The Global Markets Weekly – 7/29/16

Posted August 1, 2016 by rvillareal

July Inaction, August Action[private]

The BOJ disappointed on Friday with a modest increase in the balance sheet and no changes in policy rates.  Rather than suggest the BOJ was prepared to do whatever it takes, were they hinting  that policy may have played itself out?  The yen soared on the news but some thought the BOJ may be playing possum.  They may be more aggressive at the meeting in September, as BOJ chief Kuroda said after the decision today that their policy stance was unchanged and they could increase the balance sheet some more and could cut rates down the road.

The parade of major central banks continues with the BoE taking center stage next week.  While DE correctly called for the BoE to delay action earlier this month, we expect them to take “some” action next week at the August MPC meeting.  But how much is “some?”  As we discuss in more detail in a focus article in this weekly, the BoE is likely to keep at least some of its limited ammunition dry for the moment, waiting for a fuller assessment of the economic backdrop and outlook.  DE expects a 25 bps cut and the full relaunch of the FLS, with asset purchases kept in reserve.

But the same considerations than made us think the BoE would wait in July apply to thinking about the August decision.  First, the drop in sterling represents a extraordinary loosening of monetary conditions, equal to over a 2 percentage point drop in policy rates.  While this will stimulate exports, a weaker currency boosts prices and reduces the purchasing power of consumer s and firms.

Second, fiscal policy will be much less restrictive after Brexit, something HM Treasury has already announced.  Third, a drop in rates will weaken an already fragile banking sector. Fourth, action may reignite currency wars with Europe, which is already very upset with the Brexit process and results!

Fifth, while the UK may avoid a near-term recession, the damage may be longer-term reducing growth in late 2016 and 2017, with adverse side effects from the expected drying up of capital spending.

In other words, the UK faces a stagflationary shock which could pay out over several years and the BoE does not have easy choices in the short-run.

• S.: After a disappointing (but better than it looks) 1.2% gain in Q2 GDP, investors can chew on a host of data, headed by potentially lukewarm ISM (Mon) and jobs (Fri). No one can be sure the expected 175K gain in payrolls is “strong enough” for the Fed to hike policy rates in Sept.
• Eurozone: The markets will be digesting the results of the ECB Bank Stress Tests due for release after markets close on Friday. The concern is that in the unlikely event of a particularly poor set of results for the biggest banks could damp the recent lending revival in a region already apparently at risk from the fallout from Brexit. This ignores the fact that lending has been on an uptrend for some time.
• UK: The BoE will unveil additional stimulus measures when it presents the next MPC verdict (Th). The question is exactly what is delivered at the current juncture and what ammunition may be left in place either because the central bank wants to have options open should the economic outlook deteriorate even and/or feels constrained by the damage that sterling weakness may wreak via the rise in inflation. The BoE is likely to keep at least some of its limited ammunition dry, waiting for a fuller assessment of the economic backdrop and outlook. DE expects a 25 bps cut and the full relaunch of the FLS, with asset purchases kept in reserve!
• Japan: A quiet week with no releases scheduled after the BOJ disappointed with its timid action Friday. They are reassessing options which may lead to more serious moves at the Sept meeting.
• China: The PMI updates (Mon) should be relatively steady. The NBS should remain close to 50, while the Caixin may edge higher towards 49.

Other central banks: In Australia, amidst the still soft inflation backdrop, the RBA meeting (Tu) takes on added importance.  Even though the RBA readopted an easing bias, another stable decision is expected this time around, at least by DE but with markets more open to a fresh cut.

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