Sive Morten
Special Consultant to the FPA
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Fundamentals
This week markets mostly were watching for Central Banks' meeting - Canada and EU in particular and important statistics, across the Globe, such as US GDP, Consumer spending and some other. The drama has happened on Friday, when EUR has turned on a dime and re-established the status quo. Indeed although we've got some reasons day before that could trigger rally that we saw on EUR, but at the same times, all factors were not as strong as the rally was looking like. This has brought the fruits right on next day. And this price action better fits to our general view on EUR. Miracle has not happened and ECB remains the white crow keep lagging all other Central Banks.
Market overview
The Aussie dollar jumped on Wednesday as surprisingly strong inflation data raised the possibility of sooner-than-planned rate hikes, while the yen was calm as Japan's central bank is seen retaining its easy monetary policy stance later this week. Data showed Australian core inflation rose at its fastest annual pace since 2015 in the September quarter, and quicker than the Reserve Bank of Australia's projections.
The data backed markets' view that the RBA is behind the curve on inflation and may have to tighten monetary policy earlier than it has been publicly planning for.
"The stronger trimmed mean print will put some pressure on the RBA to rethink its forward guidance for the cash rate," wrote ANZ analysts in a note.
The Reserve Bank of Australia meets on Tuesday of next week and market pricing is at odds with RBA policymakers' insistence that there will be no rate hikes before 2024. RBA declined to buy a government bond at the heart of its stimulus program, fanning speculation the central bank will allow rates to rise earlier than expected. The central bank again resisted buying the key bond earlier on Friday.
Not all central banks are as far off from tightening policy however. Significantly, the U.S. Federal Reserve looms large for markets as they prepare for policymakers to announce next month it will start tapering its massive asset purchase programme.
The Bank of Canada also has a policy announcement, with investors expecting it will raise its inflation forecast and largely end stimulus from its pandemic-era bond buying program, making it the first central bank from a G7 country to do so. The Canadian dollar was steady, having eased a little in recent days as traders worry the BoC will temper investor expectations.
Canada signaled that it could hike interest rates sooner than it had thought. Before the announcement, which was viewed by some as surprisingly hawkish, the Canadian dollar had weakened to its lowest level in nearly two weeks against its U.S. counterpart.
The Bank of Canada comments could be the first trigger for new assessments of how interest rates will change and impact currencies as central bankers try to support the pandemic recovery without unleashing sustained inflation.
Currency markets had moved little in the first two days of this week as traders paused for monetary policy announcements from major central banks around the world, including the U.S. Federal Reserve, which meets next week.
The German government cut its 2021 growth forecast for this year, as supply bottlenecks for semiconductors and rising energy costs delay recovery in Europe's largest economy. Germany's 10-year bond yield fell to its lowest in more than a week and its yield curve flattened.
Similarly, the U.S. yield curve flattened with the spread between yields on two- and 10-year Treasuries narrowing to fewer than 104 basis points, the least since August. The 10-year yield dipped below 1.53%. It had reached 1.70% last week.
Flattening yield curves in developed markets this week may reflect concern, analysts say, that central banks will err if they tighten policy too early in the face of higher inflation that proves temporary.
The dollar languished near its weakest level in a month against major peers on Friday, hurt by a stronger euro as traders bet on earlier European interest rate hikes and as an equity rally sapped demand for safer assets.
The euro was propelled on Thursday after comments by European Central Bank President Christine Lagarde were interpreted in some quarters as not going far enough in affirming the central bank's dovish stance.
European Central Bank President Christine Lagarde acknowledged on Thursday that inflation will be high for even longer but pushed back against market bets that price pressures would trigger an interest rate hike as soon as next year. With central banks around the world signalling tighter policy amid rising prices, Lagarde said the ECB had done much "soul-searching" over its stance but concluded that inflation was still temporary, so a policy response would be premature.
She identified higher energy prices, a global mismatch between recovering demand and supply, and one-off base effects such as the end of a cut in German sales taxes as the three main factors temporarily driving euro zone inflation.
