FX

Via Marc Chandler at Brown Brothers Harriman:

Yellen Pushes Divergence Front and Center

• Risks of a Fed hike increased sharply after signals from Jackson Hole
• US jobs data at the end of the week have added significance
• Reports that the Saudi oil minister denied the need for OPEC action is weighing oil prices
• Dollar extends pre-weekend gains, but momentum easing in European morning, emerging market stocks slip to three-week lows

The US dollar’s pre-weekend gains were extended in Asia, but ran out of steam in Europe.  The easing of the momentum may set the stage for a bout of profit-taking later today and tomorrow.  The implied odds of 42% chance of a September Fed hike may be pushed back by skeptical market participants.  This week’s data is likely to show that neither jobs nor auto sales sustained the July strength.  The yen and the Norwegian krone are weakest of the majors; off about 0.30-0.35%.  The New Zealand dollar and Swiss franc are posting minor gains.  Japanese and Indian shares are higher, but weaker equities are the theme.  MSCI Asia-Pacific Index is off 0.25% (it is off eight of the past 11 sessions).  The MSCI Emerging Market equity index is  off 0.75%.  The five-day average is slipping below the 20-day average for the first time since early July.  European bourses are all in the red, with the Dow Jones Stoxx 600 off 0.5%.  While US bond yields are slightly softer, other bond markets are playing catch-up with the pre-weekend sell-off in Treasuries.   Among the emerging market currencies, which are all weaker, the South Korean won (-1.0%) and the South African ran (-0.8%) are the leaders.  

With 17 simple words and the help of clarification from her deputy, Yellen changed the near-term dynamics in the capital markets.  By saying that “…I believe that case for an increase in the federal funds rate has strengthened in recent months,” Yellen placed her marker down.

Yet the market was initially confused.  It thought the Chair was indicating a December hike not a September move, and that meant one hike not the two the June dot plots implied was thought to be appropriate by the FOMC.  Vice Chairman Fischer quickly followed his boss and explained that she implied no such thing.  Nothing she said had ruled out a September hike or two hikes this year.

And to sweeten his treat, Fischer advised watching this week’s employment data closely.  What more can be said?   The employment figures are among the most significant reports in the monthly cycle.  They are also volatile and difficult to forecast, as the May’s drop out of the blue reminds us. From nearly any other central banker it would seem reckless to link monetary policy so directly to a high frequency number, but Fischer is Fischer.  He has had a distinguished career as the chief economist at World Bank and the Governor of Israel’s central bank.  He was on both Bernanke and King’s dissertation committees.  

Still, it does not set right, but the market took the bait and ramped up the odds of a September hike to 42% from 32% the previous day.   It is the greatest probability in a month.   Most economists do appear to be forecasting the US economy to accelerate.  The Bloomberg survey median has the economy growing 2.6% at an annualized pace in Q3, and 2.3% in Q4 snapped the three-quarter streak of sub-2% growth.  The Atlanta Fed GDPNow tracker has it at 3.4%, and the NY Fed’s tracker is at 2.8%. 

The immediate challenge, however, is that in the past two months (June and July), net job growth overshot its trend.  Consider that the two-month average is at 274k.  This is the highest of the year and was only surpassed twice last year.  This year’s average is 186k, and the 12-month average is 204k.   The median guesstimate is for around 180k.   A  report of less than 144k would be disappointing.  That was job growth in April, the second lowest of the year besides May’s inexplicable 24k increase.  

Consumption has also grown faster than sustainable.  Consumption in Q2 was revised to 4.4% from 4.2%.  It is only the third quarter since the Great Financial Crisis that consumption exceeded 4%.  This will b evident in the July personal consumption expenditures.  In Q2 PCE rose by an average of 0.6% a month.  This is twice the 12-month, 24-month and 36-month average of 0.3%.  The median forecast for July is 0.3%.   The same will be evident in real spending.  The Q2 average of 0.4% is twice the long-term averages, which are stable at 0.2%.   Auto sales in August are also expected to have slowed, though remaining at elevated levels above 17 mln annualized vehicles.

For most investors and market participants, it might not make a significant difference whether the Fed hikes in September or December.  The Federal Reserve’s leadership has put the market on notice that it is coming.   This is an example of transparency as well as taking into account the interests of other stakeholders.  However, the increased prospects of a Fed hike may spur profit-taking in many summer rallies in risk assets, like the 16%+ rally in emerging market stocks since late-June, or the 11.25% rally in the MSCI World Equity Index of developed countries.  

