News That Matters Next Week 15th July

The volatility eruption in recent weeks can largely be attributed to comments from central bankers, and it means that it would not be unreasonable to view Ben Bernanke’s semi-annual two-day testimony before Congress, beginning on Wednesday, “with some trepidation,” according to ING’s chief international economist Rob Carnell.

Bernanke this week reiterated that the Fed remains committed to “highly accommodative” monetary policy “for the foreseeable future”. The general message from Bernanke – and many other FOMC members – is that the market misinterpreted the Fed’s message a few weeks ago when it suggested that tapering of asset purchases could begin by the end of the year.

The apparent mixed-messages from the Fed have led to criticisms about the central bank’s ‘open mouth’ operations. Julian Jessop, an analyst at Capital Economics, however, believes such criticism to be unfair. “The Fed’s communications have been attempting to address at least three separate issues, often simultaneously: the timescale for tapering asset purchases under QE3, the timing of the first hike in official interest rates, and the overall stance of monetary policy thereafter,” Jessop says, “comments that apply to one issue are often misunderstood to apply to another.”

Given the markets’ propensity to misinterpret comments, we should keep the Fed’s June minutes in mind. The minutes suggest that although “half” of the members would like to see asset buys tapered before the end of 2013 (this includes non-voting members of the FOMC), “many” members of the committee would like to see further labour market improvements before tapering begins.

After the release of the FOMC’s June meeting minutes, and Bernanke’s speech on Wednesday, the dollar sold off, putting in its worst two day performance since November 2011. “With the dollar tumbling and equities rising, it would seem that the risk-on-risk-off theme is once again in charge – to the detriment of the safe haven dollar,” says John Kicklighter, chief strategist at DailyFX.

US equities rallied, with the Dow Jones Industrial Average and the S&P 500 jumping to record highs. Treasuries also rallied, with yields on 10s falling from weekly highs around 2.755% to around 2.52% on Friday. “Treasury yields and Fed funds futures are probably close to where the Fed feels comfortable,” believes Rob Carnell, “so probably won’t want to risk a new sell-off.”

Vincent Chaingneau, an analyst at Societe Generale, agrees with the logic. “The market has already adjusted to softer talk from Bernanke, and we don’t see further dovish surprises in his 17-18 July testimony.”

We will also get retail sales, industrial production data, as well as the Beige Book out of the US this week. Carnell expects that “all are likely to confirm that moderate US growth continues.”

Elsewhere, new Bank of Canada governor Stephen Poloz chairs his first policy meeting this week. Despite the slowdown in the Canadian economy in the latter part of 2012, former Governor Mark Carney maintained a hawkish bias. Markets will be eyeing whether Poloz departs from this stance.

Possibilities include providing more forward guidance, which in its current form is viewed as vague by some analysts, like David Madani of Capital Economics. However, some argue that Poloz will wait to see how economic data comes in over the next few months before making any significant policy moves.

The monetary policy statement will be published along with the BoC’s quarterly Monetary Policy Report, and the consensus is that Poloz will be guided by the Bank’s current outlook in this report.

The Bank of England (BoE) minutes will be the highlight of the UK calendar next week. Almost a fortnight ago, the MPC held its policy unchanged, but took the unusual step of releasing an accompanying statement which indicated 1) rates would remain low in the near future, and 2) that the UK’s skittish economy isn’t out of the woods yet. As such, the minutes are likely to provide further insight into the new-look MPC’s thinking, and governor Carney’s approach to UK monetary policy.

Morgan Stanley expects “the central bank will become more transparent under new Governor Carney, providing the central bank with another tool to signal dovishness, and weaken GBP”. Philip Shaw, an economist at Investec, agrees, stating that the release of the statement in and of itself “reinforced expectations that the new Governor will introduce some sort of forward guidance next month” when the review on whether and how to use forward guidance is concluded.

As is to be expected, a lot of attention will be paid to the voting pattern. Many analysts doubt Carney will have wanted to be outvoted at his first meeting. And Shaw suggests “[Carney] could argue that he did not want to make a snap judgement on his fourth day in the job … and that he preferred to back an unchanged stance of policy for now.”

“It is quite feasible then that Dr Carney suggested that the committee as a whole kept its powder dry this time in anticipation ahead of what next month’s events might bring. Hence … we suspect that this time the vote might have been unanimous,” Shaw adds. This is not the consensus view. But, Shaw cautions that if this does transpire to be the case, then it wouldn’t suggest the MPC had adopted a hawkish stance – rather, that the MPC wants to keep an open mind ahead of the all-important meeting next month.

There’s also a ream of UK data scheduled for release next week, including CPI, PPI, unemployment, retail sales and public finances. CPI inflation figures for June will be of particular focus; the consensus forecast is 2.9% year-on-year – a continuation of the upward trend from 2.7% last month.

