Three Questions: Week of August 22
Good morning, and welcome to Three Questions - a look at the big uncertainties facing currency markets in the week ahead.
Here are some of the things we'll be watching:
1. What won’t Powell say at Jackson Hole?
On Friday, Federal Reserve Chair Jerome Powell’s speech will kick off the annual Economic Symposium in Jackson Hole. Though the market is waiting eagerly for his remarks, he won’t satisfy investor curiosity about the short-term rate trajectory. But much can be gleaned from what he does not say.
Powell is not going to tell us if rates are going up by 50 or 75 basis points in September. The bank’s new mantra is data-dependence and voting members will want to see key August prints before coming to a decision.
He will not say what the terminal rate in this tightening cycle is or when it will come. But he will drop strong hints the Fed believes it can stop over the next few months and then stay on hold for a while. For all the drama, internal divergences between hawks and doves have narrowed over the year. There seems to be a consensus the Fed Funds rate can rest for an “extended period” between 3.5 to 4.0 percent, far below a current inflation rate of 8.5 percent. This suggests a shared view that price pressures are indeed “transitory,” and that the institution retains its credibility.
The Chair will insist that the goal is to return inflation to two percent, but he is not going to tell us when that will happen. We already know the Fed is willing to wait - as of June, the median projection for price increases in core personal consumption expenditures was 2.7 percent for 2023 and 2.3 percent for 2024. And while the minutes of the July meeting may have overstated worries of a slowing economy, they did capture a widely-shared concern - fear of overtightening. As inflation falls, so will the willingness to risk growth to bring it down any faster.
Under the Fed’s current reaction function, inflation and nominal growth are still likely to stay higher than the pre-Covid decade. We’re not going back to the 1970s, but we’re not going back to the 2010s either. And while events outside the US matter, the exceptional contribution of Fed policy to dollar strength is mostly over. - KARTHIK SANKARAN, SENIOR MARKET STRATEGIST
2. Could the Chinese renminbi keep tumbling in the days ahead?
The yuan dropped to a two-year low in onshore markets on Friday night, and looks set to continue weakening as the growth outlook darkens and interest differentials turn more negative.
China’s economy is in trouble. Coronavirus lockdowns are hurting consumer sentiment, a crackdown on the technology sector is hurting investment, and exporters are facing tougher conditions as buying patterns in Western countries shift. Perhaps most importantly, the vast and spectacularly-overleveraged property sector is imploding in slow motion, threatening to impose systemic costs on households, businesses, and local governments - while threatening the country’s entire growth model. Data released over the last week showed precipitous falls in factory output, fixed investment, real estate, and retail sales.
The stakes are high, and policymakers are trying to respond in a proportionate manner, easing policy without fuelling new asset bubbles.
This is proving difficult: Targeted fiscal spending measures have been announced, but a lack of shovel-ready projects has delayed the economic impact. Local governments have been authorized to issue more bonds, yet most of the proceeds are likely to go into rolling over existing debt. The People’s Bank of China lowered two of its key rates last week and the major commercial banks are expected to cut their benchmark loan prime rates on Monday, but businesses remain reluctant to ramp up borrowing in the face of weaker demand conditions.
Interest differentials could turn more negative if domestic rates fall more than expected or US yields continue to ramp ahead of Friday’s central bank conference in Jackson Hole. Investors are bailing out, and we suspect pressure will only increase in the days to come.
But expectations could turn on a dime. Chinese authorities are fighting against a commodity-led rise in producer prices, and are unlikely to welcome a sustained bout of currency weakness that raises import bills. Growth forecasts could improve as leaders make supportive statements and policy efforts begin to bear fruit. And if previous buy-on-rumour, sell-on-fact dynamics hold true, US yields are likely to reach a near-term apogee before Jerome Powell’s speech. Yield gaps could narrow slightly by Friday afternoon.
As alway, be wary of anything that looks too much like a yuan-way bet.
- KARL SCHAMOTTA, CHIEF MARKET STRATEGIST
3. Is the ECB set to hike into a recession yet again?
You wouldn’t know it from looking at currency markets, but in one of the year’s biggest data oddities, the Eurozone grew in the first half of the year while the US contracted. But stresses are increasing, particularly in the region’s biggest economy. Thursday’s final estimate for German second-quarter growth is expected to come in flat, unlike the positive outcomes for Italy, France and Spain that boosted the area-wide aggregate.
