As a fairly trendless week for the dollar comes to a close, all eyes are on Friday’s US nonfarm payrolls. While the market holds its collective breath waiting for this monthly ritual, I’m not sure it has that much of a lasting impact. As the graph below shows, looking at the last six times the figure disappointed the markets (as may be the case this time, seeing as the ADP report was well below expectations), the dollar was little changed or stronger overall three days later in four of the six cases. Last month it was noticeably stronger a week later. The NFP figure is clearly important, but not decisive in setting the dollar’s course.
Much of the action now is in emerging market (EM) currencies, not developed markets (DM). The spread between the JP Morgan G7 and EM volatility indices, a weighted index of 3m at-the-money-forward options, has blown out to levels only seen before during major crises. This is entirely due to the surge in EM vol, as G7 vol has remained fairly constant. I don’t think this necessarily presages any great trauma for the DM though. Looking at the other two times this happened, in both cases it was resolved by EM vol coming down, not by DM vol going up.
The relative calm in DM currencies may be in part because while politics in the US continue to explore new and uncharted degrees of bizarreness, policy is more or less on hold. Even the trade concerns have wound down a bit after the US and Mexico reached a pseudo-agreement on NAFTA and a fairly firm deadline (29 September) was set to for a similar deal with Canada. Two weeks ago, I mentioned the Baker, Bloom and Davis indices of US policy uncertainty. At that time the latest data out was from July. The August data is now available, and it shows a marked decrease in trade policy uncertainty – still the major concern, and still well above the historical average, but down considerably from July. Other measures of policy uncertainty are mostly slightly lower too.
At the same time, European policy uncertainty is also diminishing, despite the disagreements between Merkel and Macron and the continued doubts about Italian fiscal policy. This could underpin EUR/USD over the next several weeks and at least prevent it from falling much further.
In any event, the EM crisis is clearly worrying some investors. The safe-haven CHF and JPY have been the best-performing G7 currencies this week, although not by very much (up +0.39% and +0.31% vs USD on the week).
At the opposite end, CAD was far and away the worst performer (-0.85%). Most of the decline came on Monday, as it looked like Canada was going to be excluded from the agreement that the US and Mexico had worked out. However late Thursday the currency surged after Bank of Canada Deputy Governor Carolyn Wilkins said the BoC Policy Board had discussed whether to hike rates more rapidly, before deciding instead to stick to a “gradual” path of rate increases.
Still, although Canadian rate expectations over the next several months are up a basis point or two, those over the next two years or more are still slightly less than they were even a week ago. I think the CAD remains vulnerable unless and until the US and Canada reach an agreement, which has to be done by 1 October. I should say though that I do expect them to reach some agreement by then, although the Canadians probably aren’t kidding when they say no deal is better than a bad deal.
Working as a firefighter has been described as weeks of boredom interspersed with moments of terror. That pretty much sums up the coming week. As usual for the second week in the month, there aren’t that many major economic indicators out. However, Thursday sees a Bank of England meeting, an ECB meeting, and the US CPI out all in a matter of hours. That should keep people busy for a while.
Neither the Bank of England nor the ECB is expected to make any move in rates for some time. In fact, both have pretty much said so explicitly. Still, the markets will be interested to hear what the central bankers have to say.
At their last meeting a month ago, the Bank of England voted unanimously to raise rates 25 bps to 0.75%. They said that the economy was developing broadly as anticipated in the May Inflation Report, meaning no significant surprises had occurred, and continued to forecast “an ongoing tightening of monetary policy…at a gradual pace and to a limited extent.” I wouldn’t expect to see any major change in that forward guidance. The two things to watch for are a) any change in their judgement that “the UK economy currently has a very limited degree of slack,” which is the main point underpinning their tightening bias, and b) any hint of the thinking of the MPC”s newest member, Jonathan Haskel, who will be attending his first meeting. (I would doubt though if there will be anything to dissent from this month.)
EUR/GBP hasn’t been that volatile on recent Bank of England days, even last month when they changed the rate (as was widely anticipated). I don’t expect much in the way of market fireworks this coming week, either.
I don’t expect any major change in the ECB’s statement, either. They have said that they will reduce their monthly bond purchase to €15bn a month from €30bn after September and then stop them at the end of the year. Investors will of course expect confirmation that this will take place as expected, and indeed it should. Otherwise there has been little change in the inflation or growth picture since the last meeting on 26 July and so little reason for them to change their views. I would still expect them to pronounce the risks to growth as “broadly balanced” and say that “an ample degree of monetary accommodation is still necessary.” Perhaps with the end of the asset purchase program in sight, we might get some clarity on their reinvestment policy. They didn’t discuss it at the last meeting, but it could come up at this one.
Note that while we have seen above-average volatility in EUR/USD on days when the ECB has surprised the markets, generally speaking, as often as not over the last two years ECB days have not been unusually volatile. I wouldn’t expect much excitement at this meeting, unless as I said they made some surprise change in their plan to taper off their bond purchases.
The US CPI meanwhile is expected to show a slight slowdown in headline inflation but for the core inflation rate to remain steady, and both well above the Fed’s 2% target (albeit that target is expressed in terms of the private consumption expenditure (PCE) deflator, which also remains above 2%). The dollar could get a boost from the continued above-target inflation rate. At the FOMC’s last meeting, they again said that both headline and core inflation “remain near 2 percent,” but if things continue to go this way, eventually they’ll have to change that to “above 2 percent,” at which point the market may finally be convinced that they’ll keep hiking.
The other major US indicators are on Friday, when we get US retail sales, industrial production, and the U of Michigan consumer sentiment survey. It will be interesting to see if news that some members of the US Cabinet feel they have to protect the country from the President has any impact on sentiment. My guess is that as long as the stock market keeps going up and the unemployment rate keeps going down, no one will care about what shenanigans go on in the government. Finally, the Beige Book comes out on Wednesday.
Elsewhere, we get a number of indicators out of China during the week. Monday brings the Chinese CPI and PPI, while Thursday brings the retail sales, industrial production and fixed asset investment. Little change is expected for any of them, however.
Britain has a number of important indicators out as well. Monday is “short-term indicator day,” with the trade and industrial production data coming out, as well as the new monthly GDP figure. So far the UK monthly GDP data doesn’t seem to have garnered much attention, but given how important the monthly GDP figures are in Canada, the only other country I know of that produces monthly GDP data, I expect it will soon be a major focus for UK investors, particularly as the MPC is focusing on the output gap. The monthly GDP 3m/3m change is expected to accelerate to 0.5% from 0.4%, which could prove positive for the pound. UK employment data comes out in Tuesday.
For Japan, the focus will be on the PPI and machinery orders on Thursday.
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