The Federal Reserve stands in stark contrast with the European Central Bank, the Bank of Japan and the Bank of England.  These central banks are actively engaged in easing monetary policy and, if anything, the next steps will be more not less.   This week’s data from the eurozone will favor those forces on the Governing Council that want to extend the asset purchase program from the current soft end date of March 2017.  

CPI for August is expected to be confirmed at 0.3%.  It has averaged 0.1% over the past three months, which matches the 24-month average.  It is better than the six-month average of minus 0.1% or the 12-month average of zero.  However, officials cannot be satisfied.   Unemployment may ease, but at 10% it is still too high in most countries.  The PMI reports are give no reason to think that the eurozone economy is accelerating.  

The Bank of Japan learned last week that despite its unprecedented and aggressive easing policy, deflationary forces continue to grip the world’s third largest economy.  The BOJ’s core measure, which excludes fresh food fell for five months through July, and the minus 0.5% reading is the lowest in three years.   This week’s data is expected to show that while the labor market remains tight, consumption remains poor, and still contracting on a year-over-year basis.   Industrial production may have extended the June bounce (2.3% ), but not enough to prevent the year-over-year rate from moving deeper into negative territory.  With weak domestic demand and falling exports, the risk is an increase in output builds inventories that have to be run down.

Survey data in the UK is running ahead–and to the downside–of the actual economic data.  The manufacturing and construction PMIs are the focus this week.  Both are expected to remain below the 50 boom/bust level, but less so than in July.  A new headwind may emerge in the form high bond yields, despite BOE weekly purchases, if rising US yields pull other yields higher too.   In the current environment, we suspect that a strong US dollar environment may correspond to firm sterling against the euro.  

Canada cannot keep up with the Fed either.  This week Canada is expected to report that Q2’s 1.5% contraction in GDP was the largest since the recovery began in H2 09. It is the only G7 economy that contracted in Q2 (France and Italy were stagnant).  A few days before the GDP report (August 31), Canada will report a current account shortfall in Q2 that may match a record of C$20.2 bln in Q3 10.  

The economic and monetary policy divergence may overwhelm the speculation that OPEC could agree to a freeze in output as early as next month.  One key hurdle has been the Iranian need to boost output back to pre-embargo levels.  The latest reports suggest it is close, but still a little shy of its four mln barrel per day target.   Also, it makes sense, assuming rational actors, that ahead of a possible freeze, output increase, so the freeze at a more advantageous level.   Meanwhile, US output is still slipping and imports rising.  A rising US dollar may help spur a correction to the nearly 24% rally off the early-August lows.

China’s PMI figures will also be released.  The market is less interested than it was last summer in China.  Its economy, to the extent that one has faith in the data, appears gradually slowing, while credit growth has been strong, it has long passed the point of diminishing returns.  More central to investors concerns at the moment is what appears to be a change in PBOC operations.  It has been using 14-day reverse repos to drain excess liquidity that had been driving bond yields sharply lower. 

China is hosting the upcoming G20 meeting as it does, the yuan is likely to come under new downside pressure.  The dollar appears poised to rise to new highs for the year against the yuan.  The high so far this year was set on July 18 near CNY6.7050.    As of the end of last week, the dollar had risen 4.5% against the yuan in 2016.  

In addition to the G20 meeting, there are a few other political events/issues that investors are watching.  First, after two elections and months of negotiating, Spain’s Rajoy will stand for a vote of confidence in a new minority government.  He needs a majority on the first ballot, which he is unlikely to secure.  Of more interest is the second ballot that requires a plurality.  This in turn requires around 11 Socialists (or a combination of others) to abstain.  If they do not, Spain would likely be headed for a third election, late this year or early next.  

Second, two German states hold elections in September.    Mecklenburg-Vorpommern’s election is on September 4, and Lower Saxony election is on September 11.  Mecklenburg-Vorpommern has had Social Democrat-Christian Democrat government since 2006. Many see the election as a referendum on Merkel, though of course, she is not on the ballot.  In 2011, the CDU received 23% of the vote 5.8 percentage points less than in 2006.  It seems like a rather modest bogey.  The Left Party is the third largest in the state, but the SPD refuses to form a center-left coalition.   

Another issue that investors will be mulling is a UK press report at the end of last week suggesting that government lawyers do not think Parliament approval is necessary to invoke Article 50, which formally begins the negotiations for separation.   Many observers are still skeptical that it Article 50 will be triggered next year.  However, nearly all the indications we see is for it to invoked next spring.  Our understanding is that this is what has been broadly indicated to EU officials. 

