Uncertainties Everywhere

Uncertainties Everywhere

  • As financial markets try to find some degree of stability, expectations for the timing of the first Fed hike keep shifting
  • Most of the newfound dovish views on the Fed have premised this on the elevated market volatility and/or the developments in China
  • All of this only heightens the pressure on Fed Vice Chair Fischer when he speaks on the 29th of August at Jackson Hole
  • After a volatile session, the Shanghai comp ended the day down 1.3%
  • The South Africa Reserve Bank and the South Korean officials are stepping up their defences against market volatility, at least verbally

Price action: The dollar is mixed against both developed and emerging market currencies on the day while global equity markets are mixed. The euro has been trading on both sides of $1.1500 while sterling gave up the $1.57 level to trade at $1.5650. The Australian dollar is underperforming, testing the $0.71 level. The dollar is weaker against the yen, falling back below the ¥120.0 level to ¥119.50. On the EM side, KRW has outperformed, up almost 1% against the dollar, while RUB and MYR are underperforming. The yuan was marginally stronger. It has been a mixed session after yesterday’s negative close of US equities (S&P -1.3%). The Nikkei rose 3.2% and the Kospi was up 2.6%, but China was down 1.3% and EuroStoxx are 1.5% lower. US futures, however, are up over 1%.

  • As financial markets try to find some degree of stability, expectations for the timing of the first Fed hike keep shifting. A couple of weeks ago, a survey by the Wall Street Journal found that 82% of participants expected a rate hike in September. At the same time, market based measures were far less convincing, pricing in around a 60% chance, depending on what measure you looked. Enter a week of extreme volatility with policy shifts in China and several markets participants began to shift out their expectations. Now some have begun to entertain the idea of an October hike (previously taboo since there is no scheduled press conference), others have pushed back their calls for the first hike to come only next year, while some high profile investors and observers are openly suggesting that the next move by the Fed will actually be more easing.
  • Most of the newfound dovish views on the Fed have premised this on the elevated market volatility and/or the developments in China. The latter was further fuelled by comments from voting Fed President Lockhart earlier in the week saying that “…the appreciation of the dollar, the devaluation of the Chinese currency […] are complicating factors in predicting the pace of growth.” Though he added that his view towards the timing of the move is still “later this year.” All of this has helped to reduce conviction about a hike in September. Using the Bloomberg model for backing out the probabilities via Fed Funds, we get around a 28% chance of a hike in September, 34% in October, and 51% in December (again, just one of many possible ways to do this).
  • To complicate matters, there has been no evidence of additional rapid depreciation of the yuan, and US data is coming in on the strong side. The yuan spot rate is down about 3.2% since the mini devaluation, so most of it came in the first day. Yesterday’s PMI readings show that the service sector is holding up well, even though manufacturing PMI has fared a lot worse. Meanwhile, consumer confidence rebounded, just two points away from its 8-year high level in January. Yields bounced back yesterday and continue to rise today, with 2- and 10-year US Treasury yields up around 7 bp after four consecutive sessions of declines.
  • All this only heightens the pressure on Fed Vice Chair Fischer when he speaks on the 29th at Jackson Hole. He will be speaking on inflation. As we noted previously, we will be looking for him to elaborate on how the Fed targets core inflation, and why the appreciation of the dollar, and drop in commodity prices, have a transitory impact on the general price level.
  • After a volatile session, the Shanghai comp ended the day down 1.3%. The index had an intra-session range of 8.4%, looking at peak to trough. Also, the latest data from the China Securities Finance Corporation shows the magnitude of the reduction in margin trading in local equities. According to data compiled by Bloomberg, after Monday’s session the outstanding margin loans for trading in the Shanghai and Shenzhen exchanges fell to RMB 1.2tln, from a record of RMB 2.3tln.
  • The South Africa Reserve Bank (SARB) and the South Korean officials are stepping up their defences against market volatility, at least verbally. The SARB released a statement yesterday saying that it could get involved in FX markets. The idea is to protect the country from “developments that threaten the orderly functioning of markets” and financial stability. This didn’t have any immediate impact on ZAR, nor would we have expected it to. After all, this is a commitment to a future action, and conditional on premises that are not well defined. Similarly, the Korean Finance Minister vowed to “actively” respond to financial market concerns, but didn’t cite any specific measures. Still, this moves both countries further down the spectrum of the more active central banks in the EM space, along with the likes of Brazil, Mexico, Peru and several Asian countries. So far these efforts appear to have had mixed success at face value, but it’s important to try to imagine the counterfactual: where would EM currencies be in the absence of any action?
  • The Brazilian real underperformed yesterday, making new highs for the cycle. The currency had been holding up relatively well until yesterday, but that changed with a near 2% depreciation, taking the dollar to BRL 3.6169, a level not seen since 2003. Part of the reason was, as usual, domestic. The political situation has worsened again as the most important member of the government coalition, the PMDB, threated to split from the ruling PT. This only compounded the growing concerns of fiscal slippage relative to the initial ambitious plans of Finance Minister Levy. Not even the positive news that President Dilma would conduct a political reform to cut the number of ministers was enough to improve the mood.
  • It was a light session on the data front so far. Looking ahead, US durable goods is expected to contract by 0.4% in July. However, the contraction comes after the higher reading of 3.4% in the previous month, boosted by commercial aircraft orders relating to the Paris Airshow. So the ex-transport reading will be more indicative, and here markets expect a 0.4% increase, down from a revised 0.6% in