Week ahead: More central banks in “wait and see” mode; UK election, FOMC, ECB, US-China tariff deadline…
FХ Strategist & Financial Commentator
We have quite a week ahead of us! So let’s not spend too much time reviewing the past week, because it’s by and large it’s the usual themes in the market: Brexit and trade.
GBP was the best-performing currency of the week as the Conservative Party solidifies its lead in the polls (see below). It looks like we’re going to get a Conservative majority and Brexit on schedule on 31 January. The party is billing that as “delivering Brexit on time,” but of course that’s not Brexit, it’s just the start of Brexit – they’ll then have a year or so to work out the entirety of the future relationship with the EU. As Liberal Democratic Party leader Jo Swinsonsaid, “The idea that Brexit is going to be done? We’re like in episode 1 of a 10 season box set…” Good luck!
There were two central banks meetings during the week, the Reserve Bank of Australia (RBA) and the Bank of Canada. Both joined the “wait and see” crowd, causing currencies to appreciate over week. Overall, easing expectations diminished during the week, led by Canada and New Zealand, with Britain and the EU following. Oddly enough, expectations of RBA cutting rates actually increased slightly despite the RBA’s more optimistic tone. That was due to the weaker-than-expected GDP figure on Wednesday.
The coming week: UK election, FOMC, ECB, US-China tariff deadline…
You thought maybe that as the year winds down you’d get a chance to relax. Well, that’s after this coming week. For now the year is going out with a bang with a week filled with market-moving events.
The main point of interest, the event we’ve all been waiting for, is the UK general election. At the time of writing it looks like the Conservative Party is going to get a majority in its own right, which it alleges will allow it to leave the EU on schedule on 31 January. The following graph from The Economist ( https://projects.economist.com/uk-elections/poll-tracker ) shows the average of polls up to 5 December. This kind of lead would usually be enough to allow the Tories to win a Parliamentary majority outright, although we must bear in mind that A) polls in Britain have been notoriously unreliable for the last several years, and B) this election is subject to unprecedented uncertainty, because people are no longer voting by party, they’re voting Brexit. Past performance is no guarantee at all of future performance. Added to this the first winter election since the 1920s and you have no idea who will bother voting and how they will vote.
If there’s a hung Parliament, then GBP will probably plunge. But assuming the polls are right and the Conservatives do win a majority, the question then is how far can GBP bounce? My guess is that even though it has risen ahead of the election, there is so much doubt about the polls that speculators will have to build in some risk premium. That’s why I don’t think there will be a “buy the rumor, sell the fact” response; on the contrary, I expect “buy the rumor and buy the fact even more.” Speculators are still short GBP, as are active currency managers. They’ve still got some ways to go before they’re even flat, much less long.
The real trouble of course will come further down the road when the politics cool down and the (diabolical) economics take over. But that’s for the first weekly in February.
Brexit will of course be the major topic of discussion at the EU Summit Meeting in Brussels Thursday evening and Friday. The leaders should know by Friday morning whether PM Johnson has a majority. The draft communique apparently urges the “timely ratification” of the Withdrawal Agreement. In other words, let’s get this over with ASAP. Will Brexit hurt EUR? So far it hasn’t, as far as we can tell, but once the Withdrawal Agreement is signed and chaos at the borders begins, EUR could be hit too.
Aside from that, the other burning topic under discussion at the Summit will be climate change – leaders will reportedly aim to endorse “the objective of achieving a climate-neutral EU by 2050,” according to Reuters. That could affect some energy stocks. Maybe they should hold the next summit in Venice to help focus their minds on the problem.
There are two big central bank meetings during the coming week – the Federal Open Market Committee (FOMC) on Wednesday and the European Central Bank (ECB) on Thursday. Neither of these is a “live” meeting, as it were. The market is pricing in zero repeat zero chance of any change in rates at either meeting.
What then will we be looking for? For the Fed, FOMC members are sticking to their view that the current stance of monetary policy is appropriate and it would take a “material reassessment” of the economic outlook to get them to change. Both Fed Chair Powell and Gov. Brainard reiterated that view just last week.
