[Originally published 8/19/2014]
By Neil Staines
…only half way up
Over the weekend, BoE Governor Carney added to the ongoing UK rate hike timing uncertainty by stating that the BoE will not wait for rising wages to lift rates. This follows the dovish market response to last week’s Quarterly Inflation Report (QIR). In the press conference that followed the release of the QIR, Carney twice said "wages are not a threshold for policy" adding "I can't be clearer than that." It is possible, therefore, that the weekend’s utterances indicate a certain amount of frustration, or indeed were intended to ‘smooth’ expectations ahead of the possible revelation of a dissent (or more than one?) when the minutes of the August BoE meeting are released tomorrow.
Whatever the rationale, and while we have long been advocates of a Q4 rate hike in the UK, the recent rhetoric and data, which has seen short sterling futures and GBPUSD retrace all of the hawkish response to the Mansion House revelations, have only added to the uncertainty. Expectations for the first UK rate hike have indeed been marched to the top of the hill… and then marched down again.
This morning’s UK inflation data further disappointed the rate hawks as clothing prices dragged the headline index lower in July (after boosting the June data) as the timing of price cuts distorted the annual comparison. Despite the technicalities, however, lower price pressures reduce the urgency on the BoE to act and, despite the fact that we see the wage inflation data levels in July as the low point for the year (and subsequently rising into year end and beyond), we will likely now need some signs of further acceleration in growth and/or positive price developments to prompt a rate hike in 2014 (which remains our core view). All UK and GBP focussed eyes, however, now turn to the August BoE minutes and the (very real) possibility of one (or more) hawkish dissenter.
…when they were down, they were down
In the Eurozone, the economic backdrop is increasingly and more uniformly negative. Following the very disappointing Q2 GDP data from the region last week, yesterday’s Bundesbank Monthly Report clearly stated that the "German economic outlook has clouded” and that the "data cast doubt on German H2 rebound.” Today, the focus is on the UK and the US. However, the release of the flash estimates for August PMI surveys on Thursday, will likely be key to Eurozone sentiment and, from a technical perspective, a break below the 1.3333 level in EURUSD will likely trigger further selling.
In addition to the weak economic backdrop, the political backdrop within the Eurozone is becoming more fractious and increasingly negative. As Berlin heads for confrontation with the social democratic governments of Italy and France over Europe’s fiscal compact, Moody’s warned yesterday that France’s inability to reach deficit targets would prove a test of the eurozone’s ability to enforce fiscal rules. Mario Draghi’s ‘whatever it takes’ mantra was not likely meant to include political mediation for the ‘spat’ between the eurozone’s biggest members, the negative implications of which are not yet priced by the market.
Neither up, nor down
On Friday, (FOMC voting member) Dallas Fed President Richard Fisher, stated that the "market is trading too dovishly compared to the FOMC,” following up on his previous comments that he had not dissented due to the fact that the Fed were "moving in his direction”. This sentiment fits with our view that the US economy is, and will likely continue to be, stronger than consensus expectations and, as a result, US monetary normalisation will come sooner and ultimately tighten at a faster pace than is currently the market expectation. In accordance with this view, and despite its recent frustrating progress, we continue to favour the USD on FX markets.
The US data calendar is fairly light this week, although focus will be on the release of the July FOMC meeting minutes on Wednesday and the testimony of Janet Yellen at the Jackson Hole conference on Friday. At Jackson Hole, the events are centred around the topic of "re-evaluating labor market dynamics this year” and it is likely that the sentiment and rhetoric reflect the same tone and verbiage as the recent Humphrey Hawkins testimony and July statement.
As the global economy grows at a very pedestrian pace, with global exports continually disappointing, the importance of gaining a share of that slower growth (and export market) becomes ever more important. In that environment, currency valuation is a key variable and (as we saw last night from the RBA, and recent protestations by the French) a weak USD will likely face increasing political resistance.
Our favoured view at the current juncture remains EUR weakness, as the uncertainty over growth prospects increase and the chances of further stimulus (perhaps even full blown QE) increase. As we move through the traditional holiday month of August, we expect activity and trading volumes to pick up and EUR selling to increase as stronger US growth and the ‘risk’ backdrop (with US yields holding up) continue to support the USD.