The European Central Bank (ECB) turned hawkish and the Federal Reserve System (Fed) hawk turned (slightly) dovish.
ECB Board member and Bank of France Governor Francois Villeroy de Galhau said the ECB still plans to end its Quantitative Easing (QE) program later this year, probably in September 2018 or December 2018, and the first interest-rate hike could come “at least some quarters, but not years” afterwards. He said inflation will resume accelerating as the EU’s temporary weakness passes and underlying price pressures increase. Currently, the ECB’s QE program is scheduled to run at least until September 2018, and rates are to stay low until “well past” the end of the purchases.
Villeroy’s comments echo those of Austria Central Bank Governor Ewald Nowotny, who said in early April 2018 that the ECB would end its bond-buying program by the end of the year and then raise the deposit rate to -0.2% from -0.4%, followed by another hike that would also include a rise in the key refinancing rate. The key point to note today though was that shortly after Ewald Nowotny spoke, an ECB spokesman issued a statement saying that his comments did not reflect the opinion of the Governing Council but rather his own personal views.
Speaking at the same event, Cleveland Federal Reserve System (Fed) President Loretta Mester said “it is too soon to say that we have met our inflation goal on a sustained basis.” She said some of the higher inflation recently is just due to commodity prices and base effects and is therefore “likely to be temporary.” So she was not declaring “mission accomplished” even though the personal consumption expenditure (PCE) deflator recently hit the Fed’s 2% target.
This is not to say though that she thought the Fed should pause. Rather, she argued that monetary conditions are still “accommodative” and cited several examples – e.g., the real Fed funds rate is still negative (-0.3%) – and called for a continued “gradual upward path” to interest rates. (Note that if the Fed were to bring the real Fed funds rate back up to the pre-crisis average, it would be 4.38% right now, not 1.69%) And she said that as the expansion continues, it might be necessary to push rates above what’s considered to be the long-term equilibrium level, currently estimated at 3.0%. This is in line with the Federal Open Market Committee (FOMC’s) current thinking as expressed in the “dot plot,” which sees end-2020 rates at 3.38%, but is far above what the market is expecting.
This morning in Asia, the key thing to note is that the US Treasury 10-year yield broke above 3% after Commerce Secretary Ross said the “gap remains wide” between China and the US on trade. Rising US yields have supported the dollar in Asian trading, reversing the gains made after Francois Villeroy’s comments.
NZD was the loser of the day. The movement was interesting – the currency strengthened slightly as NZD bond yields moved lower, but then suddenly in Asian trading this morning NZD yields jumped higher and the currency plunged. The spread of mycoplasma bovis, a cattle disease that’s been found in some parts of the country, is undermining confidence in the sector.
It’s a busy day today, with a lot of news coming out, including the most important US indicator of the week – retail sales – plus the most important speakers – the testimony of the two new nominees for the FOMC.
We start the day early with the first estimate of German Q1 Gross Domestic Product (GDP). It’s expected to show some slowdown in growth.
Three hours later we’ll get the second estimate of EU-wide Q1 GDP, and that’s expected to be unchanged from the first estimate. As the graph shows, revisions are a) rare and b) usually minor when they do occur. So the German figure would just be filling in the details.
The UK employment data will be more interesting. The news is expected to be mixed. The job market is expected to remain solid: the unemployment rate is forecast to remain at the current extraordinarily low level, the lowest since 1975, while the number of people working is forecast to rise at an above-trend pace.
But like elsewhere, the robust labor market is not necessarily translating into robust wage growth. While growth in base wages is forecast to accelerate a bit, growth in overall average wages is expected to slow by more. The Bank of England’s recent Inflation Report 10th of May 2018 said that “as slack has been absorbed the drag on wage growth is easing,” and that’s one of the reasons they have confidence that inflation will get back to trend. They called wage costs “a significant indicator of domestic inflationary pressures.” In that case, the decline in average wages suggests a decline in inflationary pressures, which means less need for a rate hike any time soon.
The question is, which among these four indicators do the markets watch the most closely? Research shows that the change in the number of jobs is overwhelmingly the major determinant of the subsequent movement in the currency. In fact, the wage data is largely uncorrelated with the subsequent movement in the currency. That being the case, The news could be positive for the pound.
Germany’s Centre for European Economic Research (ZEW) survey is expected to be another confirmation of the slowdown in the German and EU economies. The “current conditions” index is expected to fall further from its record-high level in January 2018, while the “expectations” index is forecast to remain steady in negative territory. This could be negative or neutral for the euro.
Dallas Federal Reserve System (Fed) President Robert Kaplan will speak to the Council on Foreign Relations in New York about the outlook for the energy market and the economy. Kaplan is a non-voting member of the FOMC. He spoke just a few days ago (7th of May 2018) and said that his base case for this year was still three rate hikes. He also said that energy is in a fragile supply/demand equilibrium, because shale production is unlikely to keep up with growth in global demand and major oil companies haven’t been investing in long-term projects.
