All About the Bank of England Ahead of US Jobs Report Tomorrow

  • The main event of the day is the start of a new communication era for the Bank of England
  • Investors appear to be mostly anticipating the first BOE rate hike in Q2 16
  • In terms of data, Australia reported a relatively good jobs report, but the market stayed focused on the increase in the unemployment rate, while German factory orders surprised on the upside
  • In EM, we note that the Mexican central bank conducted an extraordinary intervention yesterday; the Brazilian central bank releases minutes later today

Price action:  The dollar is mixed against the majors in narrow ranges.  Kiwi is outperforming, while the Aussie is underperforming after a mixed jobs report.  The euro is trading around $1.09.  Sterling is flat ahead of BOE today, trading just above $1.56, while dollar/yen is trading just below 125.  EM currencies are mostly weaker, with RUB and MYR underperforming.  KRW is outperforming.  MSCI Asia Pacific fell 0.2%, with the Nikkei up 0.2%.  The Shanghai Composite fell 0.9%, while the Shenzhen Composite fell 0.7%.  Euro Stoxx 600 is down 0.4% near midday, with Greek stocks up 3.5%.  This is the first up day since the Greek market reopened, and financials are up 5%.  S&P futures are pointing to a lower open.  The US 10-year yield is flat at 2.27%, while European bond markets are mostly firmer.

  • The main event of the day is the start of a new era at the Bank of England.  Until now, at the conclusion of the MPC meeting, the decision would be announced, but no press conference was typically held.  A few weeks later the minutes would be released, and the vote revealed.  Starting today, the minutes will be released simultaneously with the decision.  Also today, at the same time, the Bank of England will release its inflation report, which contains its economic forecasts. Less than an hour later, Governor Carney will hold a press conference.
  • If that is the procedure, what is the substance?  There are two details on which investors will focus.  First is the vote.  As many as three MPC members are likely to dissent in favor of higher rates. A dissent by Miles, however, will immediately be discounted as it is his last meeting, and his replacement, through his academic work, may be somewhat less hawkish.  The second issue is the BOE’s inflation forecasts.  It is expected to be at the 2% target in two years.  The three-year forecast is understood to be the policy signal.  The BOE has to balance a number of cross currents, including sterling’s appreciation, oil, wages, capacity constraints, and the real estate market.
  • Investors appear to be anticipating the first BOE rate hike in Q2 16, depending on which market one is looking at.  However, there appears to be about a 1 in 3 chance being priced in of a hike as soon as Q4 15.  We are skeptical of a rate hike this year.   We note that this will not be the first time that the hawks on the MPC want to raise rates.  Sterling’s strength on a trade-weighted basis is already tightening monetary conditions.  The yield on the 2-year gilt is up 20 bp this year, the most among the G7 countries.  The FTSE is up 2.5% year-to-date, making it easily the worst performing market among the major European bourses.
  • Earlier today, and overshadowed by the pending BOE flurry, the UK reported an unexpected decline in June industrial output.  The 0.4% decline compares with expectations of a small rise.  The May data were trimmed as well.  This means that industrial output rose 0.7% in Q2, not 1.0% that had been assumed by the preliminary estimate of Q2 GDP.
  • The recognition that the BOE will likely be the second major central bank to lift rates after the Federal Reserve has helped underpin sterling.  This is especially evident on the crosses.  Against the dollar, sterling has been moving sideways.  The range of about $1.55-1.57 has largely contained sterling since the middle of last month.   This broadly sideways movement has neutralized many technical indicators.  In terms of speculative positioning in the futures market, we note that the short position has been trending lower since mid-January and as of last Tuesday, stood its smallest level since last November.  This has been more a function of gross shorts being reduced rather than new longs being established.
  • Two other data points of note have been reported today.  First, Australia reported a relatively good jobs report, but the market stayed focused on the increase in the unemployment rate to 6.3% from 6.1%.  This was a function of the participation rate rising to 65.1% from 64.8%, which is a two-year high.  Full-time jobs rose 12.4k after a 25.9k increase in June. The Aussie has been drifting lower since Tuesday’s strong rally, when the RBA resisted talking the currency down.  It peaked near $0.7430 and found a bid today near $0.7315.  A break of $0.7300 signals the end of the upside correction.
  • Second, German factory orders surprised on the upside.  They jumped 2% and overshadowed the downward revision of the May series to -0.3% (from -0.2%).  Reports linked the June rise to the Paris Airshow.  Export orders rose 4.8%, led by an 8.8% rise in capital equipment orders from outside EMU.  Domestic factory orders fell 2%.  These details belie the Bloomberg headline claiming that the surge in German manufacturing orders was a sign of robust growth.  The fact of the matter is that Germany is borrowing the limited aggregate demand from other countries.
  • The euro extended yesterday’s recovery in Asia, reaching a high near $1.0945.  However, it was sold in Europe to $1.0885.  Similar behavior is evident against sterling.  Key support there is near GBP0.6930-0.6950.  For its part, the dollar has been confined to less than a quarter yen range below JPY125 against the Japanese currency.  The greenback briefly traded above JPY125 for the first time in two months yesterday, helped by raising US yields.
  • The North American economic calendar is light.  The focus remains on the US labor market.  The Challenger jobs report may draw some attention but tends not to move the market.  Weekly initial job claims recently fell to their lowest level since the 1970s (to 255k in the same week that the nonfarm payroll survey is conducted).  The four-week moving average stands just below 275k.  Barring a significant surprise, look for it to slip back below 270k to near the mid-May cyclical low of 266.5k.
  • Yesterday, the Mexican central bank conducted an extraordinary intervention, triggered by a 1% move from the previous day’s fix.  The amount was $200 mln, which comes in addition to its regular $200 mln daily auction, but it still wasn’t enough to prevent the peso from closing at a new record low (though still above the record intraday low near 16.50).  The currency has fallen during every session this week, though it has stopped underperforming so much.  The peso is down 10% YTD, with the recent drop in commodity prices adding momentum to the move.  In contrast to this approach, the Colombian central bank co-director Gustavo Cano, sounded very relaxed about the moves in its currency, despite having fallen a whopping 20% this year.  Cano stated that the devaluation has not been excessive and that the currency is now “very close” to equilibrium.  Finance Minister Cardenas has taken a similar stance, welcoming peso weakness.
  • Brazil’s central bank minutes will be released today, along with June unemployment (8.3% consensus).  COPOM signalled that the tightening cycle has ended for now.  Markets had been quick to price in rate cuts for next year, given the deteriorating economic situation.  More recently, however, signs that the government’s fiscal austerity plans will be further derailed by haggling in congress has led rates to rise and removed some of this expected accommodation.  Brazil reports July IPCA inflation Friday, which is seen rising 9.52% y/y vs. 8.89% in June.  Both IPCA and FIPE inflation are making new cycle highs, as are IGP-M and PPI wholesale inflation measures.  As such, COPOM’s communication strategy will likely be tested in the coming days.  Brazil local currency bonds are the third worst performer in EM, with 10-year yield up 97 bp YTD.