Market movers today
We get economic confidence for the Eurozone, which is expected to rise slightly in August compared to July as the global economy is strengthening.
In the US, today’s monthly private consumption data for July are going to be very interesting. Retail sales grew again in July (despite high-frequency indicators suggesting otherwise) but it may be the case that consumers substituted away from services into goods. We will know more at 14:30 CEST.
Today we will host a conference call, where we discuss the implications of the Fed’s monetary policy regime shift. Is this really a big shift or just more of the same old? And what should we make of the FX market reaction and expect going forward.
The 60 second overview
Macro. As expected, the Fed has now officially changed regime from a traditional 2% inflation target to a flexible average inflation target. There are two key differences compared to the old regime: (1) The Fed will now allow unemployment to decline significantly below what is considered ‘normal’, as long as wage and inflation pressure remain subdued and (2) The Fed will now make up for inflation running below the 2% target by allowing inflation to move above 2% for some time such that inflation on average is 2% over the business cycle. In our view, this is a positive step, but there are some unanswered questions. The formulation of the average inflation targeting regime is quite vague. How high inflation can the Fed tolerate and for how long? What will the Fed do to create inflation? Right now inflation expectations remain subdued from a historical perspective, so the Fed should ease more, but it has actually tightened monetary policy by tapering QE buying. It is very important that the Fed makes the new regime credible right away, otherwise it risks a ‘Bank of Japan’ moment, which has not succeeded with the shift to a 2% inflation target. If not credible this just means ‘0% rates and QE buying forever’.
Equities. The positive sentiment in the US equity market continues on the back of the very dovish statement from Fed Chairman Powell as discussed above. The Asian equity markets followed the positive sentiment this morning.
FI. The long end of the US Treasury sold off sharply on the back of the dovish statement from Fed chair Powell yesterday. The change in the US monetary policy towards an average inflation ‘target’ led to a solid sell-off in the long end of the US Treasury curve as it is allowing for inflation to overshoot in expansive periods. This also changed the sentiment in the European government bond market yesterday, where rates/yields ended higher.
Given that monetary conditions are going to stay very soft and we have QE programmes, we expect that there is a limit to how much rates can rise and the curve can steepen, as neither the Fed nor the ECB want an unwarranted tightening of monetary conditions.
FX. Everyone had been waiting since last week for Powell to talk at Jackson Hole. After a lot of intraday volatility, FX markets ended the day quite unchanged. Our take is the new policy of an average inflation target (AIT) supports risk markets by lowering macroeconomic uncertainty and, all things else and taken at face value, is broad USD negative. Looking ahead, the devil is in the detail. This is unlikely to translate into large shifts in FX, in the short term.
Credit. Credit markets were more or less unchanged yesterday, with both iTraxx Xover and Main moving less than 1bp. The issuance of high-beta paper continued, with Total printing a PNC10 hybrid and Sampo issuing a 32NC12 Tier 2. Both transactions were decently oversubscribed amid large tightening from IPT to final pricing.