What might such a “material” change look like? Slower growth in payrolls, like we’re expected to see this afternoon, certainly wouldn’t cut it – we’d need to see unemployment, currently 3.6%, rise to well above their estimate of the “normal” unemployment rate of 4.2% before they even start to get worried. And with this week’s consumer price index (CPI) expected to come in right around their target for inflation (see below), there’s no need on that front to cut rates either. That’s why I don’t expect any significant changes in the statement following the meeting and I believe it’s likely to have relatively little impact on markets.
Aside from the immediate direction of policy, one point of interest will be any further discussions that they have on the review of their “monetary policy strategy, tools, and communications,” as Gov. Brainard phrased it. But details of that discussion probably wouldn’t appear until the minutes are released on 3 January.
The ECB meeting is likely to be similarly pro-forma insofar as policy is concerned, but it will attract a lot more scrutiny as it’s the first one under the leadership of ECB President Lagarde. This will be her first time to give the post-meeting press conference and so to hear her views in detail.
Lagarde hasn’t made many comments about monetary policy up to now. The most she said was in her hearing before the European Parliament’s Committee on Economic and Monetary Affairs on Monday. Her comments then could’ve been taken from the statement following the ECB’s last meeting, suggesting that we can expect continuity from her rather than a new change of strategy. This is only natural as Lagarde isn’t an economist by training. She’s therefore likely to start her tenure by reflecting the views of the Governing Council more than by trying to shape them in a new direction. I expect more of the same this week as she starts to find her way in this new role. Perhaps her most important job at first will be to try to heal the divisions on the Governing Council between the doves and the hawks.
This meeting will also produce new staff forecasts for GDP growth and inflation. They’re likely to be unchanged from the previous set three months ago, and so won’t require any policy response.
As a result, I expect the important parts of her statement to be pretty much the same as in October. She’s likely to acknowledge some improvement in the global outlook, as other central banks have done, but continue with the assessment that “the risks surrounding the euro area growth outlook remain on the downside.” One possible change we can glean from her comments to the EU Parliament may be that she tempers the ECB’s willingness to change policy (“the Governing Council continues to stand ready to adjust all of its instruments, as appropriate…”) to be conditional on an assessment of the possible side effects of policy. That would be a fairly small change however without much market significance.
The Swiss National Bank also meets a few hours before the ECB does on Thursday, but their meetings are usually uneventful for the markets. Interest rates in Switzerland are currently the lowest they’ve ever been anywhere in human history. It’ll take a lot for them to go lower. Meanwhile, the SNB isn’t going to raise rates until well after the ECB starts to do so, and the way things are going that might not happen in my lifetime (see Japan).
Indicators: Japan tankan, US CPI, US retail sales, UK short-term indicator day
As if these dramatic events weren’t enough, there are several important economic indicators coming out.
Japan’s economic indicators have little effect on the markets nowadays. That’s probably because the market is well aware of the Bank of Japan’s reaction function, which can be summed up as “asleep at the wheel.” The BoJ just isn’t going to change policy in reaction to anything. Or maybe it should be “pedal to the floor,” because the BoJ can’t change policy – they’ve basically done all they can do.
The main exception to this indicator rule is the Bank of Japan’s quarterly Short-Term Economic Survey of Enterprises in Japan, known universally by its Japanese acronym tankan. The tankan is a huge survey of some 11,500 companies in Japan designed to be representative of the Japanese economy. This is the most important indicator out of Japan every quarter.
Like the Ifo or other such surveys, it’s presented as a diffusion index (DI) of the percentage of firms saying things are “improving” minus the percentage saying things are “worsening.” It’s troubling that this quarter, the DIs for both large manufacturers and non-manufacturers are expected to decline notably, although the expectations index for large manufacturers (what they expect the index to be when the survey is taken in Q1 next year) is forecast to rise a bit.
One problem with the tankan is that its effect on USD/JPY is not consistent. You might think that a rise in the DIs would foreshadow a better economy and therefore cause the yen to strengthen, while a fall should have the opposite effect. However, the tankan’s most direct link is to the stock market, since it reflects the views of companies. A weak tankan can send Japanese stocks lower. And as we all know, the yen often strengthens on a “risk off” mood when Japanese stocks fall. So even if you can forecast the results of the survey correctly, it’s hard to predict how the currency will move as a result. Nonetheless, just straight economics would suggest that a further decline in sentiment among companies ‘could eventually elicit a response from the somnolent Bank of Japan, if we listen to what Gov. Kuroda has to say. The tankan may therefore be negative for the yen.