But policymakers speaking in private were more cautious, warning that there was a risk that price growth would come down at an even slower rate than predicted and inflation would stay above 2% in 2022, two sources familiar with the discussion told Reuters. Some even see a risk that inflation could stay close to target in 2023, even if the mainstream view among policymakers was for a lower rate, the sources added.
Lagarde also took aim at market expectations for an interest rate hike next October, arguing they are out of line with the bank's policy guidance, which says rates will not rise until inflation across the 19-country euro zone is seen back at target by the middle of the forecast period and set to hold there.
Although Lagarde's words appeared timid, sources close to the discussion said no member of the rate-setting Governing Council agreed with market views.
Signalling that the ECB is not indifferent to the global environment, Lagarde said its 1.85 trillion euro Pandemic Emergency Purchase Programme (PEPP) was likely to end as scheduled next March. Such a move is widely expected by investors. With other central banks around the world are already reacting to higher inflation, the ECB is likely to remain an outlier.
The Bank of Canada indicated on Wednesday it could hike interest rates as soon as April 2022 and said inflation would stay above target through much of next year. The U.S. Federal Reserve and the Bank of England have also signalled policy tightening while several smaller central banks, from Norway to South Korea, have already hiked rates.
The euro’s losses deepened on Friday, retracing nearly half of its gains in the previous session, as euro zone inflation shot past expectations this month to equal its all-time high, creating a policy dilemma for the European Central Bank. The single currency which has broadly struggled against its rivals on Friday, slipped to more than one-year lows against the Swiss franc as Italian bond yields resumed their upward march a day after the European Central Bank struck a dovish note at a policy meeting.
Data on Friday showed inflation in the 19 countries sharing the euro rose to 4.1% in October from 3.4% a month earlier, beating a consensus forecast of 3.7%. That reading is the highest since 2008 and equals the all-time-high for the time series launched in 1997.
Money markets are nearly fully pricing in a 10 bps rate hike from the European Central Bank by July 2022 and nearly two rate hikes by October 2022. A week ago, markets were pricing in barely one rate hike by October 2022 and less than half a rate hike by July 2022.
The dollar continued to rebound from prior-day losses on Friday as the euro plunged and currency and bond markets tried to sort through inflation reports and
central bank comments amid end-of-month position adjustments.
U.S. Treasury yields rose after the government's index of core personal consumption expenditures - the Fed's preferred inflation measure - climbed 0.2% in September, showing an increase of 3.6% over 12 months.
U.S. consumer spending increased solidly in September, but was partly flattered by higher prices, with inflation remaining hot as shortages of motor vehicles and other goods persisted amid global supply constraints. Inflation pressures are broadening out, with other data on Friday showing employers boosted wages by the most on record in the third quarter as they competed for scarce workers. The industry-wide surge could undercut Federal Reserve Chair Jerome Powell's long-held view that high inflation is transitory.
The strength in consumer spending at the end of last quarter, together with falling COVID-19 infections and recovering consumer confidence bode well for a pickup in economic activity in the final three months of the year, though shortages and more expensive goods pose risks. The economy grew at its slowest pace in more than a year in the third quarter.
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose 0.6% last month after rebounding 1.0% in August, the Commerce Department said. Economists polled by Reuters had forecast consumer spending increasing 0.5%.
In the 12 months through September, the so-called core PCE price index increased 3.6% for a fourth straight month. The core PCE price index is the Fed's preferred inflation measure for its flexible 2% target. When adjusted for inflation, consumer spending rose 0.3% after gaining 0.6% in August.
Background for the Fed action
Federal Reserve officials face a ticking clock in their ability to ignore high inflation and are now navigating between their own senses of patience and risk, and a U.S. economy stymied by tangled supply chains, slow hiring and strong consumer demand. The combination of supply bottlenecks and a surge in household incomes fueled by pandemic-related government aid pushed the personal consumption expenditures price index, a key measure of inflation, to a 30-year high on a year-on-year basis in August.
