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Marshall Gittler’s weekly comment: RBA, Bank of England

August 10, 2020

August 10, 2020

Marshall Gittler’s weekly comment: RBA, Bank of EnglandMarshall Gittler

Market themes: Fed, Brexit, US-China trade

The Fed caved! Their guidance on the policy outlook and assessment of risks to the outlook changed completely. The Committee completely rewrote its previous estimate that risks to the economic outlook were “roughly balanced”, and replaced it with considerably more cautious comments about the uncertainty of recent “global economic and financial developments.” This was somewhat mystifying, as these developments were certainly visible in December too – it’s not like they suddenly became aware of Brexit or a trade war with China. And the assessment of the US economy wasn’t changed that much – they said it’s growing at a “solid rate” vs a “strong rate” in December.

One reason for the change was “muted inflation pressures,” which is certainly true. Powell said that “market-based measures of inflation compensation have moved lower in recent months,” which is also true. But most of the decline in inflation expectations came before the December FOMC meeting when they hiked rates.

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Powell also mentioned “tighter financial conditions,” but I don’t see this, at least not according to the Fed’s own gauge.

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Nonetheless, the Committee now says it “will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” Note the term “future adjustments,” instead of “further gradual increases,” which is what they used to say. That suggests policymakers don’t have a strong bias on whether the next move in rates will be up or down, but rather they will be guided by the data.

Furthermore, they also signalled that they are moving closer to an early end to their balance sheet rundown, leaving their balance sheet about 5x larger relative to US GDP than it was before the global financial crisis – hardly what would be called “normalization.”

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You can see how the probability of a hike (red line) has gone down relative to Tuesday’s level, while the probability of a rate cut (green line) late in the year has gone up. The market thinks that if they don’t hike by October, the odds are that they’re not going to hike at all, and the odds of a rate cut start to rise.

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It looks to me that they have changed their focus. They are now focusing on a) US inflation and b) the global economy. Previously, they were hiking 25 bps every quarter so long as the US economy remained steady. Now, they are pausing even though the US economy remains steady. Why? Because of “global economic and financial developments.” The US economy is doing well, but they are worried about Europe and China, not to mention Britain. This is a negative for USD because it means they won’t resume hiking until the global economic picture picks up – but when that happens, the ECB and other central banks are likely to start hiking rates, too.

I wonder if this change of view came about because of the addition of some recent Trump appointees, such as Vice-Chair Clarida. There are still several vacancies for Governors – voting positions – yet to be filled, which would mean solidifying the majority in favour of this kind of approach.

I think this change of view means the likelihood of a significantly weaker dollar ahead or at least less possibility of the dollar rising in the future.

We may get a better idea of what the Fed is thinking on Thursday when Fed Chair Powell hosts a town hall meeting. The event will be live- streamed to the public and people will be able to join the discussion through social media.

On other fronts, the Brexit fiasco got even worse. Britain’s Parliament rejected a proposal that would’ve allowed them to extend the negotiation period, and instead signalled that the only agreement they can get a majority for is one that the EU has already ruled out. Cakeism is alive and well!

The betting websites see a higher probability of Britain crashing out of the EU without an agreement, but still not very high (25%).

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Nonetheless, market professionals are hedging their bets – the risk reversals are clearly headed down (i.e, demand for puts is increasing relative to the demand for calls).

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There won’t be another vote in Parliament for some time, so there’s plenty of opportunities for ridiculous posturing, political infighting, and idiotic statements that are totally divorced from reality. I think the risks for GBP are decisively on the downside.

Finally, the US-China trade negotiations drag on. Trump met with China trade negotiator Chinese Vice Premier Liu He on Thursday; results of that meeting weren’t available at the time of writing. Unless a deal is reached by March 1, the U.S. has threatened to raise tariffs on $200bn worth of Chinese products to 25% from 10%. I wonder; having lost his precious wall, Trump needs a victory somewhere. But what constitutes a victory for him in these negotiations? Would it be to reach some small compromise and call it a major victory, as he did with the NAFTA negotiations? Or would it be to impose even higher tariffs on China to show that he’s really serious? The precedent of the NAFTA talks suggests the former, but that was before the government shutdown. Still, I think the odds are that they work out something before March. That would tend to be supportive of the dollar, I expect.

Next week: Reserve Bank of Australia, Bank of England, lots of US indicators

There are two central bank meetings next week, but neither is likely to result in a change in rates.

The Reserve Bank of Australia (RBA) meets on Tuesday. Their Cash Rate has been at 1.5% since 2016 and the market thinks it’s likely (64% probability) that it will remain there this year. If not, a cut seems much more likely than a hike, which gets almost zero probability nowadays (down from 90% just a couple of months ago).

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Even though the QoQ rate of inflation ticked up in Q4 (to 0.5% QoQ from 0.4%), the YoY rate actually slowed to 1.8% from 1.9% and remains below their target range of 2%-3%. Wage pressures remain subdued and house prices are falling. There’s no reason for them to hike rates now.

![LiteForex: ][8]

On the other hand, things aren’t so bad as to require a cut in rates at the moment. The RBA is still looking for the nation’s decade-long expansion to continue indefinitely. So no real reason to do anything. The meeting should be a snooze for the markets. Likewise, the Statement on Monetary Policy on Friday should also hold few surprises.

The Bank of England too is certain to be on hold. If the Fed decided to pause because of concern about “global economic and financial developments,” think of how things must look like in London!

The market had been expecting a rate hike sometime this year, but now investors think it’s just as likely that rates will be unchanged. They see no chance of a rate cut.

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I’m sure the decision about whether or when to hike rates has little or nothing to do with the economic outlook. It’s all about Brexit. You can see how the market has pushed out the possibility of a rate hike as it becomes more and more likely that Britain will crash out of the EU without an agreement.

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Besides, with inflation near the 2% target and headed downward (at least at the headline level), there’s no urgency to hike rates at this time anyway, except for the desire to normalize policy.

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And inflation expectations are under control – expectations are starting to trend lower.

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All told, I expect the Bank to repeat the dovish tone that it presented in December and once again emphasize the risks for growth and inflation. It will no doubt echo the Fed in talking about the deterioration of global growth prospects in general, while probably focusing on the slowdown in Europe, Britain’s largest export market. The results may add to the feeling that neither politics nor economics is particularly supportive of the pound right now and maybe a negative for GBP.

As for the indicators, there’s not that much on the schedule, as is usual on the second week of the month. Nonetheless, we may get inundated with unscheduled US economic indicators as the Bureau of Economic Analysis (BEA) and other government departments get caught up on the backlog. For example, there will be a Commitments of Traders report on Tuesday and Friday until the backlog is worked off.

In Europe, German factory orders come out on Wednesday and industrial production on Thursday.

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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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