After this Week, Does August Matter?

<br /> After this Week, Does August Matter? – Marc to Market<br />


There are four events this week that will
command the attention of global investors.
1. The Reserve
of Bank of Australia is first.
  It is a close call, though the
median in the Bloomberg survey favors a cut, including most of the banks in
Australia that participate in the poll. 
The case for it
is that price pressures are weakening,
and credit growth is slowing.
  The currency has begun appreciating
again, and the Federal Reserve cannot be counted on to lift US rates until the
end of the year, at the earliest.   
The argument
against the RBA moving is that there is no urgency to exit the “watch and
wait” mode.
  A rate cut would not necessarily
weaken the currency as Australia would still offer highest policy rate (after New
Zealand) among the high income countries. It is also not clear that the
record low interest rates are a constraint on credit growth. Better keep
the powder dry and see how events evolve, though it can be fairly confident
that New Zealand will cut interest rates later in August.  
2, Investors
are more confident of the outcome of the Bank of England’s meeting than the RBA meeting.
  After the recent dismal survey
readings, indicative prices suggest that a 25 bp rate cut is fully discounted.  A newswire survey
found 95% of the sample anticipated a rate cut, and of those, 95% expect a 25
bp cut in the base rate. 
There are two
other measures that the BOE is expected
to consider. 
 A little more than 80% of those who
expect the BOE to do more than cut rates
expect the funding for lending scheme to be extended.  Participants are nearly evenly split on the prospects for a
new round of asset purchases.   About half of those that expect a new
round of QE expected it to be between GBP25 and GBP50 bln. Outside of that
ranges the response were heavily in favor of
a larger than a smaller Gilt buying program.  
Sterling eased
to the lower end of a $1.30-$1.35 trading range as the market priced in the
easing of monetary policy. 
 It may firm back toward the upper of
the range as the soft US dollar
environment we anticipate, coupled with “sell rumor, buy fact” type
of activity.  In the futures market, speculators have a near record short
gross sterling position and have a record net short position.  
 Japan’s Prime Minister Abe seemingly hurriedly confirmed some details of
his fiscal plan. 
  If he intended on cajoling the central
bank into joining the fiscal stimulus
with a large dose of monetary support, it was insufficient.    Abe is
expected to provide more details of the fiscal
package.  The cabinet will formally approve it, and it is not clear whether
the cabinet will do so before of after it
is reshuffled, and the sequence may not
Reports already
indicate that the only about a quarter of the headline JPY28 trillion will be
real fiscal spending. 
 The freshwater number may also
include spending associated with a supplemental budget that Japan habitually
announces.   Even a slimmed down estimate needs to be discounted because frequently all the earmarked spending goes
unused.   At the end of the day, the large fiscal package is not so large
really, and it may not provide as much stimulus as head figure of around 6% of
GDP suggests.  
And even if there was greater real spending, it is not clear that it would
change investors’ views.
 At its best government spending would
create a short-run demand shock, and even given a reasonable multiplier, one
cannot be very optimistic.  The recent data shows domestic demand (overall
household spending) and foreign demand (exports) are weak and falling.  
It is not as if
this is priming the pump in the popular
Keynesian image or that the Japanese economy has been starved of public
investment as some European countries.
  Japan has recorded an average budget
deficit of 8.1% of GDP in the last six years.  The deficit has been below 8%of GDP for the last two years when it has averaged 7.2%.  This
year’s deficit was to come in below 6% before this latest round of stimulus,
and the details will help economists and investors update their forecasts.
Expanding the
monetary base by JPY80 trillion a year (more than 15% of GDP) is not
stimulating inflation expectations or actual inflation. 
 Running a significant and sustained budget deficit
has been unable to push the world’s third largest economy onto a
self-reinforcing growth path. Observers may differ on precisely what Japan
should do, but many appear to be growing increasingly convinced that it is not
a question of a marginal tweak.  
Abenomics is usually associated with the
three arrows of fiscal and monetary stimulus and structural reforms, there was
a fourth component.
  Pension funds, including the
government’s gigantic GPIF, diversified overseas and with apparently low hedge