One of the domestic issues has been over the authority to invoke Article 50.  A majority of Parliament favored remaining in the EU.  Having to secure its approval was one of the considerations that made some skeptical that it would be triggered.  There is bound to be a push back from Parliament, whose legal advice will no doubt favor its role.  

US presidential polls typically become more accurate after Labor Day.  A change among the top Trump campaign managers has corresponded with what appears to be a small bump in the polls.  He is trailing in nearly all of the swing states, and a few states that are regarded as safe for Republicans appear in play now.   This week there are two primaries that will draw attention.  In Arizona, former GOP-nominee McCain faces a primary challenge.  In Florida, former chair of the Democrat Party, Wasserman-Schultz is also in a primary contest.  Both incumbents are expected to win.  

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Hilsenrath Story

Via WSJ:
By Jon Hilsenrath and
Harriet Torry
Aug. 28, 2016 10:37 a.m. ET
14 COMMENTS

JACKSON HOLE, Wyo.—When Janet Yellen laid out options here for U.S. interest-rate policy in the years ahead, the Federal Reserve chairwoman conspicuously left off her list a controversial idea being tried in Japan and much of Europe: Negative interest rates.

Fed officials don’t think negative rates are needed in the U.S. because the economy and job market are improving and they’re hoping they’ll never have to use them in the future given their uncertainty about whether the policy works.

“I’m treating (negative rates) as an experiment that we have the luxury to watch from a distance,” Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said in an interview at the Fed’s annual Jackson Hole conference in the Wyoming mountains.

The Fed’s aversion to negative rates shows how central bankers are confronting the limits of their efforts to stimulate the slow-growing global economy.

Negative rates are like a central bank’s version of the children’s game of hot potato—the potato being money nobody wants to get left holding. Commercial banks are charged for leaving funds on deposit with the central bank. By imposing a cost on parking money safely there, the policy aims to induce banks to lend their money elsewhere, to consumers and businesses, where they can earn higher returns. That risk-taking, in turn, is meant to spur economic growth.

Central banks in Japan, the eurozone, Denmark, Sweden and Switzerland have adopted negative rates with mixed effects. The Swiss National Bank ’s policy rate is -0.75%, the Bank of Japan ’s is -0.1% and ECB’s is -0.4%.

Negative rates are highly unpopular in many places because households are unhappy they earn such low returns on their savings and banks worry it squeezes their profit margins.

Subzero rates also have had some unintended effects. In Japan, negative rates were accompanied by a rising currency, the opposite of central bank’s expectation.

In Switzerland banks responded to negative rates by making mortgage borrowing more expensive and not less as hoped. Consumers are saving more in Germany, Japan, Sweden, Switzerland and Denmark, even though the aim is to prod consumers to save less and spend more.

Still central bankers here said negative rates showed signs of working in many of their intended ways.

Yields on 30-year Japanese government bonds dropped from about 1.5% before Japan adopted negative rates in January to less than 0.5%. That could in turn drive borrowing, spending and investing in Japan, as intended.

“Declines in long-term borrowing costs have stimulated firms’ demand for long-term funding and households’ demand for mortgage loans, thereby benefiting a wide range of borrowers,” BOJ Governor Haruhiko Kuroda said here. “A significant increase in issuance of corporate bonds with a maturity of 20 years or even longer has been observed.”

ECB data released this week showed loans to households were up 1.8% from a year earlier in July and loans to nonfinancial corporations up 1.9%. That is modest but still reverses a contraction in lending in the months before negative rates were introduced.

Some worry that negative rates squeeze bank profits and impede their incentive to lend. However net income at European banks rose to more than 50 billion euros in 2015, compared with 30 billion in 2014, according to the European Central Bank.

“Negative rates work and are nothing extraordinary or immoral or absurd,” European Central Bank executive board member Benoît Coeuré said of the eurozone’s experience of negative interest rates so far. Still, speaking to the lingering trepidation about the policy among central bankers here, he said he is cautious about pushing rates “to much deeper negative levels .”

At a panel here, academics wondered whether central banks could push interest rates more deeply into negative territory by doing away with cash or imposing costs on households holding it. Cash is an impediment to imposing negative interest rates. Households and businesses can hoard it to avoid paying the penalties imposed when depositing funds in banks.

Central bankers here were reluctant to embrace the idea of pushing the policy much further, even as they defended its effects.

“There are many outstanding issues,” Marianne Nessén, who heads the Swedish central bank’s monetary policy department, said during a discussion at Jackson Hole. “Even if the experience with mildly negative interest rates has been roughly as expected, I’m not sure that we conclude that deeply negative interest rates will work in the same manner.”

