Three Central Banks Dominate the Week Ahead

Four central banks from high income countries hold policy is making meetings in the first full
week of September. 
are the Reserve Bank of Australia,  Sweden’s Riksbank, the Bank of Canada,
and the European Central Bank. Investors focus on the latter two.  
To be sure, no one expects
the ECB to change rates or policy. 
 At most, some guidance into its intentions after current
buying commitment is fulfilled at the end
of the year.  The Bank of Canada is the only major central bank that could
raise rates.  
Since early June, the Bank
of Canada put the market on notice that it no longer judged that the economy
warranted the level of accommodation that in did in 2015 when it cut rates
took one of those cuts back in July and
was expected to take the other one back in October.  News last week that
the Canadian growth continued to accelerate in Q2 spurred speculation that the
rate hike can be brought forward to Wednesday, September 6.  
Growth in Q2 unexpectedly
increased to 4.5% on an annualized basis from 3.7% in Q1
.  Economists were looking at an
unchanged rate, while in July, the Bank of Canada suggested a modest slowing to
3% was likely.   Consumption rose 2.6%.  
This is not to suggest that the Canadian
economy is firing on all cylinders.
  It is not. The housing market remains a concern
for policymakers.  The effects of the macroprudential
efforts to rein in excess in the housing market in Vancouver seem to be wearing off, warning of similar results in the
Greater Toronto area that more recently implemented analogous policies.
 Non-energy exports are struggling to find traction, they fell in June,
though are up from a year ago.  The July merchandise trade balance will be
reported the same day as the Bank of Canada meeting.  
The impact of the storm that
socked Houston and the Gulf of Mexico may encourage caution. 
 There is also uncertainty
surrounding the future of NAFTA after
Trump renewed this threat to withdraw.  The second round of NAFTA
negotiations began on September 1 in Mexico City and will continue through
September 5.   US businesses have begun pushing back against some of the
demands by the Trump Administration, especially on changes in the domestic
content rules and the push to jettison the trade tribunals.  This latter
point was a red line for Canada.  
The Bank of Canada’s meeting
on September 6 will not be followed by a
press conference or a Monetary Policy Review. 
 The Canadian dollar rallied 2.6%
against the US dollar after the strong GDP reported, and pushed the US dollar
below CAD1.24 for the first time in two years.   Speculative positioning
in the futures market is extended.
 The net long position in August reached it highest level in a little more
than four years, while the gross long speculative position moved is holding
above 80k contracts for the first time in five years. Interpolating from indications from Overnight Index Swaps, the
market has a slight lean in favor of a hike next week.  
That said, we suggest that
the Canadian dollar may weak regardless of when the Bank of Canada does.
  A rate hike may spur selling
on the fact after the rumor was bought.
 Standing pat would see the Canadian dollar weaken on disappointment.
 We suspect that the failure to hike rates would produce a better buying
opportunity.  Confidence that a hike will be forthcoming will bring in new
demand on the pullback.  A hike, ironically, will leave the market unsure
if the Bank of Canada intends to simply reverse
the 2015 cuts or will it continue to hike.  
The ECB is facing a similar
is strong, but price pressures remain subdued, and not yet, convincingly moved
onto a sustainable path toward the ECB’s target for the headline rate of near
but less than 2%.  The rise of the euro and backing up of market rates have
tightened financial conditions that in turn will, if anything, serve to dampen
price pressures.  
The ECB’s language has
evolved in recent months.
downside risks to the economy have disappeared in the wake of persistently high
growth at levels that are sufficient to absorb excess capacity.  The risk
of deflation has disappeared. This has
been an important factor driving the euro and interest rates higher.  
European equities have been
a different story. 
Money may still be flowing into European equity funds, but the Dow Jones Stoxx
600 peaked nearly four months ago.  German’s DAX peaked in mid-June.
 France’s CAC peaked in early May.   There is an under-appreciated
irony here.   The French stock market peaked shortly after Macron was elected President.  The euro gapped
higher after it became clear he would win, and it has not looked back. 
There are three components
of the ECB meeting that have to be considered.
  First, are the staff forecasts.
 These are not simply an academic
function. It is tied to policy in a way
that the Fed’s dot plots, for example, do not.  The market will be more
sensitive to a cut in the inflation forecast than an increase in the growth forecast.  Projecting lower
inflation would be understood as a dovish signal, and point to modest policy

Since the forecasts were made in June, the euro’s rise has largely offset the rise in oil price, and
while 10-year German bund yields are higher, French, Italian and Spanish
benchmark yields have declined.  
The PMIs suggest that regional economy may have lost a bit of
momentum in Q3, though it continues to operate at a high level. In the coming
days, the Eurostat will report July retail sales (likely fell) and industrial
production (likely bounced back after sharp
0.6% decline in June).  