ratios…initially. Some suggest that it was these outflows that helped drive
the yen’s decline.  Reports now suggest that since that hedge ratios are being increased, and that this is one of the
important drivers of the appreciating yen.   It may be a bit of a vicious
cycle.  As the yen appreciates, pressure mounts on Japanese global
investors to buy yen as a hedge, driving it higher, requiring more hedging.
4.  The US
July employment report caps the week.
  Economists do not expect a repeat of
June’s 287k jump, not that they had expected either.  The median
guesstimate is for an increase of around 175k, which is above the three and six-month averages (147k and 172k
respectively).  The unemployment rate may tick down to 4.8%.  Average
hourly earnings need to increase by 0.2% to maintain the 2.6% year-over-year
In the
aftermath of the disappointing Q2 GDP estimate, we suspect the markets will
have an asymmetrical response to US data.
  The markets are more likely to
respond to negative surprises than positive surprises.  For all practical
purposes, no matter how strong the data
surprises could be would sufficient to get the market to believe a hike in
September is anything but an extremely small
tail risk.   On the other hand, disappointing data could prompt more
investors to give up on a hike at all this year.  
That said, our
impression is that the low Q2 GDP was more
teeth-gnashing for investors than the Federal Reserve.
  Past comments by Yellen suggests a
focus on GDP excluding inventories and exports.  Consumption, which was identified in June as a concern, rose at
4.2% annualized pace in Q2 after a 1.5% clip in Q1.  Consumption added 2.8 percentage points to GDP.
 The other components of GDP, (government spending, business investment, and net exports) subtracted 1.6
percentage points from GDP.  The result was 1.1% GDP, adjusted for
Inventories are
not a large part of GDP, but they are volatile, and seemingly a challenge to
forecast accurately.
  The introduction and dispersion of
better inventory management (e.g., just-in-time inventories,
register-to-inventory interface) apparently has not ended the inventory cycle’s
role of driving the larger business cycle.   The three-quarter drawdown in
inventories is probably the single most important factor behind the nine-month
streak of growth below 2% (for the first time four years).   
The rundown in inventories, however, is expected to lead to
greater output, especially if demand holds up. 
  A increase in July auto sales (17.2 mln annualized
pace vs. 16.61 mln in June) points to a solid start for Q3.  It should not
be surprising if economists shift some of the growth they had anticipated for
Q2 into the second half.   
In many ways,
it seems that the August cake is already baked.
  The BOJ and ECB have signaled
reviews in September.   The September FOMC meeting is late in the month,
which arguably makes the July high frequency data less significant, and in any
event, is unlikely to boost expectations for a September hike.  
presentation at the Jackson Hole confab at the end of the August may be more
important than the data per se.
  Advance reports should make the
first estimate of GDP more accurate, and time will tell, but for the time being
it, investors need to keep in mind that it is often subject to statistically
significant revisions.  The first revision
is due August 26.   
The European
Bank stress tests results were announced
after the North American markets closed for the week.
  The only bank whose capital would be
wiped out was Monte Paschi, who hours before announced a new plan, approved by
the ECB.  It made the stress test result immaterial.  Only one other
bank that tested, Allied Irish, had a
“fully loaded capital ratio” of less 5.5%, which is regarded as an
important threshold.     
Several banks
will likely raise capital, but officials will find solace in that large banks
appear more resilient to economic stress. 
 Perhaps more of more immediate
concern to investors is not the stress
situation as much as the continued grind of the status quo.  Negative
interest rates, weak growth in lending to businesses and households, and a new
regulatory environment that is exerting pressure to de-lever creates formidable
challenges.  Capital gains, for some investors, may blunt the sting of
negative interest rates, but this is not the purpose of fixed income investment
for many.  
The euro
trended lower from early May through the UK referendum on June 23, dropping
seven cents to roughly $1.0915.
  Speculators in the futures market
accumulated a large gross and net short
euro position.   We suspect that a correction has begun that may carry the
euro toward $1.1350-$1.1400 in the coming weeks. 


After this Week, Does August Matter?
After this Week, Does August Matter?

Reviewed by Marc Chandler

July 31, 2016

Rating: 5

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