The Empire State manufacturing survey is expected to decline only slightly and remain firmly in expansionary territory (as is the Philadelphia Fed survey, due out on Thursday 17th of May 2018). This could be positive for the dollar.
But probably the US retail sales figures that come out at the same time are likely to be more important. It’s expected to show sales slowing back to trend at the headline level. That’s discouraging, especially since the previous month was a not-particularly-strong rebound from three months of declines. Apparently the slowdown this month is due mostly to lower auto sales and the other measures are expected to be either unchanged or higher. But the FX market tends to react mostly to the headline number, so this could still be negative for the dollar.
The National Association of Home Builders (NAHB) index for May 2018 is expected to rebound a bit, which in fact means remain in about the same range it’s been in recently – This could be neutral for the dollar.
Next up is probably the most interesting event of the week: the Senate Banking Committee confirmation hearings for two FOMC appointees: Richard Clarida, nominated to be Fed vice chairman, and Michelle “Miki” Bowman, nominated to be a Fed governor. As both would be voting members, their views are quite important.
Richard Clarida, a professor at Columbia University, is a highly respected macro economist with considerable experience in both the theory and practice of monetary policy. He’s made significant contributions to the academic study of monetary policy, particularly with a set of ideas known as “New Keynesian economics.” At point the academic view was that central banks shouldn’t worry about stabilizing the economy and should focus entirely on restraining inflation, but Clarida and his collaborators successfully argued that central banks could successfully intervene to revive economies – something we saw in earnest in the wake of the Global Financial Crisis.
At same time, he also knows Washington: he was on President Reagan’s Council of Economic Advisers and was an Assistant Secretary of the Treasury under George Bush. And he’s an advisor to Pacific Investment Management Company (PIMCO), the huge mutual funds company.
With the departure of former Fed Chair Janet Yellen and Vice Chair Stanley Fischer, and the pending departure of New York Fed President William Dudley, the FOMC has lost a lot of its senior leaders. Clarida should reassure the markets that the Fed continues to have experienced and knowledgeable leadership.
Given that Clarida’s views are now virtually the orthodoxy among central bankers, he could be expected to align fairly well with the views of the center of the Committee, which have gradually been shifting towards four rate hikes this year. He could add another “dot” for four rate hikes and thereby tip the median.
Bowman is an attorney who’s currently the top banking commissioner in Kansas. Her board seat is reserved for someone who works at or regulates community banks.
Bowman’s CV is far different from most other FOMC members. She has an undergraduate degree in Advertising and Journalism and a law degree. (Fed Chair Powell also has a law degree rather than an economics degree.) Much of her career was spent in Washington: she was a counsel to the US House Committee on Transportation and Infrastructure and Committee on Government Reform and Oversight. Following the 9/11 attacks, she was appointed Director of Congressional and Intergovernmental Affairs at the Federal Emergency Management Agency (FEMA), and, upon the establishment of the Department of Homeland Security, she was made Deputy Assistant Secretary and Policy Advisor to the-then Secretary. She also led a government and public affairs consultancy based in London.
San Francisco Fed President John Williams will speak to the Economic Club of Minnesota. He also spoke recently (4 May 2018), when he said that low neutral interest rates will be with us “for the rest of our lives.” Williams, a voting member of the FOMC, will take over as head of the New York Fed in June 2018.
Finally, overnight Japan announces its Q1 Gross Domestic Product (GDP). It’s expected to show no growth from the previous quarter, owing to weak private consumption, housing investment and public investment. It’s not clear though whether this marks the beginning of a trend or is just a one-off caused by a) the payback from an increase in smartphone demand in Q4, and b) a drop in purchasing power because of a weather-related rise in vegetable prices. Still, consumer sentiment is weakening, so it may be that spending is unlikely to recover much. At the same time, investment spending is likely to decrease as well (the ratio of real private capital investment to real GDP is already near its historic high) and real exports are slowing too, so Japan can’t expect much growth from investment or net exports. All told the figures will probably spark some thoughts that Japan is entering a slump and the Bank of Japan and Ministry of Finance will try to help by weakening the yen, which could be negative for JPY.
The Fundamental Analysis is provided by Marshall Gittler who is an external service provider of Claws and Horns (Cyprus) Limited, an independent analytical company. Any views and opinions expressed are explicitly those of the writer. Any information contained in the article, is believed to be reliable, and has not been verified by STO and is not guaranteed to be accurate. References to specific products, are for illustrative purposes only and are not a form of solicitation, recommendation or investment advice. Past performance is not a guarantee of future performance.