Policymakers still largely expect the pace of price increases to ease without the Fed nudging the process by raising interest rates sooner and higher than expected.
Yet that judgment now hinges on a race, in effect. Will disruptions, such as the 100-ship backup at the Los Angeles-Long Beach port complex in California, disappear before households run out of an estimated $2 trillion in excess savings accumulated during the pandemic? And will that happen before recent price hikes show up in public expectations about future inflation?
The latter may already be starting. A Fed index of inflation expectations tracked by top officials at the U.S. central bank has risen for an unprecedented five straight quarters. At 2.06%, it is above the Fed's 2% target, and likely rising. Consumer expectations have jumped, too. The Conference Board reported on Tuesday that its 1-year consumer inflation expectations survey for October hit 7.0%, the highest since July 2008.
Bond markets, also anticipating more inflation, are pricing an earlier start and faster pace to Fed interest rate hikes.
Now, half of the 18 policymakers project a hike in 2022, a move that would come as Democratic President Joe Biden's administration is financing new spending and likely before employment has returned to pre-pandemic levels. That could complicate Democrats' efforts to keep control of Congress in the Nov. 8, 2022 elections.
Fed Chair Jerome Powell has noted the emerging "tension" between the central bank's employment and inflation goals. Fed Vice Chair Richard Clarida, asked in April when he would worry that the Fed's expectation of "transitory" inflation might be wrong, cited "the end of the year." Fed Governor Chris Waller last week set the same timeline.
It's a choice Fed officials hoped to skirt with a new policy framework built to capture job gains they feel were missed in past business cycles when interest rates were raised too soon. That framework depends on inflation, job markets, and other parts of the economy behaving as they had before. For now at least, the pandemic has put some doubt around that premise.
It's not just things like a global computer chip shortage, capacity constraints in warehouse construction, or other supply issues that have stretched the Fed's "transitory" inflation narrative. The behavior of households and elected officials' actions also cloud the horizon.
Fed officials, as a result, seem increasingly open to the uncomfortable possibility that the inflation they thought they had vanquished will prove to have returned more quickly than the jobs and workers their policies were intended to entice back.
But between possible shifts in household preferences, restructuring because of the pandemic, and some signs inflation expectations may be rising, Harris wrote, "the Fed's narrative faces challenges along a number of fronts.
Continued in the next post...
This week markets mostly were watching for Central Banks' meeting - Canada and EU in particular and important statistics, across the Globe, such as US GDP, Consumer spending and some other. The drama has happened on Friday, when EUR has turned on a dime and re-established the status quo. Indeed although we've got some reasons day before that could trigger rally that we saw on EUR, but at the same times, all factors were not as strong as the rally was looking like. This has brought the fruits right on next day. And this price action better fits to our general view on EUR. Miracle has not happened and ECB remains the white crow keep lagging all other Central Banks.
Market overview
The Aussie dollar jumped on Wednesday as surprisingly strong inflation data raised the possibility of sooner-than-planned rate hikes, while the yen was calm as Japan's central bank is seen retaining its easy monetary policy stance later this week. Data showed Australian core inflation rose at its fastest annual pace since 2015 in the September quarter, and quicker than the Reserve Bank of Australia's projections.
The data backed markets' view that the RBA is behind the curve on inflation and may have to tighten monetary policy earlier than it has been publicly planning for.
"The stronger trimmed mean print will put some pressure on the RBA to rethink its forward guidance for the cash rate," wrote ANZ analysts in a note.
The Reserve Bank of Australia meets on Tuesday of next week and market pricing is at odds with RBA policymakers' insistence that there will be no rate hikes before 2024. RBA declined to buy a government bond at the heart of its stimulus program, fanning speculation the central bank will allow rates to rise earlier than expected. The central bank again resisted buying the key bond earlier on Friday.
