Drivers for the Week Ahead

  • The FOMC meets Wednesday and is widely expected to hike rates 25 bp
  • Trade tensions will remain high
  •  EU-UK Brexit deal remains far, far away
  • The drama in Italy continues
  • Germany, EU, and Japan all report CPI data
  • Several more EM central banks take center stage; most will be hiking rates

The dollar is mixed against the majors as an eventful week gets under way.  Sterling and the Scandies are outperforming, while the yen and dollar bloc are underperforming.  EM currencies are mixed.  TRY and RUB are outperforming, while INR and PHP are underperforming.  MSCI Asia Pacific ex-Japan was down 0.9%, with Japan markets closed for holiday.  MSCI EM is down 0.7% so far today, with China and many other Asian markets on holiday too.  Euro Stoxx 600 is down 0.4% near midday, while US futures are pointing to a lower open.  The 10-year US yield is up 2 bp at 3.08%.  Commodity prices are mixed, with Brent oil up 2.3%, copper down 0.6%, and gold down 0.1%.

The dollar ended the week on a firm note, but still needs to recoup overall losses that were seen the entire week.  We believe ongoing uncertainty regarding Italy and Brexit is likely to continue weighing on the euro and sterling.  With regards to EM, we think the EM-negative drivers remain in play:  rising US interest rates and heightened trade tensions.  The FOMC meeting will be the key event this week, but the response to the implementation of US and Chinese tariffs will be a close second.

The FOMC meets Wednesday and is widely expected to hike rates 25 bp.  A press conference will follow.  Note that the switch to having a press conference after each of the eight FOMC meetings held annually will begin in January 2019.  While that does not necessarily translate into more rate hikes, it does give the Fed more degrees of freedom with regards to changes in policy.

New staff forecasts and Dot Plots will be presented.  Growth and inflation forecasts could be tweaked higher, but we also suspect the Fed will follow other central banks in warning of the downside risks coming from global trade tensions.  The Dot Plots currently show two more hikes in 2018, three in 2019, and one in 2020.  The Fed’s perceived rate path seems unlikely to change this time around, especially given Governor Powell’s more cautious tone at Jackson Hole last month.

US Treasury yields remain near the cycle highs.  Furthermore, the implied yield on the January 2020 Fed Funds futures contract is trading near 2.84%.  That basically suggests another 100 bp of tightening between now and end-2019.  We can break that down further into 2 hikes still to go in 2018 and 2 more in 2019.  The market has moved closer and closer to pricing in three hikes next year, which is what the Fed currently sees.

Trade tensions will remain high.  US tariffs on $200 bln Chinese imports went into effect today.  So too will the retaliatory $60 bln Chinese tariffs on US goods.  The US has threatened to slap tariffs on a further $267 bln of Chinese goods if China were to retaliate, but no further word yet.

Over the weekend, China canceled a planned meeting with US Treasury officials, perhaps recognizing that trade policy is not being run by Treasury.  Furthermore, China officials warned that no trade talks will be held until President Trump stops threatening more tariffs.  The signs are pointing to a long and protracted conflict, which escalates the risks to the global economic outlook.

NAFTA talks between the US and Canada were extended into this week.  Reports suggest the informal talks will be held on the sidelines of the UN meeting in New York.  Comments Friday cast some doubts on a deal as US officials warned that NAFTA may go ahead with just Mexico on board.  We are not yet sure if Mexico or the US Congress would agree to this, and such a move would likely run into judicial and legislative challenges.

A EU-UK Brexit deal remains far, far away.  The Irish border issue is the main sticking point and remains a deal breaker.  Tory rebels are backing a rival Brexit plan now that May’s “Chequers Plan” was soundly dismissed by the EU at the Salzburg summit last week.  The rival plan pushes for a stripped down free trade agreement with the EU that would allow more time to address more the complicated issues during the two-year transition period to follow.

Time is running out.  Not just for the Brexit deal, but perhaps for May herself.  Next week, she will have face to face down the growing mutiny within her party at the Tory’s annual conference in Birmingham.  Therein lies the rub.  May must try to placate both the EU and her own party in a Brexit deal but risks alienating both with any compromise.  Further complicating matters is Labour Leader Corbyn’s shifting Brexit outlook, which matters if Labour were to win the rumored snap elections.

The drama in Italy continues.  Finance Minister Tria is trying to keep the budget deficit at -1.6% of GDP, while both Five Star leader Di Maio and League leader Salvini want to boost spending that would widen the deficit beyond -2% of GDP.  The leader of Five Star has threatened to leave the governing coalition if it can’t find the funds to keep their campaign promises to spend more.  Polls show public support for the League and Five Star remain strong.

Italy just revised up its 2017 deficit to -2.4% of GDP from -2.3% previously.  This was due to slower growth and will complicate Tria’s efforts as he sets new growth and budget targets on Thursday.  Over the weekend, Salvini pledged a “courageous” budget, implying one that sticks to boosting spending.  A draft budget must be presented to the EU by mid-October.

The European drama is not just limited to Italy.  Germany’s ruling coalition remains unsettled after a deal to promote her domestic intelligence chief fell apart days after it was made.  The promotion did not sit well with the junior coalition partner Social Democratic Party, with party head Nahles and Interior Minister Seehofer reevaluating the deal.  Her coalition has been fragile from the start, with many observers marveling at how weakened Merkel has become.

German September CPI will be reported Thursday.  Inflation is expected to remain steady at 2.0% y/y.  German data will be followed by the eurozone CPI Friday.  Headline is seen ticking up to 2.1% y/y, while core is seen ticking up to 1.1% y/y.  Given that the ECB just met and signaled “steady as she goes,” the data unlikely to have any near-term policy impact.

Japan reports August nationwide CPI, retail sales, IP, and labor market data on Friday.  The data are unlikely to have any near-term policy implications, as the BOJ just met last week and left all policies unchanged.  Note that last Friday, the BOJ trimmed its purchases of bonds with longer than 25-year maturities by JPY10 bln to JPY50 bln yen at its regular operation.  This is the first reduction in the segment since July.

RBNZ meets Thursday (Wednesday evening during the North American session) and is widely expected to keep rates steady at 1.75%.  Last week, Q2 GDP growth came in stronger than expected at 2.8% y/y.  This followed softer than expected Q2 CPI inflation of 1.5% y/y that was reported in July.  The market is not fully pricing in the first rate hike until Q3 2019.  The last move was a 25 bp cut back in November 2016.

After some hawkish holds were seen last week from Brazil and South Africa, several more EM central banks take center stage.  Most will be hiking rates.  Czech National Bank meets Wednesday and is expected to hike rates 25 bp to 1.5%.  Bank Indonesia meets Thursday and is expected to hike rates 25 bp to 5.75%.  Bankgo Sentral ng Pilipinas meets Thursday and is expected to hike rates 50 bp to 4.5%.

On the other hand, Taiwan central bank meets Thursday and is expected to keep rates steady at 1.375%.  Taiwan policymakers are likely concerned about the knock-on effects of the mainland slowdown.  Colombia central bank meets Friday and is expected to keep rates steady at 4.25%.  Here, the economy remains robust and the bank is likely to start hiking in Q1.