“At the heart of all this lies concerns that future growth prospects are lower than we have seen in the past decades, but the remedy for that does not lie with monetary policy. It must be found elsewhere,” she said.

One growing source of uncertainty is the effect of negative rates on household saving behavior. Low and negative rates aim to induce households to spend, but critics of these policies say the effect is the opposite. People who are trying to stockpile funds for retirement might be induced to save even more if the funds they’ve got are bleeding returns.

“The idea that low interest rates are punishing savers is a very ripe issue,” said James Bullard, St. Louis Fed president. “Everyone is doing a lot of soul-searching about these issues.”

For now the Fed doesn’t need to contemplate negative rates because the U.S. economy is improving and officials are looking to gradually raise rates from exceptionally low levels.

Ms. Yellen in her talk Friday sought to lay out a road map for how the Fed will proceed the next time there is an economic downturn and it turns back to rate cuts to stimulate growth.

She said the Fed would seek to lean on tools it used during the postcrisis period. This includes purchases of Treasury or mortgage bonds to drive long-term interest rates lower. Ms. Yellen suggested the Fed might even expand its purchases beyond these conventional investments. The Fed would also turn to assurances that rates will stay very low far into the future, she said.

On negative rates she was silent.

Write to Jon Hilsenrath at [email protected] and Harriet Torry at [email protected]

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Central Bankers Despair

This Reuters story carried by the NYTimes website details the frustration of central bankers who see less and less return from monetary policy and who pine for some sort of fiscal action to stimulate inflationary expectations amongst the hoi polloi.

Via the NYTimes and Reuters:

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Abolish Cash

Marvin Goodfriend was a long time economist at the Richmond Fed and if memory serves me well I recall him writing quite a few pieces (excellent) on monetary history. In this article Bloomberg reports that he favors deeply negative rates as cure for the next recession and to support that policy he argues in favor of zero yield cash. These discussions on the 21st century equivalent of discussions in the Middle Ages regarding how many angels could sit on the head of a pin.

Via Bloomberg:

Christopher Condon
chrisjcondon
August 26, 2016 — 11:55 AM EDT

Ex-Fed economist Goodfriend: May need to abolish paper money
‘Nothing more than the sensible application’ of economics

What should policy makers do if the next recession hits before central bankers climb out of their low-interest-rate fox holes?

Carnegie Mellon University professor Marvin Goodfriend gamely took up that question in a paper he delivered Friday at the Federal Reserve Bank of Kansas City’s annual retreat in Jackson Hole, Wyoming, making a case for why aggressive negative interest rates might be the best answer. However, by meticulously detailing the groundwork necessary to make negative interest rates effective, Goodfriend arguably also showed why they may never happen in the U.S.

The paper comes as officials debate the usefulness of negative rates deployed by the European Central Bank, Bank of Japan and several other European countries. Mark Carney, governor of the Bank of England, earlier this month rejected the idea of negative rates as an effective option and Fed Chair Janet Yellen has also played down the strategy as a productive approach to tackling the next downturn in the U.S.

Goodfriend, a former director of research at the Richmond Fed, is no fan of quantitative easing, the strategy of buying bonds when a central bank’s benchmark interest rate reaches zero. Its effectiveness in the longer-term is questionable, he said, and it steps into the domain of fiscal policy.

Negative rates, by contrast, stay firmly in the realm of monetary policy and don’t risk distorting credit markets. Making them easier to implement in the U.S. would afford the Fed more flexibility, akin to dropping the Gold Standard or a fixed exchange-rate system, he wrote.
Aggressive Action

So, negative rates it is, and we’re likely to need them, Goodfriend argued.

“Low long-term nominal interest rates today reflect underlying forces unlikely to dissipate any time soon,” he wrote. “It is only a matter of time before another cyclical downturn calls for aggressive negative nominal interest rate policy actions.”

Based on how the Fed reacted to recessions over the past 50 years, should a severe recession hit now, he says policy makers would want to push rates as low as minus 2 percent.

But there’s a problem. Goodfriend points to “long-standing institutional arrangements” under which the Fed doesn’t charge for cash deposits. Retail banks are also shy about charging customers to hold their cash, in the fear they will prompt widespread mattress stuffing.
Deep Negative

In that environment, if the Fed goes deeply into negative territory for what is likely to be an extended period, it will drive bond holders out of negative-bearing securities and into zero-interest cash, leading to what Goodfriend calls “a destructive dis-intermediation of financial markets.”

To prevent that, Goodfriend offers three ambitious options: Abolish paper currency; introduce a market-determined price for cash deposits that would rise whenever the policy rate went negative; or offer electronic currency as a substitute for paper currency on which the Fed can set a positive or negative interest rate.

