US data and Fed expectations
Volatility in interest rates continues to pick up as inflation data is mixed and central banks’ guidance becomes more important. Nowhere is this more apparent than within the Fed. Markets go a full docket for FOMC members speaking publicly last week.
On one side of the spectrum is the expectation that tighter labor market conditions will drive inflation (pure belief in the Philips Curve). The other expectation is that cyclical activity has peaked and a soft reading indicates a broad-based economic weakening. Interestingly and key to our view is that no speaker suggested waiting past 2017 to begin balance sheet reductions. Wide spectrum of opinions on US data had led to a directionless USD trade.
Yet the fall in oil prices has tipped the balance of weaker prices pressed towards the downside but allowing technology stocks to outperform, driving US equity markets higher. We retain our view that the Fed will raise bench market rates another 25bp in December but further detail its balance sheet reduction process in September.
The Fed will increasingly look too subdued to tighten through the reduction of balance sheet rather than traditional interest rates hikes. However, unbridled USD strength against G10 currencies is unlikely at European PMI to continue to signal faster GDP growth. The ECB see this development as an opportunity to move forward with their strategy to exit emergency monetary policy (including taper its monthly asset purchased).
Even though inflation data has not meaningfully improved, we believe a key announcement will take place at the September ECB meeting. In the near term, traders will be watching incoming USD data for direction. Today’s durable goods orders should decline slightly to -0.6% as industrial production reports a drop in durable goods manufacturing. The highlight of the week will be Thursday’s GDP and Friday’s personal income & spending plus PCE index.
Finally, while politics will grab the headlines and generate short-term FX pressure (take your pick on Russia investigations, repeal of Obamacare or potential Trump fiscal stimulus), for direction stick to the Fed monetary policy.
Switzerland: Data suggests continued intervention from the SNB
The Swiss deposits data release continues to outpace expectations. They are now reaching almost 580 billion CHF (578.2b vs 577.4b expected). The main reason for this is that the SNB is not ready to stop its ultra-loose monetary policy as President Thomas Jordan said and this drives strong upside pressures on the CHF. The EURCHF is standing around 1.0850 and we do not see how, at least in the medium-term, the pair could hold consistently above 1.10.
The SNB’s monetary policy depends widely on its giant neighbour, the Eurozone, and while financial markets were expecting Mario Draghi to hint a few weeks ago at the ECB meeting about a further normalisation, this has not happened yet. As a result, intervention to defend the CHF on the FX market will continue for the SNB as long as there is no normalisation from the ECB.
We also note that there are economic uncertainties in Europe and we believe that it should prevent the ECB to normalise its interest rates. Santander acquired Banco Popular in Spain and in Italy, Intesa San Paolo has been forced to acquire Banco Popolare di Vicenza and Veneto Banca. The Italian state will likely engage up to 17 billion in this operation. It is then not the exact moment for the ECB to raise rates (charge of the debt would become too massive at this point). Therefore CHF overvaluation will continue and we continue to be bullish on the Helvetic currency.
