US data and Fed expectations
|Volatility in interest rates continues to pick up as inflation data is mixed and central banks' guidance becomes more important. Nowhere is this more apparent than within the Fed. Markets go a full docket for FOMC members speaking publicly last week.
On one side of the spectrum is the expectation that tighter labor market conditions will drive inflation (pure belief in the Philips Curve). The other expectation is that cyclical activity has peaked and a soft reading indicates a broad-based economic weakening. Interestingly and key to our view is that no speaker suggested waiting past 2017 to begin balance sheet reductions. Wide spectrum of opinions on US data had led to a directionless USD trade.
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Yet the fall in oil prices has tipped the balance of weaker prices pressed towards the downside but allowing technology stocks to outperform, driving US equity markets higher. We retain our view that the Fed will raise bench market rates another 25bp in December but further detail its balance sheet reduction process in September.
The Fed will increasingly look too subdued to tighten through the reduction of balance sheet rather than traditional interest rates hikes. However, unbridled USD strength against G10 currencies is unlikely at European PMI to continue to signal faster GDP growth. The ECB see this development as an opportunity to move forward with their strategy to exit emergency monetary policy (including taper its monthly asset purchased).
Even though inflation data has not meaningfully improved, we believe a key announcement will take place at the September ECB meeting. In the near term, traders will be watching incoming USD data for direction. Today’s durable goods orders should decline slightly to -0.6% as industrial production reports a drop in durable goods manufacturing. The highlight of the week will be Thursday's GDP and Friday's personal income & spending plus PCE index.
Finally, while politics will grab the headlines and generate short-term FX pressure (take your pick on Russia investigations, repeal of Obamacare or potential Trump fiscal stimulus), for direction stick to the Fed monetary policy.
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