Official Coordination or Is the Market Getting Ahead of Itself?

Here are the data points that the consensus narrative connects.  The BIS
encourages countries not to dawdle and remove accommodation when appropriate.
The Bank of Canada indicated that after several quarters of strong economic
expansion and robust labor market growth, it is time to re-think its monetary
In a close (5-3) vote, the
Bank of England left rates on hold in June, and Governor Carney who had
forcefully argued against raising rates seemed more open. 
 It has removed some accommodation provided after last
year’s referendum through raising the capital buffer. 
The ECB has been gradually
evolving its risk assessment and forward guidance. 
 The downside risks to growth have dissipated, it
says, and the threat of deflation has been turned back. Many understood Draghi to have also indicated readiness to begin
removing accommodation.   There is a coordinated effort underway to take away the proverbial punch bowl.
Two major central banks meet
in the week ahead. 
 Both the Reserve Bank of Australia
and Sweden’s  Riksbank are likely to also
tilt their neutral stance toward a little less accommodation.
 Through statement rather than deeds, the respective monetary authorities
can downplay the likelihood that economic conditions will warrant further
This may have more market impact in Australia,
where there are some lingering ideas that
rates may still be cut, and the
Australian dollar is trading at the upper end of a year-old trading range.
  In fact, as the first half ended,
the Australian dollar is flirting with a trend line drawn off the April and
November 2016 spike highs and the highs from March this year.  It is found near $0.7725. 
The euro’s price action had
traced out some kind of topping pattern
against the Swedish krone. 
Whether it is a triple top or a head and
shoulders pattern, the neckline ( ~SEK9.70) broke dramatically, and the initial target near SEK9.60 was approached before the weekend.   It
also corresponds to a 50% retracement of this year’s euro rally.  The next target is in the SEK9.50-SEK9.55 area.
Ironically, the only major
central bank that the market is skeptical about seems to be the Federal
 The troika of leaders (Yellen,
Fischer, and Dudley) as well as a couple of regional Fed Presidents not only
want to press ahead with the course, and added to their arguments a discussion
about financial conditions and rich equity valuations.   Depending on one’s
assumptions, the Fed funds futures strip implies around a 15% chance of a hike
in September and around a 45% chance of a hike.
The story that is spun suggests that officials everywhere are telling investors that the gig
is up, that peak QE is behind us and a new monetary cycle is at hand. 
 We are skeptical and suspect that the narrative is
getting ahead of itself.  The Vice President of the ECB quickly tried to
explain that Draghi was not announcing a change in policy.  
Draghi had, we thought, been
clear that the preconditions of removing accommodation, namely a durable and
sustainable increase of inflation, had still not been achieved.  
 Even before last week’s comments, we anticipated that in September, the
ECB would likely announce an extension of its asset purchases into the first
half of 2018 albeit at a reduced pace.  Draghi also seemed clear that he
was opposed to lifting the deposit rate before the asset purchases were
Nor did Carney flip-flop
from the Mansion House Speech. 
 He outlined his considerations if
monetary accommodation should be removed.
 It seems clear from Carney’s comments that those considerations would not
be addressed in weeks but months.  
If the market ran on what it
thought it heard, the economic data due out in the coming days might provide a reality check. 
 The final eurozone
PMIs will likely confirm the moderation seen in the flash reading.
 Germany and Spain will likely report a decline in May industrial output.
Unemployment in the region is expected to have steadied at 9.3% in May.
 It is down from 10.2% in May 2016, but it is still not at politically
acceptable levels.  Retail sales are expected to have decelerated to a
2.3% year-over-year pace from 2.5% in April.  It would be the slowest pace
in three months.  
The UK June PMIs are
expected to have softened. 
 It would be the second consecutive
decline. The composite average in Q2 is unlikely to show improvement from Q1,
suggesting growth is still around a 0.2%-0.3% pace.  While median
forecasts call for an increase in industrial production and manufacturing
output, it appears to come at the cost of
a deterioration in the trade balance.
The sell-off in European
bonds dragged US bonds lower, but premium the US offered narrowed. 
 The US 10-year premium over Germany, for example,
narrowed 16 bp last week to nearly 180 bp; the smallest premium since last
November.  It peaked near 235 bp late last year.  The US two-year
premium slipped only a single basis point last week, but in the three-week slide,
the premium has narrowed by 11 bp.  The two-year premium peaked near 222
bp in early March, and since then has found a base near 192 in each month
(April, May, and now June).  
We suspect that officials in
Europe will be more likely to protest a premature backing up of interest rates
than US officials.  
taper tantrum began in Europe.  They will likely want to prevent it from
getting out of hand.  The data highlight of the holiday-shortened US week
is the employment data, and a bounce back after a soft May report is expected.  Non-farm payrolls are
expected to have expanded by around 175k-180k in June, with a 0.3% increase in
average hourly earnings.  The unemployment rate has fallen from 4.8% in
January to 4.3% in May, where it likely remained.  The underemployment
rate (U-6) fell from 9.4% in January to 8.4% in May.  It too is not
expected to have changed in June.  
Central bankers, especially
the Americans, are convinced that some Phillip’s Curve is at work,
 whereby higher labor costs (spurred by demand relative to supply) are
passed along to customers through higher prices. 
 As long as slack in the labor market is being absorbed, many Fed officials will be
confident that, at some point, wages will rise, and there will be an increase
in the general price level (inflation).  
However, before getting to
the jobs report, there will be other data that will likely play on investor
concerns about the trajectory of the economy and prices. 
 Even if the manufacturing ISM picks up as suggested
by the various Fed manufacturing surveys and the Chicago PMI reported before
the weekend, prices are likely to have softened.  Price paid may have
fallen for the third month.  
Softer goods prices would be
acceptable, perhaps, if it was associated
with an increase in demand. 
However, the continued gradually slowing
in auto sales warns of a headwind on retail sales. If the median expectation
that the US bought cars and light vehicles at a 16.5 mln unit pace in June,
then it will mark the slowest quarter since Q1 14.  

