Equity markets were already having a difficult session yesterday even before the explosions in the Kabul region which put to an end any possibility that we might finish the day in positive territory.
Not only did European markets finish the day lower, so did US markets as hawkish comments from the likes of Bullard and George kept markets off balance with the casualty reports coming out of Afghanistan adding to the sour mood.
Today’s European open looks set to be a cautious one, with stocks expected to tread water for the rest of the day as we look towards Jackson Hole and today’s speech by Fed chair Jerome Powell.
Last Friday’s late decision to hold this week’s meeting virtually appears to be a tacit admission by the Federal Reserve that the surge in the delta variant is still a clear and present danger to the US recovery, and while cases may well be starting to top out now, that may well reverse when the schools go back next month.
Of course, that doesn’t mean that there hasn’t been substantial further progress on the jobs market since the Fed set out its latest policy guidance all the way back at the end of last year. There most definitely has, and despite last week’s comments from Dallas Fed President Robert Kaplan that he might be persuaded to change his position on tapering if the data warranted, his comments yesterday suggested that he wasn’t at that point yet.
We also heard from St. Louis Fed President James Bullard and Kansas City Fed President Esther George yesterday, both saying that it’s time to start the process for ending asset purchases, with a view to stopping them by the end of next year.
There appears to be growing concern amongst a number of Fed officials that inflationary pressures are starting to become much more persistent, with deputy Fed chairman Richard Clarida expressing concern earlier this month that a much more persistent overshoot in the core PCE, would fall under the category of a more than moderate overshoot, which might require some action. We are already at 3.5% on that measure with the risk we could go higher with this afternoon’s July numbers.
With that in mind today’s Powell speech may well lay the groundwork for some sort of roadmap to be laid out at the September meeting, with the timing of any decision likely to be dependent on how good next week's August payrolls report is likely to be. We hear a lot about the risks around the Delta variant, and waiting for the risks to subside, however we could be waiting a long time for that to happen. The virus is hear to stay, and its how we learn to live with it that matters now as we head into the winter months.
The Bank of Korea raised rates yesterday because of concerns that low rates were encouraging too much leverage and that this was a bigger risk than rising delta cases. This is something the Fed also needs to be aware of, and while no one is suggesting they raise rates at this time, they do need to balance up the risks of rising delta infections rates relative to how the economy is performing, and while the economy is slowing, it’s certainly not crashing.
Powell needs to set the scene, in terms of where the economy is now relative to December last year, when unemployment was at 6.7%. It is now at 5.4% and could fall further next week. It would be most surprising if the Fed didn’t start to start to tap the brakes on bond buying now, given the improvements over the last 9 months, however it certainly doesn’t mean the central bank is about to come to a full halt. The balance sheet will still be growing, just at a slower pace. Tapering is not tightening and is merely a reflection of a better economic outlook, where we will still see bumps along the way. Ultimately it’s all about the messaging, the Fed will taper, it’s simply a matter of timing and messaging.
Before Powell’s speech we have the small matter of some more US economic data in the form of personal spending and income as well as the latest core PCE inflation data for July, and the final University of Michigan confidence data which put the wind up markets only a couple of weeks ago after it dropped sharply to 70.2 from 81.2 in July. We saw a decent rebound in personal spending of 1% in June, which was double expectations, although personal income has remained a little on the soft side, after the big gains in March.
Since the 4.2% expansion that we saw in the March numbers spending has been a little cautious, not surprising given the uncertainty over vaccine hesitancy in some US states. The ever-changing virus outlook isn’t helping either, even as most parts of the US economy reopen. Some of the slowdown in spending can be put down to higher fuel prices which may well have deterred unrelated consumer discretionary spending.
Expectations are for July personal spending to stay fairly resilient and rise by 0.4%, however personal incomes still look a little on the weak side which won’t help, especially with core inflation at a 30-year high. On the plus side, jobs growth is still heading in the right direction and wages do appear to be recovering which means all we probably need to see here is evidence of a direction of travel on the income side.
With concerns that higher prices might be acting as a break on other discretionary spending, today’s PCE numbers are likely to be closely watched after coming in at 3.5% in June. While CPI showed signs of plateauing in July, PPI did no such thing pushing even higher, with the wider worry that at some point these price pressures are likely to become more persistent. Core PCE is the Federal Reserve's preferred measure of inflation and has been trending higher for several months now, and in the space of 8 months has more than doubled from the levels it was at the end of last year when it was at 1.5%. We could see this edge even higher today, with estimates of 3.6% expected.
This does appear to be a real concern for some at the Federal Reserve, and while the consensus is now shifting towards the timing of a taper, at some point the discussion will start to move onto the timing of a rate hike if this current trend continues, though we are still some way off that.
EUR/USD – struggling to move beyond the high this week with the 1.1800 area needing to break to diminish the downside risk. The 1.1720 area still remains a key support. Below 1.1700 reopens the lows of 1.1660 lows of last week.
GBP/USD – no follow through on the move through 1.3750 has seen the pound slip back. A break below the 1.3680 level has the potential to revisit the lows of last week at 1.3600.
EUR/GBP – holding above the 50-day MA keeps the upside intact, and the highs at 0.8595. A move through the 0.8600 area retargets 0.8640.
USD/JPY – still looking toppy near 110.20, and the 200-day MA, with support at the lows last week at the 109.10 area. We need to see a break either side to determine the direction of the next move.
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