China Uncertainty Continues To Cloud US Policy Outlook

• Chinese anxieties to continue having a key bearing on monetary policy decisions
• US labour market report to provide one of the final key inputs ahead of Sept FOMC
• ECB to highlight readiness to act to downside risks to the inflation outlook

Global markets stabilise following China turmoil. Following significant declines in global equity markets earlier this week, driven by ongoing concerns over the outlook for China, the announcement of a range of policy easing measures by the PBoC - including cuts in both the benchmark lending rate and the reserve requirement ratio - provided the impetus for a turnaround in risk appetite. By Asia close, the Shanghai Composite index had recovered some of the week’s losses and Brent crude was back above $45. The recent volatility in financial markets looks set to persist, as concerns about the outlook for China and the extent to which growth is slowing down remain front of mind. Consequently, expectations of further measures from the Chinese authorities, through a further depreciation of the yuan and looser monetary policy, cannot be discounted, especially if upcoming data continue to raise doubts over the ability to hit the government’s 7% GDP growth target. Ahead of the next round of hard Chinese data, the official manufacturing PMI is expected to follow the ‘flash’ Caixin PMI in dipping below the key 50 level, which would reflect a contraction in manufacturing output, supporting the case for additional stimulus. 

China turmoil and general weakness in commodity prices complicate monetary policy outlooks elsewhere.  The impact of China and the pickup in market volatility continues to have a key bearing on the monetary policy outlook in the developed world, not least the US. Comments over the past week have highlighted the extent to which this uncertainty remains a consideration for US policy makers. Although New York Fed president William Dudley still believed that the process of normalising monetary policy would still begin this year, recent external developments made the case for a rate hike at the September meeting “less compelling” in his view. Over the coming week, speeches by Fed Vice Chair Fischer (Sat) and Boston Fed president Rosengren (Tues) will provide further insight on the extent to which the low probability attached by financial markets to a rate hike in September (c. 30%) is supported by FOMC members. 

Strong US employment report key to keep prospect of September Fed tightening in play. The upward revision to the preliminary estimate of Q2 US GDP and the stronger-than-expected July durable goods orders painted a picture of robust health for the US economy at the onset of Q3. Strength is also likely to be seen in July factory orders (Weds), although international factors are likely to weigh on the August ISM surveys (Tues & Thurs). However, it is the employment report for August that will shoulder the heaviest burden of proof to support a September liftoff. With ’some further improvement in the labour market’ indicated by the Fed as a prerequisite for a hike, a solid report would be needed  for August. We look for a 225k rise in payrolls and a dip to 5.2% in the unemployment rate. 

ECB to acknowledge external risks. The detrimental nature of mounting external risks is likely to be reflected in downward revisions to the ECB’s assessment of the euro area inflation outlook at next week’s ECB policy meeting (Thurs). This is likely to prompt Mr Draghi to reiterate that the Governing Council stands ready to expand the policy stimulus should conditions warrant such a move, although policy measures are not likely to be changed presently. Ahead of the meeting, the ‘flash’ reading of annual euro area CPI is expected to soften to 0.1% from 0.2%.

Domestic data of limited interest. Upcoming UK data should provide further colour on activity growth in Q3 following the robust pace of growth in Q2, but in isolation are not pivotal to the UK rate debate. Domestic manufacturing and services PMIs (Tues & Thurs), will provide a key gauge of growth in Q3 (see back page). Elsewhere, while weak commodity prices continue to weigh on Australian terms of trade, the RBA’s rate decision (Tue) sees only a small chance of further easing.