The Bank of Japan has not
discussed its exit strategy.  
Some have argued that by shifting policy toward targeting the
10-year yield, which requires the purchase of fewer JGBs, that the BOJ has
already begun tapering.  We do not think this is a fair assessment, and it
is one that the BOJ itself rejects.  The sell-off in European bonds
spurred a global move and the JGB was not
immune.  We expect a robust defense by the BOJ.    

While we suspect the eurozone economy is more likely to moderate
than accelerate, the Japanese economy is accelerating. 
 The Tankan Survey kicks off the quarter and
improvement is expected across the board, including a healthy jump in capex plans, which are expected to be the
strongest in a year and a half.   Japan’s Composite PMI stood at its
highest level in at least three years in May.  It may be little changed in June.   The resounding defeat of the LDP in the Tokyo election prompt another supplemental budget. With numerous accusations of improprieties and favoritism, Prime Minister Abe may find his political agenda challenged, even as there appear no alternative to Abenomics.  
The Bank of Canada has
unambiguously warned the market that it is considering raising rates. 
The market believes it.  The OIS appears to have
discounted an 80%-85% chance that a 25 bp hike will be delivered on July 12.  Canada reports both jobs and trade
in the week ahead.  Theoretically, they have the ability to disrupted
official plans, but most likely they won’t.  
Job growth has been
has generated 316.8k jobs over the past 12 months, and a solid two-thirds have
been full-time positions.  Wages
have firmed recently.  For the past three-quarters, the economy has grown around
3.5% and appears off to a solid start in Q2. Canada’s trade balance has
improved, helped by a recovery in non-energy exports.  The impact of the
softwood lumber duties will be of interest.  How much was volume impacted
or how much simply meant US consumers paid a higher price?
For two month’s the euro has
alternated between weekly gains and losses.
  In the saw-tooth pattern the weekly
advances have been larger than the weekly losses; hence the uptrend.  If
the pattern is to remain intact, it will be a down week for the euro, which is
consistent with a further clarification by the ECB and soft economic data in
the EMU (and the UK).  We expect the
market to turn cautious ahead of $1.15.   
Sterling has advanced for
eight consecutive sessions. 
 It is the longest streak in two
years.  It has approached an important technical area that kept the May
rally in check ($1.3055).  A push above this level early in the week ahead
could be similar to the end of a boxer’s punch, as opposed to a sustained breakout, especially if the fundamental data suggest Carney’s caution will
continue to prevail.  
With the BOJ lagging behind
the other central banks, short yen cross positions have been in momentum and carry buckets. 
 The dollar’s weekly close above JPY112.00 was a
constructive price development.  A downtrend line from the year’s high
intersects at the end of next week near JPY112.50.  A break of this would
further lift the tone.  On the downside, the JPY111.20-70 offers an
initial base.  
There are events next week
that may be under-appreciated. 
 The first is that Japan and the EU
are getting very close to a trade agreement.  In fact, the July 6 summit
is likely to produce a political agreement to remove all customs duties in the bilateral trade.
 The deal, according to estimates, could triple EU agriculture exports to
Japan, and increase overall EU exports by a third.  
Next week concludes with the
G20 meeting in Hamburg Germany on July 7-8.  
The theme is a fair and free trade.  It will be one of the more difficult
summits to paper over the distinct tensions as is the usual fare. There are
broad tensions with the United States.  The withdrawal from the TPP and the Paris Accords, the sanctions that threaten the Nord Stream 2 pipeline,
the reported requests for unilateral concessions from some Asian trading
partners, supporting Le Pen in France, and the threat to put a tariff on steel
imports are all flash points.  
The inability to distinguish
a squabble among friends and allies with strategic
disputes with adversaries risks raising trade tensions and isolating
America at a time when international cooperation is sought on a wide range of
issues, including fighting terrorism and reining in North Korea. 
 This could have
a longer-term impact on the dollar, and
underpin the underlying desire for an alternative, for which we would continue
to argue that there is no compelling candidate. 

However, the key to the dollar’s performance in the time frame
that matters to most investors lies with cyclical considerations and the US
economic and monetary policy. 
The debate within the
Republican Party, which has a majority in both chambers, has paralyzed the
legislative process, creating the famed gridlock, in a similar but different
way that as the inter-party rivalry has sometimes fostered. The lack of
convincing legislative progress on healthcare, for which the opposition to the
Affordable Care Act was most united, raises questions about the broader
economic agenda, and recently prompted the IMF t o revise down its growth
outlook for the US.  


Share this post

Share on facebook
Share on google
Share on twitter
Share on linkedin
Share on pinterest
Share on print
Share on email