Geopolitics, Trump doubts and policy normalisation driving the Macro outlook - Westpac

Geopolitics and uncertainties over the Trump administration are the current drivers of markets which has led markets to question the resolve of the Fed to continue their tightening cycle, in addition to US political risk from the upcoming debt ceiling negotiations, according to analysts at Westpac.

Key Quotes

“That said, the peak of the global easing and liquidity cycle has passed and monetary policy normalisation will continue to drive markets in coming months. BOC and ECB will bring this to the fore.”

“This “normalisation” view has been complicated by continued low inflation prints (particularly in US with a debate about transitory or structural weakness) and supressed wage outcomes. Despite low unemployment rates in many countries, low wages growth appears a global phenomenon, suggesting it could be a (perceived) labour supply problem, with workers fearful of two sources of acute competition – globalisation and technology.”

“These “mega-trends” are not going away and we expect technology will underpin low wage and inflation outcomes globally. This is particularly pertinent for AU and NZ where technological penetration is lower. Are central banks fighting the last war?”

“With that inflation backdrop, we expect US policy tightening to remain gradual. The Fed’s Balance sheet normalisation adds a new (untested) element, but their plans are benign and shouldn’t upend markets.”

“USD weakness has continued, and market has unwound much of the Trump reflation optimism, although equity markets seem broadly unfazed as financial conditions remain supportive of real economy. Despite improving data flow and increasing geopolitical risk, the USD remains out of favour.”

“Later in the year looks more conducive for the USD. Debt ceiling and government shutdown risk runs high in Sep and Oct and Q3 seasonals are poor. Later Q4 looks much more fertile for the USD – by then these key event risks will have been negotiated, seasonals are much more supportive and Washington will begin focusing heavily on tax cuts.”

“The EUR is strong as EU data continues to impress and credit conditions remain supportive. The ECB is preparing the ground for change (watch Draghi at Jackson Hole), but due to the continued slack in labour markets the path of guidance change will be very gradual and cautious before APP and then NIRP are reduced.”

“The UK economy has been resilient in the face of Brexit, but pressure will increase as deadlines loom. The government and its negotiation stance appear vulnerable. Recent softer headline and core CPI quashed the BOE dissenters’ calls for withdrawing accommodation. With Brexit backdrop, how hawkish can BOE afford to be?”