The week will likely also bring a slew of bad news in confidence indicators. Consumer sentiment has been plummeting for a while. The mood among enterprises could follow - impacting Germany’s benchmark IFO business survey - as the boost to the service sector from summer travel fades. The war in Ukraine has pushed gas prices to all-time highs, and Gazprom’s shenanigans are designed to maximize household and business uncertainty about winter supply buffers.
Even so, the European Central Bank is virtually certain to hike in September and take rates positive for the first time since 2014. Despite Germany’s current status as the sick man of Europe, the country’s central bankers are pushing strongly for a 50 basis point increase. With the most recent Eurozone inflation print coming in at 8.9 percent, markets are also pricing a big move. Although the program for the Jackson Hole summit is not available yet, there is usually at least one senior ECB official speaking, which will provide tealeaves and entrails for study .
For the third time in a row, ECB rate hikes could be the harbinger — if not the primary cause — of a recession. But unlike 2008 and 2011, this tightening might not inflame systemic financial stress. The first hike in that series came right before the Lehman bankruptcy, and the second was before a full-blown peripheral debt crisis. Since then, the bank has created new tools to “cap the spreads” and European populist parties — including the one leading the polls in Italy — have shed overt Euroskepticism.
The third time might not be the charm, but there is a chance this hike could accompany routine — rather than catastrophic — bad news. Sometimes interest rate policy reflects intuitive mastery at one’s fingertips - or “Fingerspitzengefuehl,” as the Germans say. At other times, central banks just do their best and hope. Perhaps this should be called “Fingercrossengefuehl”.
- KARTHIK SANKARAN, SENIOR MARKET STRATEGIST
CATALYSTS
WEDNESDAY
USD Durable Goods Orders
USD Department of Energy Weekly Inventories
THURSDAY
EUR Gross Domestic Product, Q2 (Final)
USD Jackson Hole Economic Symposium
MXN Gross Domestic Product, Q2 (Final)
CAD Survey of Employment, Payrolls and Hours , June
USD Gross Domestic Product, Q2 (Second)
USD Weekly Jobless Claims
MXN Central Bank Monetary Policy Minutes
FRIDAY
USD Jackson Hole Economic Symposium
USD Personal Consumption Expenditure, June
USD Advance Goods Trade Balance
USD Federal Reserve Speech, Chair Powell
USD University of Michigan Consumer Sentiment, August, Final
USD Baker Hughes Weekly Rig Count
COUNTERPARTIES
Some of this week's most interesting and informative reads on the state of the global economy:
“With so much talk of stagnation, inflation, and stagflation in recent months, it is worth questioning whether the prevailing pessimism is justified.”
Project Syndicate: Holes in the Recession Story
“Bitcoin is a strange amalgam, and can best be described as an extensible sub-fiat distributed virtual investment fraud hybrid, more easily referred to as a type of Nakamoto Scheme.”
Sal Bayat: The Strange Case of Nakamoto’s Bitcoin
“We FX traders are partly to blame for this because we knew for a fact that these guys were not able to make money in FX,” says the former trader. “But then when they came to crypto, everyone thought they were geniuses.”
Intelligencer: The Crypto Geniuses Who Vaporized a Trillion Dollars
“But China’s internal troubles have an upside: lower demand for imported metals, energy, food and capital goods is alleviating inflationary pressures in the rest of the world. For the first time in decades, the country’s enormous trade surplus is a boon for workers elsewhere.”
Financial Times: Beijing is Tanking the Domestic Economy — and Helping the World
“Rank every firm (excluding real-estate-investment trusts) in the S&P 500 index by their average net-profit margins last year, five years ago and a decade ago, and only four appear in the top 20 every time. Two are financial-information firms, Intercontinental Exchange and the CME Group. The others are Mastercard and Visa.”
The Economist: Can the Visa-Mastercard Duopoly Be Broken?
“We can discuss the various forecasts — 10-year bond yields, Fed funds rate, equity markets, inflation expectations, consumer confidence, etc. — noting investors as a group do a terrible job making these predictions. Surveys of investors are laughable.”
Ritholtz: What Does the Market “Know”?
“As has been found by others, we find that some of the increase in remote work that began early in the pandemic is sticking. According to firms responding to our August regional business surveys, about 20 percent of all service work and 7 percent of manufacturing work is now being conducted remotely, well above shares before the pandemic, and firms expect little change in these shares a year from now.”
Liberty Street Economics: Remote Work Is Sticking
“For decades, America gave China a vision of future prosperity. But today, America has mostly ceased to offer a model for China or anywhere else, leaving China’s leaders without a guide as they chart a course into a future filled with potential turmoil.”
Authors