Goodfriend concedes the public would probably reject option one, and option three would require “considerable investment in banking, central banking and payment system infrastructure before it could be made available.”

Option two, while it could be achieved “expeditiously,” according to Goodfriend, would also involve introducing a complex rule for determining a flexible deposit price for paper currency. As challenging as some of these obstacles might be to surmount, Goodfriend argued “removing the zero lower bound is nothing more than the sensible application of monetary economics.”

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BOJ’s Kuroda Coos Dovishly at Jackson Hole

Via Bloomberg:

Jeff Black
Jeffrey_Black
Steve Matthews
SteveMatthews12
August 27, 2016 — 2:52 PM EDT
Updated on August 27, 2016 — 4:28 PM EDT

Bank of Japan Governor Haruhiko Kuroda said he won’t hesitate to boost monetary stimulus if needed, reiterating a pledge during an annual policy retreat in Jackson Hole, Wyoming, at which central bankers stressed their need for backup from fiscal policy.

“There is no doubt that there is ample space for additional easing in each of the three dimensions,” Kuroda said Saturday, referring to the BOJ’s package of asset buying, monetary-base guidance, and negative interest rates. “The bank will carefully consider how to make the best use of the policy scheme in order to achieve the price stability target,” he told the Federal Reserve Bank of Kansas City’s symposium.

Central bankers, struggling to spur persistently disappointing growth, gathered in the Grand Teton National Park to debate how best to tackle low inflation despite having already cut interest rates to near zero or, in some cases, below zero. They heard Fed Chair Janet Yellen on Friday describe future potential options to jump-start the economy, while saying that the case for a U.S. rate hike had strengthened.

Even though the Bank of Japan is currently engaged in a review of its monetary-policy settings, due for completion in September, Kuroda’s comments underline his stance that the exercise won’t mean any reduction in stimulus despite growing doubts about its effectiveness.
‘Price Stability’

“One of the key elements of our policy is to push up inflation expectations to our price stability target and anchor them there,” Kuroda said. “The Bank of Japan will continue to carefully examine risks to activity and prices at each monetary policy meeting, and take additional monetary policy measures without hesitation.”

The BOJ’s next policy meeting is Sept. 20-21.

Benoit Coeure, European Central Bank Executive Board member, said during the same panel that his institution may also have to take further monetary measures if governments don’t act to boost long-term growth.

“We will fulfill the price stability mandate given to us,” Coeure said. “But if other actors do not take the necessary measures in their policy domains, we may need to dive deeper into our operational framework and strategy to do so.”

While slowing growth and inflation present difficulties for central banks around the industrialized world, the Frankfurt-based ECB has particular cause to urge pro-expansion measures by the 19 nations that use the euro. High unemployment, political spats and banking systems loaded with soured loans are hampering the region’s recovery from a debt crisis that started six years ago.

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Logorrhea at the Fed

Reserve Bank Presidents Bullard and Lockhart take issue with some hawkish comments delivered by Vice Chairman yesterday.

Via the WSJ:
By Harriet Torry
Aug. 27, 2016 12:18 p.m. ET
2 COMMENTS

JACKSON HOLE, Wyo.—Two Fed officials have played down the likelihood of two rate increases this year beginning as soon as next month, after the U.S. central bank’s second-in-command floated the idea on the sidelines of the Kansas City Fed’s research conference.
Jackson Hole Coverage

Vice Chairman Stanley Fischer told CNBC on Friday that Fed Chairwoman Janet Yellen’s Jackson Hole speech, in which she said the case for a rate increase has strengthened, was consistent with the central bank potentially raising rates at its meeting next month and again before the end of the year, if data shows the economy performing well.

In interviews with The Wall Street Journal early Saturday, however, two regional Federal Reserve bank presidents distanced themselves from the idea of two rate increases this year.

“The calendar would allow that, we have three more meetings,” Federal Reserve Bank of Atlanta President Dennis Lockhart said, although he added “I wouldn’t take [Mr. Fisher’s] position today.”

“If the economy in the next few weeks performs consistent with my sense of the economy, then I think we ought to have a serious discussion [about interest rates] at the September meeting,” Mr. Lockhart said.

James Bullard, president of the St. Louis Federal Reserve Bank, spoke to WSJ Federal Reserve reporter Harriet Torry in Jackson Hole about the pending decision to raise interest rates and how the United States economy has weathered global risk over the past year.