Victoria Clarke, an economist at Investec, notes a rise in inflation is “predicated on upward pressure from food, petrol and clothing prices ... However we should caution that the airfares wild card remains a threat as ever, with the moving timing of Easter having swayed recent monthly releases making it trickier to benchmark forecast moves off recent months”.

UK unemployment is expected to have been relatively stable last month, while retail sales were likely weaker in June than in May.

Turning to the Eurozone – last week, the market’s attention dramatically turned to Italy after S&P downgraded its sovereign rating by one notch to BBB, citing further weakening growth prospects. The credit ratings firm stated that they may cut the rating again if “the government cannot implement policies that would keep fiscal indicators from deteriorating beyond our current expectations”.

Despite the “IMF’s and EU Commission’s much more relaxed” stance on the Italian economy and fiscal policy, writes Giada Giani, researcher at Citi, the prospect of another wave of concern on public debt sustainability and the lack of growth, caused investors to pull back on Italian government debt resulting in an increase in 10-year bond yields of just over 10 basis points since S&P’s report was released on Wednesday.

Elsewhere in Europe, political turmoil continued to simmer in Portugal – so much so that their 10-year bond yields spiked above the psychologically important 7% mark again. Christian Schulz, senior economist at Berenberg, explains: “Unfortunately, President Cavaco Silva … quashed hopes of political stability by suggesting that all mainstream parties should form a national salvation government. Experience shows that this could be a bad idea: In Italy and Greece, such governments … collapsed early and gave rise to extremist parties at subsequent elections.”

Next week’s calendar is fairly light for events in the Eurozone. The most important data point is the German ZEW survey; the market is expecting a downbeat assessment in July. Citi offers its rationale: “After a few months during which momentum strengthened, PMIs in Germany have stalled, exports and industrial production were weak in May, and markets have been volatile.”

Lastly, ECB governing council member Jörg Asmussen is scheduled to give two speeches on Monday and Thursday. Following what initially appeared to be a revealing interview with Reuters last week – in which he was quoted as having said the ECB’s guidance on low interest rates extends beyond 12 months) – the ECB quickly denied that Asmussen was providing any more forward guidance than president Mario Draghi had at the press conference the previous week.

So it will be interesting to see whether Asmussen bows under the pressure of the ECB press office and begins to follow the central bank line, or whether he continues to surprise markets with more snippets of enlightening information.

Asian trading is likely to be dominated by the release of GDP data out of China, in the first half of the week. The recent central bank induced cash crunch, aiming to make banks more “prudent” in their lending, seems to have ended.

The shake-down seems to have had the desired effect, as overall credit levels have fallen 20.3% year-on-year according to the latest data this week, now standing at the lowest level since December 2012. The crucial question, says Mark Williams, an economist at Capital Economics, is “whether credit growth continues to slow in July. If not, policymakers may be forced to take further drastic steps.”

Wei Yao, an analyst at Societe Generale, says “the chances of upside surprises from the upcoming data releases are fairly limited. Also we don’t think policymakers will substantially ease their tough love stance.”

As China realigns its economy towards a more “sustainable” model, some are expecting annual GDP to fall to the slowest pace in two decades. The consensus forecast is for annual growth to match last month’s reading of 7.7%. However, comments from Chinese finance minister Lou Jiwei on Thursday seemed to suggest that growth may expand less than the government’s target of 7.5% in 2013, possibly coming in as low as 6.5%.

The prospect of a slowdown in China has exacerbated an already grim situation in Australia. New prime minister Kevin Rudd said on Thursday that “the truth is that the China resource boom is over”. Rudd stated that the “core task” of his government is to manage the economy’s transition away from mining dependence (of which China was a key customer), which has largely helped sustain its economy during the crisis years.

Unemployment has also risen to the highest level in four years this week at 5.7%. The Aussie-dollar has continued its recent slump, at one point, falling below $0.90 against the US dollar.

The RBA left policy on hold at its July meeting, although it maintained its easing bias. Traders will be hunting for clues as to when the RBA will cut next, with many expecting a rate cut to come in its August meeting. John Kicklighter, strategist at DailyFX notes “the market sees a 70% chance of an RBA rate next month.” Any suggestion in the minutes that a rate cut is closer may continue to put the Aussie under stress.

Elsewhere in Asia, we will also get the Bank of Japan’s minutes from its June policy meeting. The BoJ was on hold at the meeting, maintaining its aim to double Japan’s monetary base to Y270 trillion by the end of 2014.

Recent comments from policymakers are very encouraging. The BoJ dared to use the word “recovery” in its post-meeting statement for the first time since 2011. It suggests that the Bank is happy with its current levels of accommodation, given the positive tone of Japanese economic data over the last few weeks.

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