US Fed – Interest rate expectations for September decline

ECB – How will ECB react to events of recent weeks?

US Fed – Interest rate expectations for September decline

Eurozone – Leading indicators stabilize, despite uncertain environment

Differing statements ahead of ECB Council meeting next week

Next week’s ECB Council meeting will be watched closely by market participants. The question is whether and how the Council will react to the events of the last few weeks. Turbulence on capital markets poses a downward risk for the economy, even as the most recent indicators have surprised on the upside. However, the fact that the risks of a weaker economy and lower commodity prices have decreased inflation expectations is likely the most crucial consequence for the central bank from the recent events. The significance of a drop of inflation expectations in five years by two tenths of a percent is arguable. The decisive point is that this is one of the measures the ECB Council uses to measure midterm inflation expectations. The statements by high-ranking ECB officials on this topic differed in the course of this week. ECB Vice-President Constancio said that the signals coming from China so far do not justify the rout on the stock market and that the yuan devaluation is not a major factor for the Eurozone’s inflation outlook. Constancio added that the oil price development is more relevant, and the decline was affecting headline inflation, but there was nothing monetary policy could do about it. ECB Chief Economist Praet, on the other hand, sounded quite different just the next day. Praet said that recent developments had increased the downside risk of achieving the sustainable inflation path towards two percent. Further, Praet reiterated the willingness and ability of the Council to act if needed. Inflation expectations play a crucial for the ECB in setting monetary policy. At the last several meetings, the Council defined that, in the case of a material change (alongside an unwarranted tightening of monetary conditions) to the outlook for price stability, it would use ‘all the instruments available’ in response. Since there are not many instruments left, this would mean an increase and/or timely extension of its asset purchases. So, the ECB Council must decide at the upcoming meeting if the recent developments justify a material change to the outlook for price stability. In our view, it will be too early to make such an assessment - the more so as the euro has come back significantly from this week’s high and mid-term inflation expectations have increased, albeit from a low level, and remain clearly lower than at the previous ECB Council meeting in July. However, the Council could react to recent developments through a more aggressive wording concerning the risks. Possibly, the upcoming weekend will shed more light regarding the ECB’s thinking. ECB Vice- President Constancio will participate in a discussion at the Jackson Hole Symposium, hosted by the Federal Reserve of Kansas City. The topic of the panel will be Global Inflation Dynamics and other panelists include Bank of England Governor Carney and Vice-Chairman of the Federal Reserve Fischer. Should the discussion yield hints on increased asset purchases by the ECB, we would expect a turbulent market opening on Monday.

Uncertainty over timing of initial US rate hike has increased

At the upcoming symposium in Jackson Hole, the Federal Reserve might also use the opportunity to signal to markets their assessment of the current environment and the short-term outlook for monetary policy. Chair Yellen will not attend, but her deputy Fischer will. This week, Federal Reserve of New York President Dudley stated that a hike had become for him less compelling. However, he wanted to wait for further economic data before making a final decision. This statement probably characterizes the wait-and-see stance of most FOMC members at present. The outcome will hinge on whether the situation on capital markets calms or if high volatility will persist, in our view. Upcoming economic data will also play a role and here important releases are scheduled for next week. The ISM will give an indication of how the manufacturing sector is performing and at the end of the week the allimportant labor market report will be released. But in the end, even positive surprises would not trigger a rate hike if markets remain jittery.
Currently, markets give a rate hike in September a small likelihood. Any statements for example from Fischer putting the market’s assessment in doubt would move markets next week. We see the chances for a rate hike in September at 50%, higher than the market - not least, as any postponement would signal the FOMC’s serious concerns for the economy, which would affect the sentiment negatively.

Eurozone – Leading indicators stabilize, despite uncertain environment

This week’s released main leading indicators for the Eurozone have stabilized, despite an uncertain environment. Thanks to strong wholesale and construction data, the German ifo business climate rose slightly in August, against market expectations. The somewhat dampened sentiment of industry seems to reflect the current uncertain environment regarding the global economy (triggered by declining commodity prices as well as fears regarding slower Chinese growth). Coming next, the release of industry PMIs for Italy and Spain for August as well as the release of the July unemployment rate for the Eurozone will be in focus. In light of the current unstable environment, we expect the unemployment rate to remain stable at 11.1%. So far, thanks to declining unemployment as well as rising real wages, consumption has been the main driving force of the Eurozone’s recovery. Overall, the already published leading indicators for 3Q indicate slightly weaker growth of around 0.2% q/q (after + 0.3% q/q in 2Q).