While he viewed the overall global risk environment as a bit more settled, the focus is on the domestic economy, which is “chugging along,” Mr. Lockhart said. “Probably the conditions will be satisfactory for at least one more” rate increase this year, the Atlanta Fed president said.

The Fed last raised its key interest rate by quarter percentage point in December.

Meanwhile, Mr. Lockhart’s counterpart at the St. Louis Fed, James Bullard, reiterated that he is “agnostic” about the timing of the next rate increase, but he said two rate increases this year wouldn’t fit with his forecasts.
James Bullard, president of the Federal Reserve Bank of St. Louis ENLARGE
James Bullard, president of the Federal Reserve Bank of St. Louis Photo: Bloomberg News

“If we had a lot of good news and we got into the September meeting and other people wanted to go, I could support that—but again I’m talking about one increase and no planned increases after that,” he told The Wall Street Journal.

Following Ms. Yellen’s speech on Friday, financial markets raised their expectations for an interest-rate increase by the end of this year, with some economists saying an increase could come as early as next month.

Write to Harriet Torry at [email protected]

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Thoughts on Yellen

Via Millan Mulraine at TDSecurities:

TD SECURITIES DATAFLASH                   

US: Yellen Begins Hawkish Pivot

·         The tone of Yellen’s remarks was less dovish than we have come accustomed to, potentially signaling a shift in the Fed’s monetary policy stance.

·         Of particular note was the reference to the economy “nearing” its “statutory goals”.

·         Her inflation, growth and labor market outlook appears to have brightened significantly, suggesting that the dial might be shifting in a hawkish direction.

Yellen delivered a slightly more hawkish tone, offering a more upbeat assessment on the US economic performance and a more constructive outlook than she has in the past. And while she stopped short of providing any overt signals of an imminent hike, her reference to the economy “nearing” its “statutory goals” suggests that some further tightening of policy this year remains in the cards. This reference mirrors the hawkish tone of Fischer’s remarks earlier this week, and it is a departure from the past in which she has emphasized the persistent inflation disappointment as a concern. In the Humphrey-Hawkins Testimony in June, for example, she made no mention of the economy nearing target, and a week before that she even questioned whether the labor market was at full-employment.  Notwithstanding this, she stopped well short of offering a commitment to an imminent (read September) hike. She reinforced the message by saying that the case for a hike has “strengthened in recent months.” However, this was qualified by indicating the data-dependency of this decision and the uncertainty surrounding the outlook.

From the point of view of a market that was looking for Yellen to show her hand regarding the September hike odds, there was nothing in her remarks to suggest that it was imminent. Nevertheless, her more upbeat economic and inflation assessment, along with her belief that the US may be nearing its inflation and full-employment target suggests that the policy stance may have shifted in a hawkish direction, keeping alive the hopes of a 2016 hike. The hurdle may now be somewhat lower for September hike (anything north of 225K in payrolls could be a push, though the weak wage growth performance could be a complicating factor) but that also doesn’t suggest if they don’t go in September, then December could be a done deal.

With event risks in Europe and the US and new signs just this week of liquidity issues within China, the Fed will remain a highly fluid, probabilistic issue. For now, given our current economic forecasts our odds of a September move at 45%, and 70% for Dec. If the payrolls report does print above 225K, we would strongly consider moving to a September hike if the other details confirm the underlying strength. But we would want to see some persistent strength firm up the December odds before putting more faith that delivery will not slip into 2017 as we currently forecast.

In terms of Yellen’s longer-term view on the conduct of monetary policy, she offered little support for the paradigm shift advocated by SF Fed President Williams who proposed a higher inflation target or a move to a price level or nominal GDP target. However, she did lend her support to the growing chorus of Fed officials calling for a more pro-active fiscal policy stance given the limitations of monetary policy in the current environment of a low neutral rate.

Rates market implications:

The rise in rates reflecting a slightly more hawkish speech by Chair Yellen was extremely fleeting, and the 10yr is currently 3bp lower on the day.  This is a bit puzzling but is simply testament to the global demand for yield, which makes Treasuries look cheap to many other bond markets. The curve did flatten, which is consistent with a Fed that may very well hike rates this year. We had exited our flattener last week due to fear of a discussion about downside risk of inflation or a case for overshooting. With Yellen expressly noting that a higher inflation target is not under consideration, we think that the curve can continue to flatten. Much depends on data between now and the September meeting, with the key payroll report out next week. A strong number can increase the odds of a move in September. Note that the market was already priced for a 70% chance of a hike this year ahead of the speech and that appears fair to us. We are surprised that TIPS breakevens rose after the speech and would expect the strength to fade in coming days.

