Drivers for the Week Ahead

  • The major US data releases this week center around inflation; the debate surrounding the Fed’s new long-term policy statement will continue for months, if not years
  • BOC meets Wednesday and is expected to keep policy steady; ECB meets Thursday and is expected to keep policy steady; the strong euro will likely be a topic of discussion
  • The next round of Brexit talks begin Monday in London; UK reports several key data points Friday; BOE officials are already tilting dovish ahead of next week’s meeting
  • Japan has a heavy data week; Suga has emerged as the likely successor to Abe; Australia reports several confidence measures this week

What’s changed over the past week or so? Many things. Let’s start with the US. Fed Chair Powell unveiled the bank’s new “Statement on Longer-Run Goals and Monetary Policy Strategy,” in which the Fed will be given much more discretion to allow higher inflation and tighter labor markets. US data remain solid but are still showing signs of sequential deceleration. Elsewhere, Japan will have a new leader soon and that should ultimately lead to more fiscal stimulus. The eurozone is back to deflation, supporting the view that the ECB will expand QE by year-end. Same goes for the Bank of England, as policymakers have tilted more dovish recently.

Where does that leave the dollar? The dollar took a big hit after Jackson Hole and traded at new cycle lows last week. However, there is growing unease with what’s going on in the rest of the world and that helped the dollar regain some traction going into the weekend. While the US virus numbers remain high, countries that have started to reopen are seeing a resurgence in infections as well as some loss of momentum in their economic recoveries.

What’s next? The momentum for the dollar appears to have faded, as last week’s three-day bounce in DXY was unable to take out the previous week’s highs. DXY closed lower Friday, giving up gains earlier that day. For us to get more constructive on the greenback, DXY would have to break above the 94.00 area, which represents some highs from August as well as the 38% retracement objective of its fall from the June 30 peak. This corresponds with the $1.17 area for the euro and the $1.30 area for sterling. Until that happens, we believe markets will stick with the momentum trade of a weaker dollar.

 

AMERICAS

The major US data releases this week center around inflation. Or the lack thereof. August PPI will be reported Thursday, with headline expected to rise a tick to -0.3%% and core to remain steady at +0.3% y/y%. CPI will be reported Friday, with headline expected to rise a couple ticks to 1.2% y/y and core to remain steady at 1.6% y/y. We would not make too much of the stronger than expected 4.7% y/y gain in average hourly earnings reported for August. When nearly 30 mln are out of work from mostly lower wage positions, average hourly earnings are mechanistically pushed higher. No one can argue with a straight face that wage pressures are an issue.

The debate surrounding the Fed’s new long-term policy statement will continue for months, if not years. Basically, the Fed has said that it will no longer follow the Phillips Curve and tighten preemptively to head of wage pressures. Yet tolerating higher inflation is quite different from creating it. With slack in the labor market and broader economy to remain for years, it’s hard to see where sustainably higher inflation will come from. That said, the bottom line is that US rates will stay lower for longer. Full stop.

The Fed media embargo went into effect Saturday and so there will be no more Fed speakers until Powell’s post-decision press conference September 16.  At that meeting, the Fed will release its updated Summary of Economic Projections. The Beige Book report was relatively uninspiring, noting increased economic activity across most Fed districts but generally modest and below levels prior to the pandemic. Indeed, many districts noted a slowing pace of growth in tourism and retail after some recovery was seen. Lastly, some districts reported slowing job growth and increased hiring volatility.

Weekly jobless claims will be reported Thursday.  Initial claims are expected at 845k vs. 881k the previous week, while continuing claims are expected at 12.907 mln vs. 13.254 mln the previous week.  However, the caveat going forward is that the BLS just changed its seasonal adjustment methodology last week, making it more difficult to compare changes going forward. Still, when all is said and done, recent data suggest the labor market is still healing, albeit slowly. The August jobs data were solid, but the 1.371 mln jobs gain continues the sequential loss of momentum seen across most US economic indicators.

The August budget statement Friday will be of interest. Consensus sees a deficit of -$250 bln. If so, this would push the 12-month total up to -$2.975 trln and just shy of the June record of -$2.982 trln. The Congressional Budget Office warned last week that the deficit will rise to a record -$3.3 trln in FY2020 ending this month. The CBO also said the debt to GDP ratio is likely to rise above 100% in FY2021 and will continue climbing to 109% in FY2030.

Other US data releases are minor. July consumer credit will be reported Tuesday and is expected to rise $12.95 bln. July JOLTS job openings will be reported Wednesday and are expected at 6000 vs. 5889 in June. July wholesale trade sales will be reported Thursday.

