The market is fickle. It has jumped from one candidate to
another as the most likely Fed Chair. Until his belated and mild
criticism of the President dealing with race issues, economic adviser Cohn was
regarded as the most likely successor to Yellen at the head of the
Fed.
When Cohn fell out of favor,
it was seen as a contest between Yellen
and former Fed Governor Warsh. Powell's stock rose recently, and there have been reports
that Treasury Secretary Mnuchin favors him. Yellen had slipped in
the betting markets, as president-as-disrupter has little time for tradition or
the fact that Yellen has steered the Fed quite remarkably through tapering,
rate hike and now balance sheet reduction with very little drama. Today she has moved back into second place
behind Powell.
Yesterday, reports suggesting that Trump
was enthusiastic after meeting with Taylor saw his stock rise in the betting
websites and may have prompted a reversal in the yields. The US 10-year yield closed higher,
and the December futures contract surrendered the gains scored in the wake of
the disappointing CPI report before the weekend. The 2-10 curve did not
change; yields rose nearly uniformly by three basis points. We caution
against reading too much into the process whereby Trump meets the different
candidates for the post that his staff has identified. Also, although the
Taylor rule would suggest higher rates may be appropriate, Taylor himself is
opposed to blindly following any model. Nevertheless, many see Taylor as
being more hawkish than Yellen or Powell.
PredictIt has Powell as the most likely
nominee, with a little more a one-in-three chance. A week ago, his chances were
even-money. The new new thing is
that Taylor. His odds improved to improved to one-in-five from one-in-ten
yesterday, but have eased back to about one-in-six It is pretty much a
dead heat between Taylor and Warsh, with Yellen in second with a one-in-five
chance.
Bank of England Governor Carney testified
today, affirming that a rate hike may be appropriate in the coming
months. He did
not seem to break any new ground in his first testimony before Parliament's
Treasury Select Committee since the June election. Carney did acknowledge
that inflation is close to a peak, which is why many participants were did not anticipate the hawkish turn by the
MPC. In early September, a Bloomberg survey found a little more than 20%
of its survey respondents expected a hike this year. Now full three-quarters do.
Today's UK CPI data was in line with
expectations. The
new preferred measure CPIH ticked up to a 2.8% year-over-year pace from 2.7%,
while CPI rose 0.3% for a 3.0% year-over-year pace. The core rate was
unchanged at 2.7%. Separately, the government's house price index rose
5.0% in August from a year ago, which is up from a revised 4.5% pace in
July (initially reported at 5.1%).
The message the market heard from Carney
is that the rate hike that is likely in the coming month will likely be a one-off as last year's cut is unwound. Short-sterling futures flattened at
lower yields. That is to say that interest rates fell with deferred contracts seeing sharper declines in interest rates than the
nearby contracts. However, sterling's roughly 0.5% decline today
owes itself just as much to politics as economics.
That nearly the major currencies are
trading heavily against the US dollar today,
make take some of the sting from sterling's decline, but it is one of
the heavier major currencies today. Prime Minister May's trip to Brussels seemed not to
have broken the logjam. The effort and then failure weighs on fears of
the UK being amputated from the EU
without a new deal. The next window of opportunity to shift the
negotiations will take place at December Summit. The EU seems to be clear
on what it needs from the UK, but the UK officials are reluctant to do what is required seemingly in the hope of striking a better deal. Perhaps,
it is my own lack of imagination, but it
is difficult to imagine a better deal than the UK had, with its numerous opt-outs and rebate.
Sterling's decline brought it within
spitting distance of the 61.8% retracement objective of its rally from
approaching the $1.3025 area on October 6 to the high at the end of last week
near $1.3340. That
retracement is found near $1.3145 and
today's was near $1.3155. Initial resistance is seen in the $1.3200 area and then $1.3240-$1.3250.
Italy's central bank is in the news today. There seems to be an agreement
between a couple of opposition parties, including the Five-Star Movement, and
the main governing party, the PD that the Bank of Italy should have a new
governor when the Visco's term is complete at the end of the month.
Following the reforms at the Bank of Italy, Draghi was the first new
governor. He took the job at the ECB before his term was complete.
Visco is the first governor to complete his term under the new rules.
Many had expected Visco to be appointed
to a second term.
Visco has been blamed for Italy's banking
woes, even though the banking systems challenges pre-date his tenure and
important steps have been taken over the past several quarters to begin
addressing the sector's challenges. When fully taking into account the amount of
non-performing loans, the reserves put aside to cover them, the amount on
average of residual value, we suspect that Italy's banking system may be in
better shape than the popular press recognizes in its focus on only the amount
of NPLs.
Meanwhile, with the LDP fortunes looking
better in the coming weekend election, there is heightened speculation that BOJ
Kuroda could be reappointed to a second
term. His current
term ends in mid-April 2018. It is unusual for a BOJ Governor to serve a
second term. It has not happened in a generation. While Kuroda's
reappointment would signal continuity of policy, we suspect that if Kuroda is not reappointed, someone with his activist monetary policy commitment would be named.
The Party of Hope did not offer an alternative to Abenomics in general or
Kuroda's monetary policy in particular. The two main differences are over
the 2019 retail sales tax and nuclear power.
Japan's election this weekend is the next
important political event.
Next week's ECB meeting is the next key central bank meeting. It is
particularly important because the ECB is expected to provide details of its
asset purchases starting next year. Investors are particularly focused on the length of the
program and the amount of assets that
will be purchased.
A new twist to the plot was suggested this week. A report citing "central
banker officials familiar with the matter" suggest that some beginning
with the maximum they are willing to see the ECB's balance sheet expand.
The limit is said to be 2.5 trillion euros. Where this number comes from
or what it is to signify is not clear. It is
suggested as if there was a meeting of the minds, so to speak at the
beginning of the operation.
At the end of this year, the Eurosystem's
balance sheet would stand near 2.28 trillion euros. This
in turn implies that next year's purchases may be around 200 bln euros.
If the drawn-out over nine months, this
is about 22 bln euros a month, down from 60 bln currently. A clear
advantage of the smaller amount is that it eases the concern of shortages under the current rules. And to our
earlier point, the ECB could add its reinvesting of maturing proceeds,
estimated at 10-15 bln euros a month in 2018 to the net new purchases, and
announce its gross purchases target.
We recognize that there are important
periods in which interest rate differentials do not drive the euro-dollar
exchange rate, but over time we have not found a better anchor. We have noted that the US
two-year premium has been trending higher for the last couple of months.
It has not been below 2.00% for two months and reached almost 2.38% today, the
highest since 1999. When the euro
peaked against the dollar on September 8, the US premium was 2.02%.
The 10-year premium has also trended
higher. Today, the
US 10-year yield was 195 bp above a similar German Bund. It is the most
in three months. It is moving above its 200-day moving average (~193 bp)
for the first time since May.
The euro frayed the lower end of the band
of support we identified at $1.1750. A convincing break of this area would signal a return
to the low near $1.1670 seen after the recent US employment data, with the
August lows set near $1.1660. The topping pattern that the euro appears to have carved out projects toward
$1.1600. The $1.1680 area also may correspond to the neckline of a larger
topping pattern that would project toward $1.1280 (more on that
soon).
Central Bank Chiefs and Currencies
Reviewed by Marc Chandler
on
October 17, 2017
Rating: