After wobbling a bit for a few days, markets recovered their poise and it’s back to risk-on despite warnings from the world’s central bankers that the worsening trade disputes could derail the global economy (see below). S&P 500 was up only a bit, but NASDAQ 100 and Russell 2000 gained more to close at record highs. Chinese stocks though continued to decline on a Xinhua report that China will take strong measures to counter the US tariffs. JPY and CHF fell in the calmer atmosphere.
In the currency market, the big story of the day is clearly NZD, which fell sharply ahead of the Q1 GDP report. The figure came in exactly as expected, with growth slowing to 0.5% qoq (2.5% yoy) from 0.6% qoq (2.9% yoy) in the previous quarter. The qoq change is 0.2 ppt less than the Reserve Bank of New Zealand (RBNZ) forecast last month and suggests that the RBNZ may be on hold for even longer than people had thought. Investors already saw little chance of a rate hike this year (12% probability) and some forecasters are now saying they won’t move until 2020.
Although the figure exactly matched expectations, there was no “sell the rumor, buy the fact” response; on the contrary, NZD kept falling afterwards. Oddly enough, NZ bond yields also rose; usually you would expect yields to decline after a weak GDP figure. But the auction of 20-year bonds had the lowest bid-to-cover ratio since they started issuing such bonds in 2016, while 10-year yields were up 8 bps. Perhaps the idea is that the government will have to embark on a more stimulatory fiscal policy? Really though, growth of 2.5% yoy is hardly a recession (yet). I think the decline is overdone and NZD should stage a modest comeback today, especially with risk sentiment improving.
USD gained on the day as Fed Chair Powell reiterated his faith and confidence in the US economy. Speaking at the ECB’s Sintra forum, Powell said, “With unemployment low and expected to decline further, inflation close to our objective, and the risks to the outlook roughly balanced, the case for continued gradual increases in the federal funds rate is strong,” He did mention concerns over US trade policy as the one factor that could derail the economy. “Changes in trade policy could cause us to have to question the outlook,” he said. “For the first time, we’re hearing about decisions to postpone investment, postpone hiring.” The other three central bank heads on the panel chimed in as well on that theme, all with negative comments as you can well imagine.
Finally, we have some activity on the schedule for today.
There are two central bank meetings: the Swiss National Bank and the Bank of England. Plus an Ecofin meeting.
The Swiss National Bank (SNB) is simple. It’s on hold so long as the ECB is on hold. They will never move first, because their main target is the EUR/CHF exchange rate, which has started to come down again, no doubt much to their distress. Since the ECB just announced that they’ll keep rates on hold at least until the summer of 2019, don’t expect anything from the SNB for the next year, either.
The Bank of England is certainly going to be the more interesting of the two. The market sees almost no possibility of raising rates this month. Rather, the question will be what hints they give about the future course of policy, especially a rate hike at the next meeting in August. After three months of declines, inflation stabilized in May at an above-target level. Does that make it more likely that they’ll hike in August? The odds of an August rate hike are put at slightly less than 50-50, probably because the Q2 data so far have been mixed. The manufacturing, trade and pay data for April was weak, but retail sales rebounded and the May services PMI was fairly strong. The mixed data makes it unlikely that the Monetary Policy Committee (MPC) will change its view notably in either direction. I would expect a similar tone to the May statement and the same 7-2 vote to keep rates unchanged, with result that GBP probably ends the day a little weaker.
Later in the day, BoE Gov. Carney will deliver the Mansion House Speech, so we can expect to get a little more clarity on the situation then. I think he’s likely to adopt a more dovish tone in this speech while still keeping to the Bank’s tightening bias.
A rate change – or even a change in tone – is more likely in August, when they issue a new Inflation Report with new forecasts. That will also be the last meeting with Messrs. McCafferty and Saunders, the two uber-hawks who keep dissenting in favor of a rate hike. They’re both leaving the MPC shortly after the meeting, to be replaced by people who apparently have more middle-of-the-road views. It might make it more difficult to get a consensus for a rate hike after that.
The Eurogroup/Ecofin meeting of finance ministers from the EU and the Eurozone meets. As you may have already guessed, they’ll be discussing Greece. The country’s last debt repayment is scheduled for 2059, so I imagine that Greece will be a semi-permanent agenda topic for them. As for what they’ll be discussing, they have to decide on the final disbursement to Greece and possibly on additional debt relief for the troubled country. It’s more complicated than that, and the IMF is in there somewhere, but as long as they can paper over the cracks until 2059, then it shouldn’t be a major factor for the markets again.
Now if it were Italy instead of Greece that they’re discussing, that would be a different story, because Italy is too big to bail out. But Italian bond yields have come back down substantially, indicating that everyone thinks the country is more or less OK for now. (But notice that spreads have not returned to where they were before the election.)
Other indicators and events
Today and tomorrow, the Bundesbank and the Banque de France will hold a joint conference in Paris on “Monetary Policy Challenges.” International experts will discuss the current challenges facing monetary policy and the international role of the euro. Bundesbank President Jens Weidmann will give the keynote speech today. There are a number of papers and panel discussions that might be worth listening to if you happen to be interested in such topics as “How Global Currencies Work: Past, Present, and Future,” but since most of the speakers are academics except for Weidmann and Banque de France’s Villeroy (who gives a 15-minute welcoming speech), probably only Weidmann’s speech might have something of immediate interest to the market.
Later in the day, there will be a conference in Vienna about The Future of the EU, a few days before Austria takes over the Presidency in the EU Council. ECB Governing Council members Ewald Nowotny and Gaston Reinesch (Governor of the Central Bank of Luxembourg – did you even know that Luxembourg had a central bank? There were 582,972 people in Luxembourg in 2016, and before the euro, the Luxembourgish franc was tied one-to-one with the Belgian franc. What do they need a central bank for?) will participate in a panel discussion on Competitiveness, Solidarity and Subsidiarity. In case you’re wondering, “subsidiarity” is EU jargon for taking decisions at the most local level possible rather than at the EU-wide level.
As for the routine data, the UK public sector net borrowing (PSNB) (excluding banks) is expected to rise, except since the figure isn’t seasonally adjusted, we have to look at the 12-month moving average to make any sense out of it. The forecast amount would keep the 12-month average on a gradual decline, consistent with the government’s pledge to bring down borrowing.
But what would be the effect on GBP? Would healthy government finances be considered a plus and therefore good for the currency, or would a less expansionary fiscal stance, coupled with fewer gilts for foreigners to buy, mean a weaker currency? Hard to tell. The Mundell-Fleming model of exchange rate determination shows it can go either way. So I just looked at the result – what happens to GBP/USD and EUR/GBP following the release – and found that in fact this indicator has virtually no correlation with the subsequent movement of the currency. Apparently I’m not the only one who can’t figure out how it should affect the currency. I’m therefore going to stop following it.
The Philadelphia Fed manufacturing survey is expected to be down somewhat, although still well in expansionary territory. This compares with the Empire State survey last Friday, which was forecast to fall to 18.8 from 20.1 but in the event rose to 25.0. Will we see a similar outperformance this time too? Looking at the data for the last 10 years, the two have moved in the same direction 45% of the time, meaning it’s basically random.
Finally, overnight Japan releases its national CPI data. The national rate of inflation is expected to follow the Tokyo rate of inflation and decelerate somewhat. In particular, the poor pitiful core inflation measure is expected to be a little closer to the dreaded zero line. No wonder the Bank of Japan last week changed its statement to read that inflation was “in the range of 0.5-1.0 percent” rather than “around 1 percent” as they said in March. (They’re referring to the old-style core CPI, which just excludes fresh food. It’s expected to remain at +0.7% yoy this time.) In theory a slower rate of inflation should be negative for the currency, but since nobody expects the BoJ to loosen rates further nor to tighten at any time in the foreseeable future, it probably won’t have much effect.
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