Diverging Monetary Policy Expectations

A critical driver in the foreign exchange market and the global capital markets more generally, is the ongoing preparation by the Federal Reserve for a rate hike, while many additional central banks, including the ECB, warn investors that more accommodative monetary policy may be necessary.  In the days forward, the economic data and recognized speeches will occur in the context of building expectations.

After Draghi'utes press conference following the ECB conference last month, market expectations for additional monetary stimulus is operating high.  However, while many marketplace participants view it as a done deal, it is not clear that they forged a consensus.  The recent economic data suggests that expansion continues apace, and if not impressive, steady.  Core inflation is running at 1.0% year-over-year, that while soft, is not signaling the deflationary spiral.  Moreover, the European economic locomotive, Germany, expects to have found better traction after a weak August and a predict that both orders data and industrial output information bounced back. 

As we noted last week, the Eurozone economic data does not seem consistent with the feeling of urgency Draghi's expressed lately.  Either the economic data flow deteriorates, or it will be hard to reach a consensus for new bold action.  If the financial data is in line with consensus, recommending that the Eurozone expanded by 0.4% in Q3 as it did in Q2, which is also the average quarterly development since the middle of 2014, then your risk is that the pendulum of anticipations will swing back to mild action.  An increase in the duration of the purchases may be more likely than buying more, or even cutting rates deeper in to negative territory, as experienced seemed possible following Draghi.

The Fed cannot be very disappointed along with Q3 GDP figures.  As it had anticipated, the largest inventory swing in four years weighed upon headline growth, but final domestic sales (excludes inventories and net exports) rose Two.9%.  Although this is slower than Q2's 3.7% pace, it is better compared to 2014 (~2.4%) and H1 2015 (~2.3%).  It speaks to the resilience of the US economy.  Moreover, after tax income flower 3.5%, allowing consumption to add 2.2 percentage suggests GDP and an increase in cost savings.

There are at least nine Fed officials speaking in the 7 days ahead.  We argue that the actual Fed's leadership defines the hawk-dove scale at the Fed.  This really is to say that several Fed officials are more dovish than the troika associated with Yellen, Fischer, and Dudley, and several are more hawkish. Methodologically, we suggest that policy hails from the leadership, so location emphasis on their views.  In addition, we suggest investors be sensitive to changes in views.  That Brainard and Tarullo among the governors, for example, that have more dovish than the troika.  It would be more newsworthy if they softened, rather than maintained, their stance.

The US reports ISM for manufacturing and services, the Chicago PMI offers any kind of hint, there is upside risk to the consensus estimate of 50 and 56.5 respectively, and auto sales, which might slow slightly from the nearly 18.1 mln unit annualized pace in September.  However, the most crucial report of the week is the month-to-month nonfarm payroll report.  The degeneration of the last two job reviews has not had confirmation through other labor market blood pressure measurements, including the weekly jobless claims, where the four-week moving average is actually making new cyclical lows.

The October employment report expects to become the best in three months, with job growth picking up to 180k from 142k in September.  The three-month average is 167k.  The internals may be as important as the headline.  Included in this are the possibility of an upward revision to the August and September reports, the potential for the unemployment rate to slip to 5.0% and the underemployment rate (U-6) to dip beneath 10% for the first time since 2008.  The year-over-year pace of hourly earnings increase can tick up to 2.3%, which is the upper finish of the recent range.

While the Eurozone data is not poor enough to suggest the need for urgent monetary action, the US data doesn’t seem to justify the emergency setting of the Fed Money rate.  Barring a significant surprise, this week's data should keep a December rate backpack very much in play. Remember for the majority of the Federal Reserve, the continued absorption of slack in the work market, understood as the sufficient and necessary condition to boost wages, which in turn are the key to core inflation, and heading inflation converges to core inflation. 

Three central banks from high-income countries meet in the coming days:  The Reserve Bank of Australia, the Bank of England as well as Norway's Norges Bank.  On balance, the market does not expect any kind of to change rates, but the RBA may be the closest call.  Soft inflation data with a backdrop of variable mortgage rate hikes through leading banks spurred the actual speculation.  The derivatives marketplace put the odds at almost 50/50.  However, strong domestic credit score growth may have bought the RBA some time.  The Norges Bank cut rates at the last conference and signaled a lower repo-rate path. It appears for the moment, though, that it is happy to wait and watch. 

Under the new conversation regime, the Bank of Britain will release the moments and the quarterly inflation report at the same time as its rate choice.  The BOE appears several months at least from raising interest rates.  There has been one dissent at the past two meetings.  There seems to be a greater risk of someone joining the dissent compared to McCafferty giving up his call for an immediate hike.  Even if the dissent does develop, the forecasts contained in the inflation report will illustrate why this will remain a group for some time.  Note for example that the 5- and 10-year breakevens have fallen by about 35 bp because the end of H1.  Similarly, the actual implied yield on the 06 2016 short-sterling futures contract has rejected about 40 bp since mid-July. 

The BOE is widely expected to be the second major central bank to hike rates following the Federal Reserve.  This anticipation should help sterling outperform most other major currencies on the divergence hypothesis.   However, the perceived gap between the Fed's move and the BOE'utes move can be several months and there lay sterling's vulnerability.  At the same time, growth appears to be moderating and transferring composition.  This PMI information expects to shed more light on this. The manufacturing activity forecast is to moderate for that third consecutive month whilst services are expected to have quickened their own expansion, snapping a three-month downturn. 

Monetary conditions in the UK have stiffened in recent weeks.  Sterling has risen near 3.0% (Two.85%) on the BOE's broad trade-weighted measure since mid-October.  At the same time, 10-year gilt yields go up by 16 bp.   Even if blunted by the 1.5% rise in the FTSE 100, monetary conditions have become less accommodative, leaving the actual BOE to make a nuanced argument that it is not really the right time to raise prices yet, but that day continues to approach. 

Another highlight of the week forward is Japan's public providing of Japan Post.  It will require three forms, a holding company, a bank and an insurance company.  It will list November 4.  It is the world's largest IPO of the year and the biggest Japanese IPO since 1988.  Its aim is domestic retail investors, and preliminary reports indicate strong interest.  It is unlikely to be a substantial factor in pushing the pound. 

The BOJ left policy on maintain last week, which disappointed lots who had anticipated an expansion of its asset purchase strategy.  While BOJ's Kuroda offers guarantees that further easing will come if necessary, investors are thinking about what will take to reach that tolerance.  Current core inflation is negative and after weak output and household spending information, it is likely the economy contracted in July-September period after contracting April-June.  

Contrary to what some refer to as the "technical definition," Japanese authorities do not appear to regard what Japan is experiencing as a recession.  Still continued weak point in Q4, and the risk which base effects lift heading inflation, but does nothing for measures of core inflation, will likely keep conjecture running high for addition monetary easing either past due this year or early next. 

China's PMIs released over the weekend are unlikely to have much long lasting impact. The PBOC has on average, cut rates every other month this year.  The PMI data is consistent with other data recommending that the service sector, that the government wants to grow, is doing better than the manufacturing sector, which continues to slow.  Additional targeted easing measures are likely this year.  With the new five-year plan agreed upon, the next important focus is the IMF's decision on the SDR, expected later this month.

The Week Ahead: Building Anticipations is republished with permission from Marc to Market