Drivers for the Week Ahead

  • The US dollar is narrowly mixed to start what could be a pivotal week
  • The Federal Reserve is really center stage
  • There is much data that will be reported in the week ahead
  • Australia’s Prime Minister Abbott is facing a last minute leadership challenge
  • In EM, the Chilean and Thai central banks meet this week

Price action:  The dollar is mixed as a pivotal week gets under way.  The dollar bloc and the yen are outperforming, while the Scandies and the euro are underperforming.  AUD is the strongest of the majors as a leadership challenge is mounted against PM Abbott.  The euro made a new cycle high near $1.1375 but has since given back those gains to trade close to $1.13.  Sterling is trading flat near $1.5450, while dollar/yen is testing the 120 area again.  EM currencies are mixed as well.  RUB, PHP, and INR are outperforming while TRY, ZAR, and the CEE currencies are underperforming.  MSCI Asia Pacific was down 0.1%, with the Nikkei shedding 1.6%.  Chinese markets were down, with the Shanghai Composite down 2.7% and the Shenzen Composite down 6.7%.  Euro Stoxx 600 is up 0.3% near midday, while S&P futures are pointing to a lower open.  The US 10-year yield is down 1 bp to 2.17%, while European bond markets are mostly firmer.  Commodity prices are mostly lower.

  • The US dollar is narrowly mixed to start what could be a pivotal week.  The week is made up of two parts:  before and after the FOMC meeting.  Before the meeting we expect broad consolidation, with a modest downside bias in the dollar, as some of the late longs (established after the August 24 frenzied sell-off) get shaken out by either the loss of momentum or lack of conviction that the Fed will hike this week.
  • The Federal Reserve is really center stage.  The issues have been debated ad nauseum.  The Fed had seemed to be edging toward a hike this week before the recent Chinese developments and the jump in capital market volatility.  Indeed the subsequent tightening of financial market conditions, and the slide in the US stock market, has been more associated with easing monetary policy, not tightening it.
  • A Bloomberg poll found 49 of 90 economists surveyed still expect a hike this week.  However, as we have noted, the pricing of various market instruments suggest that market participants see a considerably lower risk.
  • A Fed hike was expected to have been accompanied by dovish reassurance that the normalization would be gradual, and the peak in the Fed funds rate would be well below the past peak.   And the opposite may also be true.  If the Fed does not raise rates, official spin may be more hawkish.  Yellen may stress that a rate hike this year is still the most likely scenario.  Outside of giving up on the possibility of two hikes this year, the FOMC’s dot plots may not show much change in the fundamental assessment.   True to its seemingly systematic bias, the Fed appears to be underestimating the decline in the unemployment rate, but overestimating the increase in price pressures.
  • Another important point that the Fed’s leadership has emphasized is that a rate hike is not going to produce tight monetary conditions.  Rather monetary policy will shift from being extremely easy to just very easy.
  • There is much data that will be reported in the week ahead.  The US reports consumer prices, retail sales, and industrial output figures.  The eurozone reports industrial production and the final August CPI.  Germany’s ZEW will be released.  The UK reports consumer prices, the latest labor market readings and retail sales. Japan reports industrial production and trade figures.
  • However, the data is pale in comparison to the central bank meetings.  The focus is of course on the Federal Reserve, but the Bank of Japan and the Swiss National Bank also meet.  The general view in the market is that none of the central banks act.  Yet the risks abound.
  • The Swiss National Bank is the least likely to surprise.  Without much fanfare, the euro has steadily risen against the Swiss franc, and before the weekend reached its highest level (~CHF1.1050) since the franc’s cap was lifted back in January.  The SNB will say it is ready to act if needed but there is no sense of urgency at the moment.  Moreover, the record paper losses the SNB reported in H1 14 is being pared this quarter.  The Swiss franc has depreciated about 3.5% against the dollar since the end of June and 5.2% against the euro.
  • There is only a slightly greater chance that the BOJ moves.  Most who expect additional monetary stimulus see it coming next month rather than now.  With deflationary forces not convincingly defeated, inflation far from the goal, and economic growth patchy, many think the BOJ has to step up its unorthodox monetary easing.  If boosting the monetary base by JPY80 trln a year is not sufficient, will growing it by JPY90 trln really do the trick, as a member of parliament and an adviser to Abe suggested last week?
  • BOJ Governor Kuroda is still sounding relatively upbeat.  He seems to be playing down the official core measure of CPI (which excludes fresh food), and seems to be placing more emphasis on the measure that excludes food and energy.  After spending the last few months on his controversial political agenda, Abe appears to be returning to economic issues, and fiscal support for the economy, which could include a supplemental budget as early as next month.  Pending fiscal stimulus also argues against more monetary easing now.
  • Australia’s Prime Minister Abbott is facing a last minute leadership challenge later today by former Communications Minister Turnbull.  This is the second leadership challenge this year.  In February, Abbott pleaded for six more months to turn the economic situation around.  A national election will be held next year, and polls show the Abbott’s Liberal Party losing handily.  There is a special election in Western Australia that was thought to be a litmus test for the Liberals, but Turnbull and his allies cannot wait.  Polls suggest that the Liberals will likely hold on to the seat that was opened by the passing of a Liberal MP.  This is part of the internecine struggle in the Liberal Party.  Turnbull had led the Liberal Party until Abbott forced him out in 2009.
  • Yet with the terms of trade shock and the weaker economy, Abbott has seen his support fade.  Turnbull is three times more popular with the voters than Abbott.  There does not appear to be a significant programmatic difference.  It seems mostly about personalities, ego, and style.  For its part the Australian dollar has extended last week’s gains.  The $0.7150 area is the nearby cap, but potential extends toward $0.7200.
  • In EM, the Chilean and Thai central banks meet this week.  Neither is expected to change policy, but if we get a surprise, it would be from Chile.  Chile is facing similar conditions as Peru, where the central bank surprised markets last week with a 25 bp hike.  Chile has adopted a more hawkish stance of late with inflation above target and still rising.  If it does not hike this week, a move in Q4 seems likely.  To state the obvious, EM’s fortunes this week will be shaped by the FOMC.