FX Strategy implications:

While we firmly believe that it is the prospective path of policy that matters most for the USD (which at this juncture is very benign), Yellen’s acknowledgement that the case for a hike has “strengthened” should not be dismissed. We think as we transition into the fall season that risk/reward dynamics look more appealing for the USD as we anticipate that concerns elsewhere – such as in Europe where political risks will come to the fore – will provide some support to the USD. Indeed, we have taken on a bearish stance on the EUR recently. Fed probabilities remain well contained and are still pricing in a 75% chance of a hike in December suggests to us that USD weakness should be faded and if anything, a reason to begin accumulating longs at these levels. We think Yellen’s speech also reaffirms our belief that asymmetries have formed in USDJPY to the topside – at least on a tactical basis. As for the CAD, we see two-way risks, however, as soft underlying macro conditions do not provide much justification for material strength while a globally low yielding environment draws foreign portfolio interest into dollar bloc FX like the CAD. For now, we see the topside attractor as 1.3060 and monitor 1.2830/50 as a key pivot zone that would open downside potential towards 1.2760 where we would accumulate more long positions.

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FX

Via Marc Chandler at Brown Brothers Harriman:

Dollar Still Rangebound Ahead of Yellen

• The highlight for today is Fed Chair Yellen’s Jackson Hole speech at 10 AM ET
• During the North American session, the US reports advanced trade and wholesale inventories for July, Q2 GDP revision, and University of Michigan sentiment
• The UK reported Q2 GDP
• Japan reported July inflation figures
• Local press is reporting that South African President Zuma is planning a cabinet shuffle; Mexico reports July trade

The dollar is softer against the majors in narrow ranges ahead of Yellen’s speech.  The dollar bloc is outperforming while sterling and the Norwegian krone are underperforming.  EM currencies are mixed.  ZAR, PLN, and IDR are outperforming while RUB, CNY, and TRY are underperforming.  MSCI Asia Pacific was down 0.5%, with the Nikkei falling 1.2%.  MSCI EM is up 0.1%, with Chinese markets falling 0.1%.  Euro Stoxx 600 is down 0.1% near midday, while S&P futures are pointing to a higher open.  The 10-year UST yield is down 1 bp at 1.56%.  Commodity prices are mixed, with oil down 0.5%, copper up 0.5%, and gold up 0.4%.

The highlight for today is Fed Chair Yellen’s Jackson Hole speech at 10 AM ET.  Both Dudley and Fischer have already provided their general take on the economic outlook and prospects for a Fed hike this year.  It seems unreasonable to expect Yellen to substantially deviate from their views.

Although a September hike seems unlikely, there is nothing to be gained from Yellen ruling it out.  The Fed wants investors to know that every meeting is actionable, though there is no precedent for a move in November, the month of the US national election.  According to the Fed funds futures, the market has upgraded the odds of a September hike to 32% currently from 18% on August 1 and 26% on August 5 after the US jobs data.

During the North American session, the US reports advanced trade and wholesale inventories for July, Q2 GDP revision, and University of Michigan sentiment.  It’s worth noting that the Atlanta Fed’s GDPNow model now has Q3 SAAR growth tracking at 3.4%, down from 3.6% previously.  The drop was due to weak existing home sales data reported this week.

The UK reported Q2 GDP.  Headline GDP 0.6% q/q, as expected.  Looking at the components, private consumption rose 0.9% q/q vs. 0.8% expected, GFCF (investment) rose 1.4% q/q vs. 0.4% expected, government spending fell -0.2% q/q vs. 0.3% expected, and exports rose 0.1% q/q vs. 0.7% expected.  So far, the post-Brexit economic data have shown resilience and even outright strength.  This should keep the BOE on hold next month.  

German GfK consumer confidence was reported for September.  It came in at 10.2 vs. 10.0 expected.  Yesterday, German IFO confidence came in much weaker than expected for August.  Elsewhere, France reported Q2 GDP.  Growth came in as expected, flat q/q and up 1.4% y/y.  

Japan reported July inflation figures.  The national headline CPI was steady at -0.4% y/y, as expected, while core (excluding fresh food) came in at -0.5% y/y vs. -0.4% expected.  Excluding food and energy, the inflation rate edged down to 0.3% y/y from 0.5% in June, the lowest since October 2013.  Tokyo August headline inflation came in at -0.5% y/y vs. -0.4% expected, which suggests downside risks to the national CPI next month.  Data overall have come in on the weak side recently, feeding market expectations that greater pressure will be on the BOJ for further easing.