Not all central banks are as far off from tightening policy however. Significantly, the U.S. Federal Reserve looms large for markets as they prepare for policymakers to announce next month it will start tapering its massive asset purchase programme.
"We think the dollar is going to turn lower from here especially when the Fed does start tapering as people start to 'sell the fact'" said Daniel Lam senior cross-asset strategist, at Standard Chartered Wealth Management. "That's already happening as people kind of front run it," he said.
The Bank of Canada also has a policy announcement, with investors expecting it will raise its inflation forecast and largely end stimulus from its pandemic-era bond buying program, making it the first central bank from a G7 country to do so. The Canadian dollar was steady, having eased a little in recent days as traders worry the BoC will temper investor expectations.
"While the market is likely correct in expecting another C$1bn cut in the pace of asset purchases, the more sensitive question is on the policy rate, and here we think it might be next to impossible for the Bank of Canada to validate market pricing on lift-off timing," Michael Hsueh, research analyst at Deutsche Bank in New York, said in report.
Canada signaled that it could hike interest rates sooner than it had thought. Before the announcement, which was viewed by some as surprisingly hawkish, the Canadian dollar had weakened to its lowest level in nearly two weeks against its U.S. counterpart.
"You're going to see more FX volatility and swings here," said Ed Moya, senior market analyst at broker OANDA. Traders will have different expectations for inflation in each region, Moya said, adding: "Interest rate differentials are going to be really hard to calculate for some currencies."
The Bank of Canada comments could be the first trigger for new assessments of how interest rates will change and impact currencies as central bankers try to support the pandemic recovery without unleashing sustained inflation.
Currency markets had moved little in the first two days of this week as traders paused for monetary policy announcements from major central banks around the world, including the U.S. Federal Reserve, which meets next week.
The German government cut its 2021 growth forecast for this year, as supply bottlenecks for semiconductors and rising energy costs delay recovery in Europe's largest economy. Germany's 10-year bond yield fell to its lowest in more than a week and its yield curve flattened.
Similarly, the U.S. yield curve flattened with the spread between yields on two- and 10-year Treasuries narrowing to fewer than 104 basis points, the least since August. The 10-year yield dipped below 1.53%. It had reached 1.70% last week.
Flattening yield curves in developed markets this week may reflect concern, analysts say, that central banks will err if they tighten policy too early in the face of higher inflation that proves temporary.
The dollar languished near its weakest level in a month against major peers on Friday, hurt by a stronger euro as traders bet on earlier European interest rate hikes and as an equity rally sapped demand for safer assets.
The euro was propelled on Thursday after comments by European Central Bank President Christine Lagarde were interpreted in some quarters as not going far enough in affirming the central bank's dovish stance.
Lagarde's "pushback was not forceful enough," opening the way for the euro to test $1.1680 in the near term, TD Securities strategists wrote in a note. However, "extrapolating (euro strength) beyond that seems like a big ask a week ahead of the Fed's meeting where taper will be announced," they said.
European Central Bank President Christine Lagarde acknowledged on Thursday that inflation will be high for even longer but pushed back against market bets that price pressures would trigger an interest rate hike as soon as next year. With central banks around the world signalling tighter policy amid rising prices, Lagarde said the ECB had done much "soul-searching" over its stance but concluded that inflation was still temporary, so a policy response would be premature.
She identified higher energy prices, a global mismatch between recovering demand and supply, and one-off base effects such as the end of a cut in German sales taxes as the three main factors temporarily driving euro zone inflation.
"While inflation will take longer to decline than previously expected, we expect these factors to ease in the course of next year ... We continue to see inflation in the medium term below our 2% target," Lagarde said.
But policymakers speaking in private were more cautious, warning that there was a risk that price growth would come down at an even slower rate than predicted and inflation would stay above 2% in 2022, two sources familiar with the discussion told Reuters. Some even see a risk that inflation could stay close to target in 2023, even if the mainstream view among policymakers was for a lower rate, the sources added.
