The dollar remains strong vs EM currencies but has been weakening vs the majors. The crisis in Turkey, the main focus in emerging markets last week, has receded from the headlines for the time being. Not settled by any means, but TRY was relatively steady this week after collapsing a week ago. Other EM crises have arisen in its place though, each with its own particular story: ZAR on a bizarre tweet by Trump; BRL on former President Lula’s growing lead in the polls for October’s presidential election (even though he’s barred from running as he’s in jail); and MXN on hesitation about NAFTA after it seemed like a deal might be imminent.
For the major currencies however the FX market has been focusing once again on the turmoil in US politics and the Trump administration’s trade disputes as the US and China implement more tariffs on each others’ goods.
The graph below shows the Baker, Bloom and Davis indices of US economic policy uncertainty, drawn from the frequency of newspaper mentions of policy uncertainty, among other sources. The long-term average is 100. What it shows is that the uncertainty surrounding fiscal policy (the purple line) is around average, while the uncertainty surrounding monetary policy (green line) is well below average. The uncertainty around trade policy (red line) however is tremendous. That’s the biggest uncertainty right now.
Overall though the uncertainty surrounding policy has been declining over the last few months.
In fact, with the exception of trade, no FX-relevant area is showing particular uncertainty right now. That’s one reason why the trade issue is so big right now – not much else to worry about, except maybe US politics, and that’s been a zoo for many months now.
The other reason the dollar has been weak recently is disappointing US economic statistics. The extremely weak housing figures – sales of existing homes fell to the lowest level in two years in July – are just one of a run of below-expectations indicators. Looking at August’s indicators, 14 missed expectations, five beat and three were in line – meaning almost three indicators missed expectations for every one that beat. That’s pretty disappointing. But while US economic indicators have started to surprise on the downside, EU indicators, which had been undershooting expectations for some time, are now coming in more or less in line with expectations. Europe is now ahead of the US for the first time since mid-February (as are Japan and the UK). That may be one reason why the dollar is coming under some pressure.
The focus during the coming week will probably remain on the trade fracas and the gathering US political crisis. Albeit US politics have lurched from crisis to crisis for many months now, this time it does seem to be getting a bit more serious. As one legal commentator said in the New York Times, “We are approaching a reckoning, where criminal and perhaps impeachment processes will begin asking hard questions.”
There are not that many major indicators coming out to take the market’s attention off of politics. The main point of interest will be an update on inflation from the US, EU and Japan.
In the US, the economic focus following the Fed’s Jackson Hole symposium will be on Wednesday’s 2nd estimate of US GDP and Thursday’s July personal consumption expenditure (PCE) deflator. 2Q GDP is expected to be revised down slightly to 4.0% qoq SAAR from 4.1%, which would not be a significant change.
The PCE deflators however are a different story. The core PCE deflator, the Fed’s preferred inflation gauge, is expected to hit the Fed’s 2.0% inflation target. That’s BINGO!
The July FOMC statement said that headline and core inflation “remain near 2 percent.” If this statement changes in September to “have reached the Committee’s symmetric 2% objective,” then it will be success on both parts of the dual mandate, and no reason to hold off bringing rates back to a more normal level – which by the way would be 4.45%, if the real (i.e., inflation-adjusted) Fed funds rate were to return to the average level prevailing before the 2008 financial crisis (which it won’t, but just saying…).
The EU inflation figures also come out during the week, with German CPI on Thursday and EU-wide CPI on Friday. In this case though no accelerating in inflation is expected, meaning no reason for EUR to get a boost. In that case, the best hope for the euro is Monday’s Ifo survey, which is forecast to show an improvement in expectations for Germany.
Japan sees its usual end-of-month data dump, with employment data, industrial production, retail sales and Tokyo CPI all coming out Friday morning Tokyo time, together with the weekly capital flows data. The Tokyo CPI is probably the most important of these for the FX market. While the headline figure is expected to accelerate a notch, the core measures are forecast to remain at the same rate of change, which would provide no particular impetus for trading.
As for the UK, Monday is a bank holiday. During the week the only notable indicator coming out is UK mortgage applications on Thursday, and even that isn’t so notable. In the absence of any major economic indicators, traders may be thumbing through the 148-page guide that the Government published this week to help people prepare in case the UK fails to reach an agreement with the EU. I doubt if reading that will make anyone any more optimistic about the pound. In any case, EU chief Brexit negotiator Michel Barnier warned that a deal won’t be agreed before the major European summit on 16 October, so there’s plenty more time for the uncertainty to build. The main question I have about sterling is, will we hit EUR/GBP parity before GBP/USD parity?
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