Three events that will capture the market's attention next week: The consequences of the Japanese election, the first look at US Q1 GDP, and the ECB meeting. The central banks of Turkey and Russia also meet. Both are expected to cut interest rates, following rate cuts in the middle of last week by South Korea, Indonesia, and South Africa. Japan goes to the polls on July 21 to elect the upper chamber of the Diet. There is little doubt that the LDP-Komeito coalition will retain its majority. The real issue is whether it keeps its 2/3 super-majority, which allows it to pursue constitutional changes. The economy itself is struggling, and the sales tax increase in October is unpopular. In addition, news of a (~JPY20 mln or 5k) gap between pension payouts and the cost of a
Marc Chandler considers the following as important: Brexit, ECB, federal reserve, Japan, Russia, US
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The market impact may be minor and primarily limited to the headline effect. What the Fed decides to do at the July 30-31 meeting is not so much a function of Q2 GDP. It is not really based on the current data, and as the Fed's Clarida explained, one needs to move before the data turns down. NY Fed's Williams call for swift, preemptive action when necessary also helped depress the implied yield of the August fed funds futures to a new contract low below 2% before rebounding a bit ahead of the weekend and after the NY Fed suggested Williams comments were misinterpreted.
The market was eager to believe the Fed was going to cut 50 bp in one move that it seemed to willfully confuse the seeming assurances of the timing with the magnitude of the move. At one point, the fed funds futures market was pricing in around a 70% chance of a 50 bp cut. The pendulum of sentiment began swinging back, but it still finished the week better than a one-in-five chance of a 50 bp cut.
The position that the non-voter Minneapolis Fed President advocated a couple weeks ago, to cut rates by 50 bp was a minority view then and remains so now. The only voting member to favor a rate cut in June, St. Loius Fed Bullard has articulated a clear preference for two quarter-point moves. By leaning over its skis, so to speak, the market showed its bias--it wants to believe in lower rates, higher stocks, higher gold, and a weaker dollar.
Judging from the June job creation, core retail sales, and manufacturing, the economy ended the quarter upbeat. The early survey data for July have shown the momentum has picked up. The Empire State manufacturing index rose twice as much as expected, and the Philadelphia Fed survey jumped to 21.8 from 0.3. It was the biggest rise in a decade and four times more than expected.
The Fed has identified the problem as one of uncertainty. We remain unpersuaded that a 25 or even a 50 bp move offsets the uncertainty stemming from US trade policy, the partly related slowing of the world economy, Brexit, or the approaching debt ceiling. We are not convinced that a rate cut will be transmitted to the household sector via lower debt servicing costs. The main obstacle to stronger business investment does not appear to be high-interest rates, so it seems a bit dubious that a rate cut now would boost it.
However, the channel in which a rate cut could be important is as a signal of a lower neutral reading. The Fed's forecast of the long-term rate of fed funds has gradually been reduced but 2.5% the median dot is still too high. The implication is that the monetary setting may be tighter than commonly understood. Officials may be reluctant for practical and ideological reasons to put the equilibrium level below the current inflation target but in the world of surplus capital that we argue characterizes the modern era, that is where it might ultimately lie. That said, the Fed is reviewing its policy framework and its findings are expected in the first part of next year.
South Korea, Indonesia, and South Africa cut rates last week. Among emerging markets, the focus shifts to Turkey (July 25) and Russia (July 26). Colombia and Hungary central banks also meet but are not likely to move.
It is the first meeting of the Turkish central bank since the governor was dismissed. There is no doubt that a rate cut will be delivered. The issue is the magnitude. The median forecast in the Bloomberg survey, with 27 respondents is for a 200 bp cut in the one-week repo rate to 22%. The average estimate was for a deeper cut to 21.6%. Turkey's inflation has fallen much quicker than rates, and this does appear to give the central bank scope to cut. The year-over-year increase in consumer prices peaked last October near 25.25%. In June it stood at 15.72%. Before the weekend, the central bank's survey of inflation expectations over the next 12 months fell to 13.90% from nearly 16.5% at the end of last year.
Russia's central bank meets and is also poised to cut the key rate, which stands at 7.50%. Real rates are a headwind on the economy, and in June, both the manufacturing and service PMI readings were below the 50 boom/bust level. Price pressures appear to have peaked in the spring near 5.3% and in June stood at 4.7% year-over-year. Rates were cut by 25 bp in June. Another one or two more rate cuts this year are possible barring new shocks.
Three emerging market central banks (South Korea, Indonesia, and South Africa) cut rates on July 18 and all three currencies rose, even before the dollar was sold on Clarida and Williams comments. Turkey and Russia may not be as fortunate. The dollar is near three-month lows against the lira (~TRY5.60) with aggressive Fed easing priced in as well. The dollar has traded above TRY5.80 once this month, and that provides proximate cap.
The dollar recorded the lows for the year in June against the Rusian rouble near RUB62.50, and the recovery bounce took it back to RUB64.00, which is now acting likely resistance. The greenback spent most of the mid- March-mid-June period between RUB64-RUB65.70. Note that the correlation between the percent change in the exchange rate and the percent change in the price of oil is most inversely correlated (-0.61) on a rolling 60-day basis. It is the most in three years.