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Market commentators/analysts continue to cite “hopes” that Fed Chair Powell will adopt a more dovish tone than that of last week’s FOMC minutes (from the July meeting) when he delivers his address at the Jackson Hole symposium on Friday as supporting the market’s broader appetite for risk. These hopes for a more dovish Powell are premised on the idea that the FOMC is worried about the worsening state of the Covid-19 outbreak in the US. There have been two recent signs that the Fed might be turning a tad more dovish; 1) the fact that the Fed moved the Jackson Hole symposium to an online only event to reduce Covid-19 spread risks and 2) comments from usually hawkish FOMC member Kaplan last Friday who said the worsening delta variant outbreak might force him to re-evaluate his economic forecasts for the US this year. Meanwhile, Consumer Sentiment and business survey data for August has thus far underwhelmed and this, compared with a slowing in some of the hard data metrics from July (like retail sales), might also be a cause for concern at the Fed as it signals the pace of the US recovery is slowing. Given the above, some market participants will be hoping that Powell will not signal or hint that the Fed is ready to start tapering in the coming months, as most other market participants seem to expect.
The counter-argument to this is that the most important economic factors watched by the Fed are 1) inflation (which remains well above the Fed’s 2.0% target and may remain there for a protracted time) and 2) the recovery in the labour market (which has been going very well in recent months and the signs from this month’s jobless claims numbers suggests that this should continue in August). The inflation target has already been met, as many FOMC members have already conceded (other economists would say it has been massively overshot) and the labour market is likely to very soon fulfil the “substantial” further progress (towards its pre-Covdi-19 health) condition outlined by the Fed as a necessary requirement to begin the tapering of their QE purchases. The Fed recognises that resurgence of the pandemic is not having the same economic impact that it has in the past given 1) widespread vaccination and 2) the resultant reluctance to reimpose economic restrictions and so might be “clutching at straws” if it uses this as justification to delay QE tapering. It is worth remembering, as some prominent US economists have pointed out in the past, that low interest rates are what really stimulates the US economy and QE programmes are more of a financial crisis fighting measure. Despite the current uptick in Covid-19 cases, the financial system does not appear anywhere near close to crisis point (like was the case back in March 2020) and, given that FOMC members have argued recently that they are sceptical as to how much continuing with QE purchases right now is actually helping the economy, it seems unlikely that the Fed is going to meaningfully pushback its QE tapering timeline to help the economy as Covid-19 infections rise again.
Given all of the above, it seems as though markets might be getting ahead of themselves with regards for their hopes for a more dovish tone from Fed Chair Powell. Though he may well nod to the increase in pandemic related risks, it is still very likely that he will hint towards a QE taper announcement in the coming months, as has been the market’s base case over the last few weeks. This may provoke a hawkish reaction in markets, which at the very least would likely result in some upside in the US dollar and some downside in gold. US equity markets may take a slight knock at the time, but the positive backdrop of strong earnings growth in recent quarters as well as low developed market bond yields (which remain not too far above historic lows in most G10 countries, including the US) ought to keep things supported and the buy-the-dip mentality that has been so successful over the past 10 months alive.
In terms of what markets are doing this morning; risk appetite remains on the front foot, with global equities, crude oil and other risk sensitive commodities all seeing further, albeit more modest, gains this Tuesday. Starting with equities; after rallying more than 1.0% yesterday, the FTSE World index (an index of more than 3.9K stocks in nearly 50 countries, covering 95% of global equity market capitalisation) is up a further 0.2% this morning and has now retraced more than 80% when it pulled aggressively back from record highs last week; the FTSE World’s record high is 872.69 (set on Friday the 13th of August) and it printed lows just above 850 last week, but has now recovered all the way back to around 868 this Tuesday. The recovery in US equities has been even more impressive; the S&P 500 surged back to fresh record highs on Tuesday, closing just under 4480 and this morning, E-mini S&P 500 futures came very close to hitting the 4500 marks. Now turning to commodities; after surging from under $62.00 lows to above $65.00 on Monday (a more than 5.0% gain at the time), front-month WTI futures are up nearly another 2.0% this Tuesday at not far from the $67.00 mark. Short-term supply concerns in Mexico (an oil platform fire in Mexico that killed five workers has taken 421K barrels per day I supply offline), optimism that China has contained its recent Covid-19 outbreak (no new cases were reported for a consecutive day) and concerns that oil markets had become oversold are all being cited as reasons for crude’s continued accent. Industrial metals (Copper +0.4%) are also for the most part higher, despite the US dollar stabilising today in wake of its recent pullback from nine-month highs.
The combination of better risk appetite (i.e. stocks higher) and recent strength in commodity prices mean that in G10 FX markets, we continue to see outperformance in commodity linked currencies like CAD, AUD and NZD. The Loonie was yesterday’s big winner, with USDCAD continuing its sharp reversal from close to 1.3000 (which it nearly hit last Friday) as it closes in on the 1.2600 level. But the kiwi is today’s big winder, with NZDUSD up nearly 0.9% on the session. Hawkish remarks from assistant RBNZ Governor Hawkesby are helping; he said that the bank was considering a 50bps hike last week and the only reason they opted to hold rates was due to the “communications” challenges surrounding the fact that the country has only just been thrown back into strict lockdown. Moreover, another senior central banker said on Monday that the new outbreak did not constitute a game-changer for the RBNZ yet (i.e. they still see themselves on course to hike interest rates in the near future to address growing inflation/overheating/housing bubble risks).
Back to the US dollar, the DXY is consolidating around the 93.00 level and, commodity G10 FX aside, is flat against most of its other G10 major pairings. EURUSD is flat just under 1.1750, GBPUSD is flat just above 1.3700 and USDJPY is flat consolidating just above 109.50. The latter has been highly subdued this week amid equally subdued conditions in US bond markets, where the US 10-year yields has been going sideways either side of the 1.25% mark for the best part of seven sessions now. Traders argue that aggressive rebound in stock, commodity and risk/commodity sensitive FX markets after last week’s correction aside, markets are broadly likely to remain subdued for the rest of the week in the run up to Fed Chair Powell’s remarks at the Jackson Hole event on Friday.
The Day Ahead
Influential ECB member Schnabel speaks at 1330BST and might be worth a watch for more colour on the ECB’s recent inflation targeting policy shift (the bank adopted a symmetric 2.0% inflation target). US New Home Sales data for July at 1500BST is unlikely to move markets. Oil traders will be watching the private API crude oil inventory report at 2130BST. Things are otherwise likely to be quiet and boring, with the main theme to focus on being fresh developments in the state of the global pandemic.