Bank of Canada meets Wednesday and is expected to keep policy steady. The bank has been on hold since its last 50 bp cut March 27. At its last policy meeting July 15, Governor Macklem noted that the bank’s economic forecasts suggest that rates will remain at current levels for at least two years. USD/CAD is finding strong support near the 1.30 area, just above the December 31 low near 1.2950. Break below those levels would set up a test of the October 2018 lows near 1.2915 and then 1.2785.

 

EUROPE/MIDDLE EAST/AFRICAs

The European Central Bank meets Thursday and is expected to keep policy steady. However, it will likely be a dovish hold that sets the table for further easing by year-end. The economic outlook continues to worsen and this will have to be acknowledged in its updated macroeconomic projections. Last week, eurozone August CPI came in at -0.2% y/y vs. expectations of a 0.2% rise and is the first deflationary reading since May 2016. Also, July retail sales fell -1.3% m/m vs. expectations of a 1.0% rise.

The strong euro will likely be a topic of discussion. Since the July 16 meeting, the euro has gained 4% vs. the dollar and 3% vs. the yen. Last week, ECB Chief Economist Lane signaled some concern about the strong euro, noting that it feeds into the bank’s forecasts and policy settings. Press reports suggest ECB policymakers are worried about the impact of the strong euro on exports and inflation, noting this will harm the economy. On the six ECB decision days so far this year, the euro has weakened on four of them and gained on two of them. Expect Madame Lagarde to field a lot of questions about the euro this time around.

Ahead of the ECB decision, there will be some key data releases. Germany reports July IP (4.5% m/m expected) Monday, followed by trade and current account data Tuesday. Final eurozone Q2 GDP data will also be reported Tuesday. France (5.0% m/m expected) and Italy (3.5% m/m expected) report July IP Thursday, followed by Spain (3.6% m/m expected) Friday. The full eurozone IP won’t be reported until September 14.

The next round of Brexit talks begin Monday in London. Expectations are low, as both sides are dug in with regards to the two most contentious areas, fisheries and level playing field. EU’s Barnier said he is “worried” and “disappointed” by the current state of the talks, adding that the UK will need to soften its position in order to reach an agreement. UK’s Frost warned of limited progress this week while sticking with the hardline approach to fisheries by backing industry calls for greater catches for UK fishermen.

The UK reports several key data points Friday. July GDP (6.7% m/m expected), IP (4.2% m/m expected), construction output (10.0% m/m expected), services index (7.0% m/m expected), and trade (GBP3 bln expected) will all be reported that day. Bank of England next meets September 17 and no change in policy is expected. The bank will release its updated macro forecasts at the November 5 meeting, which may provide the opportunity to set the table for another expansion of its QE program before year-end.

BOE officials are already tilting dovish ahead of next week’s meeting. Deputy Governor Ramsden, Governor Bailey, and MPC member Vlieghe appeared before parliament last week and delivered a fairly downbeat outlook for the economy. Ramsden noted that “We have headroom to do materially more quantitative easing if we need,” adding “We have the operational and other capabilities to do it fast if market dysfunction required that. So we can influence both the size and pace.” Bailey noted risks to growth remain to the downside, while Vlieghe warned “There is a material risk in my view that it could take several years for the economy to return to full capacity and inflation to return sustainably to target, even with monetary policy at its current settings.”

 

ASIA

Japan has a heavy data week. July real cash earnings (-1.8% y/y expected), household spending (-3.7% y/y expected), current account (adjusted JPY1.445 trln expected), and final Q2 GDP (-28.5% SAAR expected)will be reported Tuesday. August machine tool orders will be reported Wednesday. July core machine orders (-18.2% y/y expected) will be reported Thursday, followed by August PPI (-0.5% y/y expected) Friday.

Bank of Japan next meets September 17 and no change in policy is expected. The bank will release its updated macro forecasts in its Outlook Report at the October 29 meeting. Reports suggest the bank may upgrade its monthly economic assessment, though it would likely signal that the economy was no longer in the “extremely severe situation” flagged in its last assessment from July rather than suggesting a robust recovery. Reports suggest that any change will be finalized at the BOJ meeting.

Yoshihide Suga has emerged as the likely successor to Shinzo Abe. Reports suggest the LDP leadership vote will be held September 14. As chief cabinet secretary, Suga has served as Abe’s right-hand man and so we do not foresee any deviation from Abenomics. We still expect another slug of fiscal stimulus before year-end, all the more so for Suga to make a strong statement of policy continuity.

Australia reports several confidence measures this week. August NAB business conditions will be reported Tuesday. September Westpac consumer confidence will be reported Wednesday. The RBA left rates steady last week but expanded its Term Funding Facility for banks. Banks can access additional funding equivalent to 2% of their outstanding credit for three years at a fixed rate of 25 bp. The RBA also signaled willingness to ease further, noting that it “continues to consider how further monetary measures could support the recovery.”