Lagarde also took aim at market expectations for an interest rate hike next October, arguing they are out of line with the bank's policy guidance, which says rates will not rise until inflation across the 19-country euro zone is seen back at target by the middle of the forecast period and set to hold there.
"Clearly under the current analysis (those conditions) are not satisfied and certainly not in the near future," Lagarde said, adding that it was not for her to say whether markets were getting ahead of themselves.
Although Lagarde's words appeared timid, sources close to the discussion said no member of the rate-setting Governing Council agreed with market views.
"Lagarde clumsily read from paper that market bets on interest rates were not in line with the ECB's guidance," Nordea economist Jan von Gerich said. If her intention was to bring market pricing more in line with the ECB’s guidance, she failed miserably."
Signalling that the ECB is not indifferent to the global environment, Lagarde said its 1.85 trillion euro Pandemic Emergency Purchase Programme (PEPP) was likely to end as scheduled next March. Such a move is widely expected by investors. With other central banks around the world are already reacting to higher inflation, the ECB is likely to remain an outlier.
The Bank of Canada indicated on Wednesday it could hike interest rates as soon as April 2022 and said inflation would stay above target through much of next year. The U.S. Federal Reserve and the Bank of England have also signalled policy tightening while several smaller central banks, from Norway to South Korea, have already hiked rates.
The euro’s losses deepened on Friday, retracing nearly half of its gains in the previous session, as euro zone inflation shot past expectations this month to equal its all-time high, creating a policy dilemma for the European Central Bank. The single currency which has broadly struggled against its rivals on Friday, slipped to more than one-year lows against the Swiss franc as Italian bond yields resumed their upward march a day after the European Central Bank struck a dovish note at a policy meeting.
President’s Christine Lagarde’s failure to push back against market expectations of higher interest rates has brought out the bears with Danske Bank strategists expecting the euro to fall to $1.10 over the next 12 months saying “if inflation proves longer-lasting, the comments today makes us less confident that ECB would not change policy rates eventually.”
Data on Friday showed inflation in the 19 countries sharing the euro rose to 4.1% in October from 3.4% a month earlier, beating a consensus forecast of 3.7%. That reading is the highest since 2008 and equals the all-time-high for the time series launched in 1997.
“Investors are just not buying what the ECB is saying,” said Marios Hadjikyriacos, a senior investment analyst at brokerage XM. With inflation expectations going ballistic, markets are betting the central bank will be forced to take its foot off the gas sooner, first by slashing asset purchases and then with tiny rate increases.”
Money markets are nearly fully pricing in a 10 bps rate hike from the European Central Bank by July 2022 and nearly two rate hikes by October 2022. A week ago, markets were pricing in barely one rate hike by October 2022 and less than half a rate hike by July 2022.
The dollar continued to rebound from prior-day losses on Friday as the euro plunged and currency and bond markets tried to sort through inflation reports and
central bank comments amid end-of-month position adjustments.
U.S. Treasury yields rose after the government's index of core personal consumption expenditures - the Fed's preferred inflation measure - climbed 0.2% in September, showing an increase of 3.6% over 12 months.
U.S. consumer spending increased solidly in September, but was partly flattered by higher prices, with inflation remaining hot as shortages of motor vehicles and other goods persisted amid global supply constraints. Inflation pressures are broadening out, with other data on Friday showing employers boosted wages by the most on record in the third quarter as they competed for scarce workers. The industry-wide surge could undercut Federal Reserve Chair Jerome Powell's long-held view that high inflation is transitory.
The strength in consumer spending at the end of last quarter, together with falling COVID-19 infections and recovering consumer confidence bode well for a pickup in economic activity in the final three months of the year, though shortages and more expensive goods pose risks. The economy grew at its slowest pace in more than a year in the third quarter.
"The economy has a supply problem not a demand problem," said Christopher Rupkey, chief economist at FWDBONDS in New York. "The economy has money to burn and that is why inflation will be hard to extinguish."
