judges it needs less, but for various, and admittedly not always well
understood, complex factors, conditions are more accommodative.
This need not be a question of whether monetary policy is market-dependent
or data-dependent. The confusion may lay with the
popular claim that the Fed has a dual mandate. In truth, it has three.
In addition to full-employment and price stability, is financial
stability. The tightening of financial conditions in Q3 15 deterred the
Fed from hiking in September, as it had encouraged investors to anticipate (and
strategists:-( ).
Investors also will focus on
indications about the coming new balance sheet regime, where the Fed will not
simply roll over all maturing issues. In effect,
it will unwind the swap that has been dubbed
QE. The Fed swapped reserves for Treasury bonds and mortgage-backed
securities. Officials want to make the process as least disruptive as
possible.
A preliminary proposal was
for a very small start (understood to be a few billion dollars) and gradually
(quarterly) increasing. There seemed to be an inclination to
include both Treasuries and MBS in the process. There was little
indication of the end game or desired
size of the Fed's balance sheet, but it seems to be understood that it will
have to be bigger than status quo ante.
The Bank of Japan meets. There seems to be an increase of interesting in the
Diet and media about the exit strategy. The message from the Bank of
Japan is patience. It is too early to have a meaningful discussion.
Although some measures deflation has
abated, the Q1 GDP deflator, which some economists argue is a more accurate
measure of prices, was minus 0.8%.
The fact that the central
bank's balance sheet is growing by less than the JPY80 trillion target ought not be confused with tapering. It is a modification to QQE. The shift to targeting
the 10-year yield necessitated buying fewer government bonds. Ideas that
the BOJ would revise up its growth forecasts were dashed last week when the estimate
for Q1 GDP was halved to 0.3%.
Nevertheless, the stronger foreign impulses and the increasing investment
may be bolstering the official confidence
of that economic growth is solid a little above trend, and the output gap
gradually is being closed.
Given that monetary policy
is still open-throttle easing, then it follows that officials would prefer the
movement of the currency not run in the opposite direction. Our general impression remains that Japanese
businesses and officials are content with JPY110-JPY120. However, barring a
change in rhetoric or practices, the near-term direction seems broadly driven by the change in US yields.
The Bank of England's
Monetary Policy Committee meets. No one expects a change in rates.
Forbes, recently the lone dissent for an
immediate rate hike will likely persist, but it is her last meeting. The
MPC is also short a Deputy Governor, making a 7-1 vote is the most likely
scenario. The electoral outcome may not be a direct economic factor or featured
in the minutes.
Sterling's decline is not
material. It appreciated by nearly 1.6% against the dollar so far in
Q2 and was up about the same in Q1. The euro-sterling exchange rate has
been in broad trading ranges since the
second half of last November, roughly GBP0.8300-GBP0.8850. It was at
GBP0.8340 at the end of June 2016. Sterling's decline was not capital
flight in the face of political uncertainty. British bonds and stocks rallied.
Both the two and 10-year government yields eased 2.5 bp. The FTSE
100 rallied (~1.0%) ostensibly aided by a weaker sterling, but the more domestic FTSE 350 advanced nearly as
much (~0.9%).
These central bank meetings
and last week's ECB meeting may render the market somewhat less sensitive to
this week's high frequency data. The high frequency data is expected
to confirm the general macro situation. Of
note, the US reports CPI (core likely stable at 1.9%), retail sales (soft
headline and steady but inspired 0.2% increase in the GDP components), and
industrial output (consensus expects a small gain, but the risk is for small
declines especially after the outsized 1.0% increase in industrial output and
manufacturing in April).
In Europe, the eurozone
reports April industrial production. It fell in February and March,
but it is expected to have improved, rising 0.5%. It will reaffirm the
sense the eurozone economy is growing at
a steady pace. In Sweden, price
pressures are expected to ease in April after a squeeze higher earlier.
The UK reports on inflation,
employment, and retail sales. Simply put, CPI and labor conditions are expected to
have been little changed, and retail sales will most likely weaken. The preferred CPIH expected to
have risen 2.6% over the past year, the same pace as in April. It
finished last year near 1.8%. The core rate may have eased to 2.3% from
2.4%. Employment growth is expected to be steady in May, and average
weekly earnings are expected to have been
steady in April, 2.4% above a year ago
level (3m/3m). The ILO measure of unemployment is expected to be steady
at 0.6%, but the claimant count spiked higher and remains elevated.
Retail sales jump 2.0% in April, partly due to the calendar effect of Easter.
Half or more of the rise will likely be
unwound.
Australia reports June
inflation expectations. It has been between 4.0% and 4.3%
since the start of the year. Even though in May was at the lower end of
the range, we see downside risks. It finished last year at 3.4%.
Australia also reports May employment data. It is likely to return
toward earth from its recent stellar performance, creating 60k jobs in March
and 37.4k positions in April. Last year's average was a little less than 9k a
month. The 2015 and 2016 average was almost 17k.
