Major equity indices declined markedly during the past week after a strong performance in the past few months. Notably the major US indices have entered correction territory as they touched more than 10% during the week, primarily driven by the tech sector. The technology sell-off is driving cross-asset uncertainty and thus the reasons should be found in stretched optimism pulling back a bit or similar technicalities. Or, macro uncertainty is driving the sell-off and so Brexit, US politics or geopolitics are underlying reasons, which may act as more persistent gravity. We lean to the former.
Looking ahead and with the notion this sell-off is technical in nature, next week’s FOMC meeting should evoke some calm. The events of recent weeks show latent risks remain high and at the current point in time, this will likely force the hands of various central banks who are likely to re-iterate continued economic support on the back of this and may even add to such. The Brexit saga continues with renewed tensions after the UK government considers passing an Internal Market Bill, which undermines the Withdrawal Agreement on areas including state aid and Northern Ireland customs. The EU has given the UK until the end of the month to amend the bill.
Next week’s key focus is the FOMC meeting on Wednesday after its decision to embark on average inflation targeting. We expect a change of forward guidance by stating that ‘the Committee expects to maintain this target range until it is confident that inflation will run above 2% for some time’ and to increase QE buying. We think the Fed will recognise the importance of building up credibility right away, especially as inflation expectations remain subdued. See Fed Monitor: Forward guidance linked to inflation outcomes and faster QE buying on the cards, 2 September.
ECB’s monetary policy meeting yesterday was in line with expectations. It conveyed a confidence in its narrative of a recovery, notably in the manufacturing sector, while the language on inflation was not alarming, despite continued low projections. The ECB did not seem too concerned about the anti-inflationary effect of the recent euro strength.
Next week in the euro area, we get September ZEW on Tuesday and final HICP figures for August on Thursday. ZEW will set the tone for the September PMIs in the following week. High frequency data suggests that the euro recovery has continued in September but at a slower pace. ZEW expectations have already shown a stellar rebound in recent months, so a small setback here would not be surprising. More interesting will be whether the current situation assessment continues to head up.
In Japan, we will look out for the leadership election in the ruling Liberal Democratic Party on Monday, which will decide PM Abe’s successor. Cabinet chief secretary and Abe’s right hand Yoshihide Suga looks set for the win, which has comforted markets following Abe’s shock resignation two weeks ago. Suga will continue with Abe’s accommodative economic policy. While Suga has indicated he is ready to have Bank of Japan take additional monetary easing steps, we expect it will refrain from cutting rates and keep its QQE with yield curve control unchanged next week.
