The focus of the week that’s just ending was first and foremost, the US mid-term elections, and secondly, the FOMC meeting. Both went pretty much as expected: the Democrats took the House, the Republicans retained the Senate. As for the FOMC, they kept rates unchanged. But both events will have implications for the future.
The main surprise in the US elections was the lack of any surprise – the result was pretty much as the polls had predicted, which may be a surprise given the poor history of polls over the last few years. They were indeed a rebuke to Trump, but not as much as one might have thought, given the passion he arouses in many people. It’s clear that – how can I say this tactfully? – there are people of very different views in different places in the US. The urban/rural split in US politics couldn’t be clearer.
What will be the policy implications? On the one hand, it will probably stop the Republicans from implementing more of their agenda, but on the other hand, they were having a pretty hard time doing that to begin with – aside from appointing judges and dismantling pollution controls, it’s hard to discern much of an agenda. Don’t look for any more tax cuts, but increased infrastructure spending could be one point that everyone agrees on.
The Democrats may be less in favor of tariffs than the administration, but historically the Democrats have not been dogmatic free trade advocates and the current crop is no exception, as far as I can tell. (In fact the tariffs weren’t a major issue in the election debate.) And in any event, it seems like Trump is getting ready to cut a deal with China already.
One good point is that the Democrats have historically be less interested in shutting down the government, so the negotiations over the debt ceiling should be easier.
In any case, I only have data by President, not by Congress, but the fact is, both stocks and the dollar tend to do better under the Democrats than under the Republicans. So there is no inherent reason why the dollar should fall just because the Democrats have some power again. On the contrary, if they can restrain the more extreme tendencies of the administration, it should be all for the good, as uncertainty will be reduced.
As for the Fed, Thursday’s statement was virtually identical to September’s, except of course for the section about raising the fed funds target. They said that the unemployment rate “has declined” rather than “has stayed low,” which is a bit better, but on the other hand, they also noted that business fixed investment “has moderated” rather than “grown strongly.” Otherwise, no changes at all. We’re still on track for a rate hike in December, in my view, although a December rate hike is only priced in as a 74% probability. It’d be a buyer.
We’ll have to wait for the minutes to hear about any discussions they may have had on some of the technical problems that the Fed faces, such as paying interest on reserves or the crunch in the money market cause by their reduction in bond holdings, or whether they started discussing the framework of monetary policy as was adumbrated back in the August minutes. Before then though we may get some color on the mood of the meeting when Fed Chair Jerome Powell speaks on Wednesday (see below).
The coming week: OPEC, US & UK CPIs, Japan GDP
The week starts on Sunday, when the Joint Ministerial Monitoring Committee, a six-member body representing OPEC and non-OPEC oil ministers, meet in Abu Dhabi to discuss scenarios for production next year. The background to the meeting is record US production, rising inventories, and falling prices. OPEC’s own production has also been rising after an agreement back in June to lift production. You can see from the graph how a) global oil production has increased despite the OPEC cuts, and b) how the US and other non-OPEC producers have used the OPEC cutbacks to increase their production.
The meeting will only put together an interim review before the ministers meet next month, but still, their agreement could indicate what the group as a whole is likely to do. I think they may recommend cutbacks in production, which would tend to be bullish for oil and for oil-related currencies, such as CAD.
As for the indicators, there’s nothing on the schedule on Monday and little on Tuesday or Friday. Wednesday and Thursday though have a lot packed into them.
The big indicator of the week will be the US CPI on Wednesday. The CPI isn’t the inflation gauge that the Fed actually targets –that’s the personal consumption expenditure (PCE) deflator, or more accurately, the core PEC deflator – but the market pays attention to it almost as if it were. In any event, with the employment side of the Fed’s dual mandate more than fully met, it’s only inflation that’s constraining the Fed from tightening faster. With headline inflation expected to rise back to 2.5% yoy and core inflation forecast to stay at 2.2% yoy, the figures should confirm that the Fed was right to say again that inflation “remains around 2%” and there isn’t any reason to slow the pace of tightening. USD-bullish.
Later Wednesday, Fed Chair Jerome Powell will discuss national and global economic issues with Dallas Fed President Robert Kaplan at an event hosted at the Dallas Fed. This will be closely watched, because there was no press conference after Thursday’s FOMC meeting and so this is our first opportunity to get more detail on that meeting.
Other major US news expected out during the week includes retail sales on Thursday and industrial production on Friday, although industrial production isn’t that significant for the FX market.
Wednesday also sees GDP announcements from Japan and Germany, plus the second estimate of EU-wide GDP.
Japan’s economy is expected to have contracted somewhat in Q3. Weak exports, sluggish business spending and a fall in consumer spending all add up to a fall in output. Thursday’s weak machinery order figures, which showed the largest month-on-month decline ever, make a negative surprise more likely. That should in theory weaken the yen. Then again, if Japanese stocks decline as a result, that might strengthen the yen. Or perhaps, judging from the impact of the machinery order figures, it might have no effect on the yen at all.
Later in the day, Germany will be announcing its Q3 GDP, three hours before the preliminary EU-wide GDP is released. We’ve already had the advance EU-wide Q3 GDP; this is the preliminary version, i.e. the second estimate, so there shouldn’t be that much of a change. As you can see, normally there isn’t any change, and when there is, it’s usually minor, 0.10 percentage point.
What I wonder though is, do people pay more attention to the Germany GDP than to the EU-wide GDP? The thinking might be that where Germany goes now is where the EU as a whole is going next. The German GDP figures may still affect the market anyway. In that case, the expected small decline (-0.1% qoq) in German GDP would contrast with the small rise (+0.2% qoq) in EU-wide GDP.
It’s a big week for UK indicators. There’s the employment data on Tuesday, CPI on Wednesday, and retail sales on Thursday. CPI will naturally be the most important one.
But as usual, Brexit takes priority over economics. There seems to be some movement towards compromise, but the fundamental conundrum remains: the EU either needs a border with Britain, or it needs Britain to be in the customs union. Britain refuses to have a border and refuses to commit to indefinite membership in the customs union. While there has been some speculation in the Times of London that an agreement is near, other papers don’t seem to be echoing this view. The Financial Times noted that a leading member of the Democratic Unionist party, whose support is essential for keeping the Conservatives in power, said PM May is “heading for a no deal” in the Brexit negotiations. I expect GBP to sway back and forth based on Brexit news, with the odd gyration based on economic indicators periodically.
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