Political developments
compete with economic developments for investors' attention. UK Prime Minister May's top two advisers resigned, but there does not appear to
change in key cabinet positions. May is trying to hold on, but reports suggest
the pressure to resign is mounting. It is difficult to envision her last for long. In
terms of Brexit, EU President Tusk noted that the end date of
negotiations is fixed, the start date is
not. The controversial positions of the DUP,
upon the government will rely on to support the minority government, in some ways makes the
Tories appear even more desperate and weak rather than strong and stable.
Rates will likely remain lower for longer, and sterling may be a bit weaker than it otherwise would have been.
The UK appears to have entered a more fluid political situation just as
the negotiations were to begin. Its position seems to have been compromised. There still seems to be little scope for a soft Brexit if by that is mean a dilution of the EU's demand that the four freedoms must be respected.
At the same time, the risk is hubris among the celebratory
Labour. It is not clear how much was due to Corbyn's newly discovered charisma and
how much was a vote against something (what that something seems to be a bit of a Rorschach Test presently). Moreover, a moral victory may sound nice, but Labour still lost, and it
follows a drubbing in the local elections last month. Even if another
election is forced, as many now think
will be the case, perhaps later this year, a Labour government still does not
seem a likely scenario.
The first round of the
French parliamentary election is likely to show the hope and enthusiasm for
Macron and his new party that may incite
a realignment of French politics. It is a bit too stylistic to push
the point far, but it is as if Macron is taking part of the pro-business
right-wing of the Socialists and combining them with centrists and moderates
among conservatives (the Republicans and others) to forge this new political
movement. In addition to a strong pro-European stance, Macron has
indicated that labor market reforms will be his first big push.
Out of France and Germany,
where Merkel is in a strong position to be re-elected, the political climate in
Europe has a few areas of concern. Catalonia has indicated it will hold a referendum on
independence on October 1. This
will be a protracted conflict with Madrid, which has not given its approval.
In Italy, the great political compromise of adopting a German-like
electoral system appeared to collapse last week after a deputy from the
Five-Star Movement submitted an amendment. The prospect of fall elections had
weighed on Italian bonds, and the
collapse of the compromise saw the Italian
bonds rally.
Separately, we note the
large Italian banks are considering injecting capital into the two troubled
regional banks so to allow a precautionary recapitalization. This would avoid equity investors and
subordinated creditors from realizing losses. Reports suggest that a
junior credit of one of the troubled banks matures on June 21, so a decision
would seem to have to be made before
then.
Meanwhile, the Eurogroup meeting will approve the
tranche payment so Greece can make a seven
bln debt servicing payment to it official creditors next month. However, the meeting promises to be
dramatic. Unless the finance minister is
prepared to reduce Greece's debt burden in a meaningful and substantial way,
the IMF will participate as an adviser and not provide funds. More importantly, it means that Greece still will
not be able to return to the markets, and that, as we have warned, makes a
fourth assistance package likely. At the same time, given the thrust of the US Administration, it is possible
that it would block the IMF participating in a new
package in any event. There is the talk
of converting the ESM into a European
IMF, with how the power is allocated to
the institution an important distinction.
Lastly, US political drama
will not go away. It is still, however, too early to
tell the extent of the distraction on the legislative process that is taking
place. Committee work continues. The Financial Choice Act that
seeks to replace and repeal the national financial regulatory framework (Dodd-Frank)
passed the House of Representatives last week. However, its fate is
similar but different than the attempt to replace and repeal the Affordable
Care Act (Obamacare). The House version will not pass the Senate, and the
Senate leaders have indicated they have
other priorities.
US Attorney General Sessions is expected to testify before the Senate Intelligence Committee on the investigation into Russia's attempt to influence the US election. Sessions reportedly met with Russian official more time that he initially acknowledged. Separately, he also is being blamed for the ineffective strategy to impose a ban on immigrants from a select number of countries. There are reports that he offered his resignation. He is thought to be a likely candidate for the reshuffle of President Trump's senior team that has long been rumored to taking place soon.
US Attorney General Sessions is expected to testify before the Senate Intelligence Committee on the investigation into Russia's attempt to influence the US election. Sessions reportedly met with Russian official more time that he initially acknowledged. Separately, he also is being blamed for the ineffective strategy to impose a ban on immigrants from a select number of countries. There are reports that he offered his resignation. He is thought to be a likely candidate for the reshuffle of President Trump's senior team that has long been rumored to taking place soon.
Many are closely following
the tight congressional race in Georgia to fill the seat vacated by the new
Secretary of Housing and Human Services. It has become the most expensive
congressional election in history, and between the first round (April 18) and
the second round (June 20), the UK called and held a national election.
In any event, both parties see it
as an important harbinger for the midterm elections in 2018.
Disclaimer
Politics and Economics in the Week Ahead
Reviewed by Marc Chandler
on
June 11, 2017
Rating: