Rate of change in US
unemployment to affect Fed tapering
Uncertainties in the timing of both tapering and rate hikes
Last Wednesday the Fed minutes for July's FOMC meeting were
released. We note that all Fed members agreed to start tapering the asset
purchase programme later this year. There is still high uncertainty regarding
the timing of this tapering. There is also uncertainty based on the anticipated
rate at which the gap between the unemployment rate, presently at 7.4%, and the
current threshold of 6.5% can be closed. Indeed the minutes reveal a new debate
concerning the lowering of this threshold which was highlighted by a couple of
Fed members. The first reaction of the markets was negative as stocks fell and
bond yields went up further.
Markets, in particular the bond market, are now looking even
closer at the employment situation in the US. On Thursday, the latest figures
for initial jobless claim came out at 336K, more negative than before and
higher than expected. This led to short-term relief in bond yields and
supported stocks further.
The overall situation in the US economy has improved during
the last weeks. The housing market stabilised, most confidence indicators are
rising and GDP growth rates went up further. We believe in a strong US domestic
market additionally driven by the shale gas revolution. This is likely to lead
to additional investments in durable goods. This environment may potentially
push bond yields higher towards 3.5% which can be a region where stock markets
may react significantly and rising housing costs may affect mortgage demand
negatively and therefore housing investment.
Mr Carney introduces
forward guidance
The BoE is also linking its monetary policy to unemployment
On 7 August, the Bank of England (BoE) provided forward
guidance on interest rates. The BoE does not intend to raise the Bank Rate
(currently at 0.5%) until, at a minimum, the unemployment rate has fallen to 7%
or below. Should this threshold be met, it would not automatically lead to a
raise in interest rates but to a reassessment by the BoE of its policy.
Moreover, the forward guidance could be bypassed if one out of three conditions
were to be breached. These three conditions, or knockouts, are based on:
- the inflation outlook (if the Monetary Policy Committee
finds it more likely to see CPI inflation, 18 to 24 months ahead, 0.5
percentage points or more above the 2% target),
- inflation expectations (if medium-term inflation
expectations, measured by survey and forecasts on market participants, no
longer remain sufficiently well anchored),
- financial stability (if the Financial Policy Committee
judges that forward guidance is causing asset bubbles).
It should also be noted that as long as the unemployment
threshold is not reached and that no knockout has been breached, the BoE
intends not to reduce its asset purchase programme and even stands ready to
expand it. As the BoE currently only expects to see unemployment reach 7% in
the second half of 2016, at the earliest, forward guidance suggests that
monetary policy should remain supportive for the next three years.
Additional quantitative easing unlikely in the next months
The introduction of forward guidance indicates a new
monetary strategy from the BoE, which previously relied mostly on expanding its
asset purchases programme. Furthermore, the improving UK economy coupled with a
Committee, which was already against additional stimulus when the UK economy
was weaker, signal that an increase in quantitative easing is unlikely in the
next months.
Short-term outlook
for GBP is positive
The market is not convinced by the BoE's forward guidance
Mr Carney's arrival as the BoE's chairman was expected to
bring a more dovish tone to the BoE's monetary policy. However, the announced
forward guidance was widely expected by the markets and the knockouts soften
the pledge, especially as the minutes later showed that one member voted
against the guidance as he wanted a more rigorous condition (i.e. a shorter
time horizon) on the inflation outlook. Taking into account the latest strong
economic indicators, market expectations continue to bet on a first hike in
2015. As a result, long-term interest rates have risen and the British pound
has appreciated.
The outlook is supportive for the British pound in the
coming months
Short-term drivers are in favour of further British pound
appreciation. Indeed, the IMM data (see page 7) show that investors are still
short, therefore capitulation among GBP sellers could lengthen the current
appreciation of the pound. Also, as previously mentioned, the introduction of
forward guidance marks a shift in the BoE's monetary strategy. Therefore, an
increase of the BoE asset purchases is unlikely in the coming months,
especially in light of the recent batch of strong economic indicators. On the
other hand, the medium-term outlook is less positive for the British pound, as
its central bank stance should remain very dovish in 2014 relative to the ECB
and the Fed, which should be in the midst of its tapering process. Taking into
account the technical configurations, GBP/AUD represents our preferred way to
be exposed to further GBP strength, with an objective at 1.8144. Our second
preferred cross is GBP/JPY, but we would wait for lower prices as fiscal policy
uncertainties are elevated. GBP/CAD could also be interesting as it is close to
breaking a three year range. A decisive break of the range would likely lead to
a phase of GBP appreciation towards 1.7699.
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Monetary Policy
US Federal Reserve (Fed) - Next meeting: 17 September
• The strengthening labour market and higher inflation has
increased the likelihood to see tapering of the monthly $85 billion bond-buying
programme in September. However, the pace of the reduction is expected to be
extremely gradual and highly dependent on the labour market and the inflation
outlook. A termination of the asset programme in mid-2014 likely represents the
most optimistic scenario.
• The Fed funds rate will not be raised as long as the
unemployment remains above 6.5% and the inflation outlook is consistent with
the Fed's 2% target. Therefore, a rate hike seems very unlikely in 2014.
European Central Bank (ECB) - Next meeting: 5 September
• The OMT with its potentially unlimited purchases of debt
creates a strong and credible backstop to protect the eurozone’s weaker members
from high borrowing costs.
• The ECB has broken an unwritten rule in July by giving
forward guidance on interest rates. Based on a subdued outlook for inflation,
rates are expected to remain at present levels, or lower, for an extended
period of time (without giving a clear deadline). The apparent lack of
discussion about rate cuts contrasts with the "extensive discussion"
before July's meeting.
Bank of Japan (BoJ) - Next meeting: 5 September
• The BoJ has introduced its "quantitative and
qualitative monetary easing", a bold and aggressive monetary programme
aimed at reaching an inflation target of 2% in a 2 year time window. In order
to do so, the monetary base will be doubled (from ¥138 trillion at end-2012 to
¥270 trillion at end-2014), mainly by increasing JGB purchases (of all
maturities). The reduction in JGB volatility favours no change in the BoJ's
programme.
• Thus the BoJ changed its target for money market
operations from the overnight call rate to the monetary base.
Bank of England (BoE) - Next meeting: 5 September
• The BoE has maintained the size of its asset purchase
programme at £375 bn and has announced forward guidance on its monetary policy.
Barring some exceptions, a supportive monetary policy will remain in place as
long as unemployment remains above 7%.
• Using the BoE's forecasts, interest rates are expected to
stay at 0.5% till late 2016.
Reserve Bank of Australia (RBA) - Next meeting: 3 September
• The Australian economy is suffering from a growth
transition from the resources sector (whose peak may have already occurred) to
the other sectors. The RBA has eased its monetary policy over the past 18
months to help this transition and would also welcome a lower AUD, whose levels
are still viewed as high, as an additional support.
• Thus, the RBA has lowered the cash rate by 25 basis points
to 2.50% and has left the door open for more stimulus, though rates should
remain unchanged at least until the November meeting.
Bank of Canada (BoC) - Next meeting: 4 September
• The BoC is expecting exports to be the key driver to boost
growth in the private sector. Notably, the central bank is committed to leave
rates unchanged as long as there is significant slack in the economy and a soft
landing is emerging in the housing market.
• The overnight rate was left unchanged at 1%.
Swiss National Bank (SNB) - Next meeting: 19 September
• The SNB is expected to continue to defend with the utmost
determination the minimum exchange rate at 1.20 in EUR/CHF.
• Target range for 3-month Libor is unchanged at 0.0-0.25%.
Short GBP positions
remain elevated
The International Monetary Market (IMM) non-commercial
positioning is used to visualise the flows of funds from one currency to
another. It is usually viewed as a contrarian indicator when it reaches an
extreme in positioning.
Since our last weekly report, the main significant changes
in IMM positions have been the move back into positive territory for Euro
positions and the lack of change in short GBP positions, despite a significant
rally in GBP/USD. From a technical point of view, both currencies remain in a
long-term downtrends compared to the US dollar. However, IMM positions suggest
that the British pound could benefit from a more significant reduction of GBP
short positions. On the other hand, the current long EUR positioning and its
proximity to the February peak favour a cautious view on EUR/USD.
The Japanese yen and the Australian dollar remain extremely
shorted. While we continue to favour medium-term weakness in both currencies,
the high uncertainties in Japan linked to the willingness of Abe's government
to address the dismal public debt through a sales tax hike and structural
reforms, indicate a risky environment in the short-term. On the other hand, the
relentless effort of the RBA to lower its currency and the strong exposure of
Australia to a the slower growth in China make us more comfortable with our
bearish outlook in AUD/USD.
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