The US CPI will be released a few hours before the FOMC makes its decision on Wednesday. This index isn’t what the Fed uses as its main inflation guide – that’s the personal consumption expenditure (PCE) deflator, or more specifically, the core PCE deflator. Be that as it may, the market pays attention to it as if it is. It’s expected to show headline inflation bang on the Fed’s 2% target, while core inflation is forecast to continue to run a bit above that rate. If the Fed takes this into account – and I’m not sure whether they do – it certainly won’t indicate any need for any change in policy any time soon. USD positive
Other key US indicators coming out during the week include producer prices on Thursday and retail sales on Friday.Retail sales are important because everyone is pinning their hopes on the broad shoulders and deep pockets of the US consumer to sustain growth. As Gov. Brainard said last week, “There are good reasons to expect the economy to grow at a pace modestly above potential over the next year or so, supported by strong consumers and a healthy job market…” This week’s figure is expected to confirm that narrative as retail sales are forecast to grow exactly in line with the trend that’s encouraging everyone so much. USD positive
Other important indicators out during the week include UK short-term indicator day on Tuesday. That’s when the monthly GDP figure, the trade data, and industrial & manufacturing production are all announced. Of course two days before the election these key data may not affect the market as much as it usually would. In any event, the GDP data – the most important – are expected to be miserable. GDP is forecast to rise 0.1% mom, which is pathetic after three consecutive months of decline. The 3m/3m change is forecast to fall to zero – stalling. GBP negative if indeed anyone is paying attention, which they may not be.
Watch out for Tariff Sunday
While we count down the days left in the year, there’s one big date left for the financial markets: Sunday, 15 December. That’s the day when the US is scheduled to raise tariffs on Chinese goods. It’s a key day for the long-running US-China trade war.
Here’s the background.
Back in August, Trump raised tariffs on $250bn worth of goods from China to 30% from 25% effective 15 October, and to 15% from 10% on the remaining $300bn worth of goods, effective 15 December. But a few days before the October deadline, Trump announced that he was suspending the increase as the US and China had tentatively agreed on the “first phase” of a trade deal, with China agreeing to buy up to $50bn in American farm products and to accept more US financial services in return. This “Phase One” agreement was supposed to be a limited agreement that would allow both sides to claim victory while soothing financial markets.
But China started making additional demands, such as for the rollback of some existing tariffs, and that tentative “Phase One” agreement was never signed.
Now the question is what will happen on 15 December: will Trump go ahead with that tariff increase? Last week the talk from the administration was that he was likely to postpone the December round of tariff increases even if the two sides hadn’t reached a “Phase One” agreement. But the scuttlebutt this week is that he will indeed go ahead. Trump said that a trade deal is “dependent on whether I want to make it…” “In some ways it is better to wait until after the election…and we’ll see whether the deal is going to be right,” he said. (“The election” of course being the Presidential election next November.)
If Trump does postpone the tariff increase, it would cool the temperature around the trade talks. The gesture may help to offset the impact of the “Hong Kong Human Rights and Democracy Act of 2019,” a bill that Congress enacted which China feels is an interference in its domestic affairs and a thumb in its eye while the two sides are trying to work out this trade issue. With both sides calmer, an agreement would be easier to reach. On the other hand, if he goes ahead and ups the tariffs, it will signal a new level of tensions in the trade war and probably elicit reciprocal actions by China. That would probably cause a massive “risk off” move in the markets.
While Sunday is the deadline for this – and so strictly speaking I should write about it next week – I expect the decision to be made sometime during the coming week. That will be another major hurdle for the markets.
Up to now I’ve thought that with Trump facing so many fights at the same time, he’d want an easy and quick victory somewhere. But recently he’s been booed at several sporting events in the US and mocked by his peers at the NATO conference. He can’t stand being ridiculed. I now think he’s likely to dig in his heels, just to prove he’s tough. I expect him to go ahead and allow the tariffs to be increased, causing a “risk off” move that will send gold, JPY and CHF higher and AUD (and probably USD) lower.
But of course his behavior is unpredictable; much depends on who the last person to talk to him is, and it’s not going to be me. As Humphrey Bogart said in The African Queen, “you pay your money, you take your choice.”