The second component is the
ECB’s next policy step.
had expected that the ECB would take advantage of the new staff forecasts to
announce that it will extend the asset purchases next year but at a slower
pace.  However, the strength of the euro,
which briefly traded above $1.20 last week (and approached the 50% retracement
objective of the depreciation that began in mid-2014-~$1.2165), has increased
the risk that the ECB waits a little longer to announce its decision.  It must ultimately extend the purchases or
make a potentially destabilizing hard stop (except for the reinvestment of
maturing issues that are estimated to run at a little more than 10 bln euros a
Instructing the relevant
committees to review the issue, in the context of a lower inflation forecast
would be seen a dovish development, but we don’t think it changes the
is two aspects
of the policy that is important to
investors, assuming that no new assets are added to the mix or taken away
(though we would not rule out stopping buying ABS, which has seen low and
diminishing interest):  the length of the extension and the amount to be
The current extension was
for nine months (until the end of this year).
  We suggest a six-month extension now maximizes
the flexibility that policymakers need.  It would also cover the period of
the run-up to the Italian election next spring (the date and rules have yet to
be determined).   
At its peak, the ECB was
buying 80 bln euros of assets a month. 
 This was reduced to 60 bln since March.  If the
ECB were to reduce the purchases to 40
bln euros a month as a majority of the Reuters poll would have it, this would
imply the ECB would be expanding its balance sheet for nearly all of 2018.
 This is too big a commitment, which despite the program’s
flexibility, will be seen by such an announcement.  We suggest that a 30
bln reduction (to 30 bln euros) would maximize the ECB’s flexibility.
 Having made a 30 bln euro adjustment, it could do so again in after H1
and end the purchases.  On the other hand, if needed it could taper
further at mid-year.   It would also allow continued broadly adhering to
the capital key, which is an important principle in Europe beyond its use in QE.
The third-factor investors need to grapple with is the euro and market
moving above $1.20 on August 29, the euro could not sustain the momentum, and it has slipped lower.  The
disappointing US core PCE deflator and employment growth saw the euro make
another run at $1.20 before the weekend (~$1.1980) before selling off on
reports of the ECB’s cautiousness next week.  The euro finished just off
session lows.  At the start of this year, many were concerned about the extreme long dollar positioning.  Dollar sentiment seems as extreme now but
in the opposite direction, and the euro is the un-dollar of choice.  
From March 2015 through June
2017, the euro was largely range-bound between roughly $1.05 and $1.15. 
 The highs in August 2015 and May
2016 marked by similar price action as we saw last week–euro rally to new
highs but finishing on its lows.  We had linked our expectation of a
better fourth quarter for the dollar partly to the idea that the lifting of the
US debt ceiling will drain around $400 bln as the Treasury’s steps to maneuver
around the ceiling are reversed.  

Due to the idiosyncrasies of
the US political system, the emergency funds for the area devastated by the
recent storm may be tied to lifting the
debt ceiling.
  It is not clear, but this could take place in
the coming days.  Lifting the debt ceiling would ensure that the
government does miss a debt payment.  New spending authorization is a
different matter.   The failure to reach an agreement could lead to a temporary
shutdown of what are regarded as
unessential services.  
President Trump has threatened to allow the government to shut if
funding for the wall with Mexico is not provided.  

That brings us to the third
central bank that will draw investor attention. 
 The FOMC does not meet until
September 19-20.  However, ahead of the blackout period (starts September 9), several Fed officials will speak.  We
think Governor Brainard and NY Fed President Dudley comments are the most
important. Brainard previously seemed to lead the Fed’s concern about the
international prospects, and more recently was among the first to flag the
softening price pressures.   

Dudley part of the troika
(with Yellen and Fischer) that seem most often expressing the policy
most recently suggested the balance sheet operation would begin shortly
(announcement this month), and that he would be inclined to raise rates again
provided there were no downside

The impact of the storm
could shave 1% off Q3 GDP and 0.5% of Q4
GDP to use rough and ready estimates 
 It will produce all kinds of distortions in the
economic data. How will the Fed navigate those, on top of the drama in
Washington?  Can the Fed begin allowing the balance sheet to shrink in
October even if the government may be shut?
 We look toward Brainard and Dudley to shed light on how the Fed is
wrestling with these issues.  


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