And Now, the Fed
The market has monetary policy on its mind heading into the new trading week thanks to the actions of the European Central Bank (ECB) this past Thursday. One of the world’s largest central banks, the group is making a bid – perhaps unintentional and perhaps not – to be the most accommodative group of its size. Already sporting a negative rate, a large balance sheet and a T-LTRO program; President Draghi steered his team back into an expansionary phase of dovishness despite his retiring in a few months. Testament to their forward guidance efforts, the market largely expected the 10 basis point cut to its discount rate (to -0.50 percent), the restart of quantitative easing or QE (20 billion Euros per month starting Nov 1) and the introduction of tiered lending aimed at helping banks struggling with profitability. In fact, the move was so thoroughly baked in that the Euro’s initial tumble reversed to gains and capital markets seemed little charged after the effort was made official. On the one hand, the ECB will be happy that it avoided triggering a volatility event which could create more difficult conditions to support moving forward. Alternatively, there is more than a little ‘wealth effect’ assumption to the transmission of current monetary policy. Underwhelming response from the markets could signal monetary policy is reaching the limits of its effectiveness. That is the unpredictable scene we are met with as we approach the Fed’s policy event.
The Federal Reserve’s policy event is scheduled for Wednesday at 18:00 GMT. Even putting aside the existential crisis traders are facing with the concept that monetary policy may be losing its effectiveness, this was due to be an important meeting. September’s meeting represents one of the ‘quarterly’ events whereby we are due the Summary of Economic Projections. That includes the updated forecasts for interest rates that the markets watch so closely. Even more pressing with this particular meeting, is the question as to whether the Fed will follow up with its first rate cut in a decade this past July. After that meeting, Chairman Powell said the move was a ‘midcycle adjustment’, a phrase repeated in the official perspective of the group in the meeting minutes. That would insinuate that the next reduction – if there would be one – depends heavily on data. As it happens, recent jobs figures weren’t gangbusters but the trend is still the best in decades. Further, core inflation registered by the CPI was accelerating above target. These are not the developments that would signal easing is urgently necessary. Nonetheless, we are facing a serious difference of opinion on the subject with the market still pricing in a robust 80 percent probability of a rate cut - though down from certainty just a week ago. Does the Fed dare disappoint the market and trigger capital market fear that will in turn necessitate central bank support later regardless or will it cut despite its explicit remarks that it was unnecessary and tarnish its credibility?
Many market participants – especially those that have benefit from the zombie-like complacency bid these past years – would advise protecting market gains to avert any speculative slump that can make more tangible the economic pain. Yet, the long-term risks of satisfying risk takers can be severe and irreparable damage to credibility and ultimately an inability to fight serious fires in the future. The global market is struggling under trade wars and the natural flagging of the economic cycle. There is certainly appetite for the world’s most hawkish, large central bank to make a more consistent distribution of support, but satisfying these appetites would only draw attention to the state of dependency growth and market performance attached to stimulus and negative rates – not to mention dissuades fiscal powers from taking on the responsibility themselves. If the Fed refuses to act and there is investor fallout globally, those central banks already all-in will find their own credibility razed to the ground. A lot rides on the Fed, and not just for the Dollar or Dow.
Good Will and Rumors of Economic Pressure Points in Trade Wars
There is an unmistakable enthusiasm around the state of the US-China trade war over these past two weeks. It started slowly enough with the suggestion that the two sides would return to the negotiation table in earnest early next month with leaders from each camp suggesting they were optimistic. As far as inspiration goes, that doesn’t even rank as a far-fetched cue for optimism. We have seen far too many slow starts of this exact type flame out and ultimately result in a worsening of relations between the two. Thankfully, there were more tangible efforts of good will to build momentum upon. China announced that it was waiving tariffs on 16 US imports that were previously taxed – the first such course reversal since the trade war began. Despite the relative minimal move, the US responded by announcing that it would delay the increase of tariffs on $250 billion in Chinese imports from 25 to 30 percent by two weeks, pushing it from October 1st to the 15th. Looking to surpassing that frequent trip point after the first round, China then followed up with the announcement that it would exempt US pork and soybeans from tax at the ports.
This is indeed tangible progress, but recall that the higher level officials are not due to meet until early October. Further, there have been frequent false dawns whereby the absence of a compromise has not resulted in status quo but rather an escalation. Nonetheless, there is clear evidence that both sides are interested in boosting market sentiment – such good will reciprocation would never have occurred previously as each would have deemed it an overdue step by the liable party. For China’s part, it is concerned about the state of its local economy and financial system already under significant pressure. In the US, the Presidential elections are over a year away, but the campaign is already starting; and the rising fear of recession is posing a serious problem for Donald Trump. Fully reversing the trade war actions and striking a trade agreement would take serious time and capitulation from states and personalities not commonly known to ‘surrender’. It is still possible however. The real question we should ask though is: will the lifting of trade wars recharge growth or investment appetites? The absence of a ballooning crisis is not the same thing as seeding GDP or returns. Trade wars have taxed an already threadbare global economy while highlighting the dependency on external sources of support like central banks simply to keep the masquerade going. It is not a good point in time to look at markets through rose colored glasses.
Repeated Accusations of Currency Manipulation Will Spur a Currency War
There were a number of skeptics of the value added and intent from the ECB’s decision to escalate the support this past week – including some of the key bank members themselves. However, one person’s criticism that was fully expected as they took their rates deeper into negative territory and announced the restart of the QE program was US President Donald Trump. He has reflected on their efforts more often these past months as a platform to critique the Federal Reserve. Rather than decry their efforts as purely manipulative in a bid to earn growth at the expense of more virtuous trade partners, he has held their course up as a template for which the Fed is falling behind on. His berating of Chairman Powell has been relentless, but the haranguing hasn’t changed the central bank’s course – well, not as much as intended considering the President’s policy mix has weighed markets which the Fed is less capable over ignoring. At what point will a President frustrated by slowing growth and a central bank that is unwilling to supplement for the pain the trade war is causing – and ultimately incapable of holding back any serious collapse in economy – decide to take exchange rates as a tool into his own hands?
The ECB’s moves will raise his ire, but the rebound in the currency will frustrated his claims that they are principally a move to devalue the currency. Such details haven’t held him back before however. With the Dollar holding near two-year highs with Euro, Yen and Yuan at the very lease employing serious policies that have at least a secondary result of FX depreciation; this will stand out as a genuine option in the event of emergency (a fading campaign in the face of economic struggle). Adding to the pressure, the Swiss National Bank (SNB) and Bank of Japan (BOJ) will likely hit upon the POTUS’s radar in the week ahead. Both are due to deliver policy updates. The SNB is not expected to cut rates further, but it is already hovering at a -0.75 percent rate and attempts to simply keep pace with the ECB so as not to allow EURCHF to drop. Meanwhile, the BOJ is similarly expected to hold course, but recently its officials have stated they were looking into the option of plumbing negative rates in a bid to finally earn the policy response they have failed to render thus far through a dovish mix anchored by an open-ended stimulus program.