Local press is reporting that South African President Zuma is planning a cabinet shuffle.  Potential removals reportedly include the Ministers of Higher Education, Agriculture, Public Works, and Trade and Industry, as well as the Deputy Finance Minister.  No mention of Finance.  While such a move wouldn’t be surprising in light of the recent municipal election losses, investors could still get spooked in the current environment.  Finance Minister Gordhan was not mentioned in the press report, but a recent poll by a major local bank showed that about half the respondents expect him to be eventually removed.  

Mexico reports July trade.  Exports have contracted y/y in 11 of the past 12 months, and the only exception was a 0.3% y/y gain in May.  Petroleum exports have been weak, as one would expect, but non-petroleum exports have also been weak.  Imports have also been contracting, and so deterioration in the trade and current account balances has been limited.  While the sluggish economy is likely to keep Banco de Mexico on hold for the time being, much will depend on the peso.

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Some Corporate Bond Stuff

Via Bloomberg:

IG CREDIT: MSFT, GE Cap Long Bonds Topped Most Active List
2016-08-26 09:54:22.153 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $14.6b Thursday vs $16.1b Wednesday, $15b the previous
Thursday. 10-DMA $13.4b.

* 144a trading added $1.8b of IG volume vs $2.4b Wednesday,
$1.5b last Thursday

* The most active issues:
* MSFT 3.70% 2046 was 1st with evenly weighted client
flows accounting for 83% of volume
* GE Cap 4.418% 2035 was next with client trades taking
100% of volume
* MS 4.10% 2023 was 3rd with client flows taking 100% of
volume; client buying 3x selling
* MYL 3.95% 2026 was most active 144a issue with client and
affiliate trades taking 100% of volume

* Bloomberg Barclays US IG Corporate Bond Index OAS unchanged
at 136, the low for 2016
* 2016 high/low: 215 (a new wide since Jan. 2012)/136
* 2015 high/low: 171/122
* 2014 high/low: 137/97
* All time high/low back to 1989: 555 (Dec. 2008) / 54
(March 1997)

* Current market levels vs early Thursday:
* 2Y 0.780% vs 0.758%
* 10Y 1.568% vs 1.551%
* Dow futures +7 vs -23
* Oil $47.16 vs $47.00
* ¥en 100.42 vs 100.39

* U.S. IG BONDWRAP: Light Calendar Continues With Only 1 SAS
Deal
* August volume $120.3b; YTD $1.14t

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QE in Sweden Damages Market Liquidity

Via Bloomberg:
August 25, 2016 — 11:24 AM EDT
Updated on August 26, 2016 — 3:48 AM EDT

The man in charge of managing Sweden’s state debt signaled the Riksbank may soon be reaching the limits of its government bond purchase program amid signs that liquidity is suffering.

“What we’re saying to the Riksbank is that the market is functioning quite well, but that there are risks, looking ahead,” Thomas Olofsson, head of debt management at the Swedish National Debt Office, told Bloomberg.

Riksbank First Deputy Governor Kerstin af Jochnick said last week the bank is probably approaching a limit for how much more in government bonds it can buy. The comments narrowed spreads in the municipal bond market, while government yields rose.

“I have no objection to Kerstin af Jochnick’s reasoning on these issues,” Olofsson said. “If I had thought her reasoning was wrong, I would say so.”

Af Jochnick said the Riksbank could “technically” buy covered bonds, corporate or municipal bonds if needed, as part of its mandate to reach a 2 percent inflation target. The bank has had a negative policy interest rate since February last year.

Monetary policy in Sweden has failed for almost half a decade to drive inflation back to target. The bank this year extended its QE program, targeting about 37 percent of nominal government debt by the end of 2016 and about 9 percent of inflation-linked state paper.

According to Olofsson, one sign that liquidity has deteriorated since the Riksbank started buying bonds two years ago is the decline in volumes for given spreads. There has also been an increase in the number of re-sellers over the summer that have had to ask the debt office for help to deliver government bonds to investors through repo transactions.

“It will be interesting to see during the autumn if we will have to continue to do repos of the present volumes, because that would possibly be an indication that the market isn’t functioning as well as before,” he said.

The Riksbank’s asset purchases have helped push Swedish yields down to historic lows. But Olofsson said he currently sees no reason to issue a 30-year bond since investors haven’t expressed an interest. He said interest rates on outstanding bonds maturing in more than 10 years would have to decline for the debt office to actively ask the market whether there’s enough demand for such bonds.

“We need to focus on maturities that create the foundations for a liquid market and in that context we must focus on ten-year bonds,” he said. “We don’t have the borrowing need required to issue bonds with a lot of different maturities.”

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