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose 0.6% last month after rebounding 1.0% in August, the Commerce Department said. Economists polled by Reuters had forecast consumer spending increasing 0.5%.
In the 12 months through September, the so-called core PCE price index increased 3.6% for a fourth straight month. The core PCE price index is the Fed's preferred inflation measure for its flexible 2% target. When adjusted for inflation, consumer spending rose 0.3% after gaining 0.6% in August.
Background for the Fed action
Federal Reserve officials face a ticking clock in their ability to ignore high inflation and are now navigating between their own senses of patience and risk, and a U.S. economy stymied by tangled supply chains, slow hiring and strong consumer demand. The combination of supply bottlenecks and a surge in household incomes fueled by pandemic-related government aid pushed the personal consumption expenditures price index, a key measure of inflation, to a 30-year high on a year-on-year basis in August.
Policymakers still largely expect the pace of price increases to ease without the Fed nudging the process by raising interest rates sooner and higher than expected.
Yet that judgment now hinges on a race, in effect. Will disruptions, such as the 100-ship backup at the Los Angeles-Long Beach port complex in California, disappear before households run out of an estimated $2 trillion in excess savings accumulated during the pandemic? And will that happen before recent price hikes show up in public expectations about future inflation?
The latter may already be starting. A Fed index of inflation expectations tracked by top officials at the U.S. central bank has risen for an unprecedented five straight quarters. At 2.06%, it is above the Fed's 2% target, and likely rising. Consumer expectations have jumped, too. The Conference Board reported on Tuesday that its 1-year consumer inflation expectations survey for October hit 7.0%, the highest since July 2008.
Bond markets, also anticipating more inflation, are pricing an earlier start and faster pace to Fed interest rate hikes.
"Early on, patience was easy," Fed Governor Randal Quarles said last week. "The fundamental dilemma that we face ... is this: Demand, augmented by unprecedented fiscal stimulus, has been outstripping a temporarily disrupted supply." Yet the economy's "fundamental capacity" remains intact, and Fed officials want to keep interest rates low as long as possible to let employment rise. "Constraining demand now, to bring it into line with a transiently interrupted supply, would be premature," Quarles said, but "my focus is beginning to turn more fully ... to whether inflation begins its descent."
Now, half of the 18 policymakers project a hike in 2022, a move that would come as Democratic President Joe Biden's administration is financing new spending and likely before employment has returned to pre-pandemic levels. That could complicate Democrats' efforts to keep control of Congress in the Nov. 8, 2022 elections.
Fed Chair Jerome Powell has noted the emerging "tension" between the central bank's employment and inflation goals. Fed Vice Chair Richard Clarida, asked in April when he would worry that the Fed's expectation of "transitory" inflation might be wrong, cited "the end of the year." Fed Governor Chris Waller last week set the same timeline.
"We seem at an inflection point and the question is whether some of the old problems are coming back to haunt us," said Peter Ireland, an economics professor at Boston College.
It's a choice Fed officials hoped to skirt with a new policy framework built to capture job gains they feel were missed in past business cycles when interest rates were raised too soon. That framework depends on inflation, job markets, and other parts of the economy behaving as they had before. For now at least, the pandemic has put some doubt around that premise.
It's not just things like a global computer chip shortage, capacity constraints in warehouse construction, or other supply issues that have stretched the Fed's "transitory" inflation narrative. The behavior of households and elected officials' actions also cloud the horizon.
Fed officials, as a result, seem increasingly open to the uncomfortable possibility that the inflation they thought they had vanquished will prove to have returned more quickly than the jobs and workers their policies were intended to entice back.
"It goes without saying that the Fed feels burned by the last business cycle," Ethan Harris, global economist at Bank of America, wrote recently. Interest rates were raised, but inflation never reached the Fed's 2% target and potential job gains were left on the table.
But between possible shifts in household preferences, restructuring because of the pandemic, and some signs inflation expectations may be rising, Harris wrote, "the Fed's narrative faces challenges along a number of fronts.
Continued in the next post...