Central Banks Going Their Own Ways

July 15, 2021

Markets are still on board with Fed Powell’s reassuring message on inflation
The BoK kept rates unchanged while also tapering its bond purchases; Chile’s central bank joined Brazil and Mexico in their tightening cycle, while Turkey and Korea left rates unchanged, as expected
Australia’s labor market remains resilient, but the impact of the latest virus wave is still to come
Crude continues its downward slide after U.S. supply data and signs that a supply deal on OPEC+ might be at hand

The dollar is mixed on the day but trading in narrow ranges. The DXY index is at 92.3, right in the middle of the month’s range. KRW is the main mover of the day, benefiting from the hawkish BoK outcome overnight and solid data from China. Global equity markets are also mixed, but mostly lower. S&P futures are down slightly but still close to record highs. Most European bourses are down, with the EuroStoxx index falling 0.4%. Asian stocks were mixed. Major fixed income markets are little changed.

AMERICAS

Yesterday’s main event was Fed Powell’s comments to the House Committee, where he stuck to the usual reassuring message on inflation – which markets seem to accept. Powell reaffirmed the need to focus on the transitory elements of the current inflation spike and reiterated that “substantial further progress” is still to come for the U.S. economy. That said, he would “absolutely” act on inflation if needed. Powell also mentioned that the FOMC will continue the “bond-buying debate in coming meetings.” While this is self-evident, we imagine that the debate will intensify from here, eventually reflected in Fed communication. As seen by breakevens, implied inflation rates have subsided somewhat over the last couple of sessions, with the 10-year at 2.35% around the middle of the range over the last several months.

Fed manufacturing surveys for July will start to roll out. Empire manufacturing and Philly Fed surveys will both be reported today. The former is expected at 18.0 vs. 17.4 in June, while the latter is expected at 28.0 vs. 30.7 in June. This would continue the trend that we saw for the survey readings in June. That is, most fell but remained at historically high readings. June IP is expected to rise 0.6% m/m vs. 0.8% in May.
The bank of Canada kept rates unchanged at 0.25%, as expected, while also tapering its bond purchases. QE will be adjusted to a target pace of C$2 bln per week, reflecting the “continued progress towards recovery.” We also get confirmation that the BOC is likely to hike rates in H2 2022, though exactly when is still unclear. At this point, we think it’s more likely to happen on the earlier side. The bank downgraded its 2021 growth forecast by 0.5 ppts to 6% this year but upgraded the 2022 and 2023 forecasts to 4.6% and 3.3%, respectively.

Chile’s central bank joined Brazil and Mexico in their tightening cycle by hiking the overnight rate by 25 bps to 0.75%, as expected. The decision was unanimous, based on rising inflation expectations and economic activity returning towards pre-pandemic levels. Based on the central bank’s forward guidance, we should expect the cycle to take the policy rate to over 3%. This will probably happen in increments of 25 bps, though we wouldn’t discard a more decisive move if the political situation heavily impacts the peso.

EUROPE / MIDDLE EAST / AFRICA

The trend in the UK labor markets still looks favorable, but there is still a lot of uncertainty about what will happen with the end of the furlough program in September. The 3-month unemployment rate ticked higher by 0.1 ppts to 4.8%, and the employment count rose 25K (far less than the average forecast of 91K). But job vacancy increased, and alternative labor market data from the tax system show underlying strength. That said, it’s tough to predict how the end of the furlough program will impact this picture and how easily those who come off the program will be re-absorbed into the labor market. This is undoubtedly one of the main factors holding back the BoE from adopting a less dovish posture – and rightfully so, in our view. Yesterday, BoE Deputy Governor Ramsden came out with some decidedly hawkish comments. He said inflation could peak at 4%, suggesting policy may have to be tightened on the earlier side.

Turkey’s central bank left its policy rate unchanged at 19.0% yesterday, as expected, acknowledging higher short-term price pressures. We still think the odds of a hike this year are high, but we don’t think it will happen in the next few meetings. The June inflation print came in uncomfortably higher than expected at 17.5% y/y, and some of the pressures from the weaker lira and higher energy costs have probably not fully yet kicked in. Indeed, the bank said it would keep policy “tight” until inflation slows significantly. We should get some more clues about the bank’s intentions when they publish their updated inflation report at the end of the month. The lira and local fixed income markets are little changed after the meeting.

ASIA

Australia’s labor market is holding up well. Data for June showed a 29.1K employment increase, well above the 20K expected, while the unemployment rate unexpectedly fell 0.2 ppts to 4.9%, the lowest level in 10 years. The participation rate remained unchanged at 66.2%. Unfortunately, this picture will surely start changing soon with the impact of the recent lockdowns. Indeed, Victoria State is entering a 5-day lockdown starting today at midnight. This should ensure that the RBA will remain on its dovish trajectory. The Australian dollar and local assets were little impacted by the data. The yield curve has been following the broad global bull-flattening move, with the 10-year yield now at 1.30% from around 1.75% in April.

Overnight data out of China was on the strong side. GDP came in at 7.9% y/y for Q2, with the quarterly figure rising to 1.3% (1.0% expected). Retail sales and industrial production declined by less than expected to 12.1% y/y and 8.3% y/y, respectively. Officials should take comfort in the convergence between retail sales and IP, one indicator that China’s rebalancing directive is on the way. But the bottom line here is that the data reaffirms that the recent RRR adjustment was not any indication of an impending economic downturn.

Bank of Korea (BoK) left rates on hold yesterday at 0.5%, as expected, with one dissent in favor of a hike. The worsening virus numbers and the partial lockdown of Seoul didn’t discourage BoK officials from their intention to hike this year, but it could push back the timeline. The board will discuss a hike starting in the next meeting, but we think it’s too soon for a move. Even with the supportive fiscal backdrop, we doubt officials would risk a policy mistake by hike rates until the infection curve improves. The won outperformed on the day, up 0.6%, but it’s still over 1% weaker since the start of the month. Local rates have come off a bit, especially in the back end, but the moves have been modest.

Indonesia saw surprisingly strong trade figures for June. The trade balance nearly halved to $1.3 bln, but both exports (54.4% y/y) and imports (60.1% y/y) were far higher than expected. Exports were boosted by energy and imports by raw materials and, to a lesser extent, consumer goods. We see this as positive news, despite the impact on the current account balance, but it’s still hard to get a lot of confidence in the Indonesian economy. New daily cases rose to a record of nearly 55K as of yesterday, justifying the latest mobility restrictions. Still, the rupiah has held up well recently, flat on the month compared to modest declines in most other regional currencies.

COMMODITIES

Crude continues its downward slide after U.S. supply data and signs that a supply deal on OPEC+ might be at hand. On the OPEC front, reports claim that the UAE could get a more generous supply quota helping resolve the deadlock with Saudi Arabia. Meanwhile, U.S. inventories for gasoline and distillates were considerably higher, according to EIA data. Gasoline inventories rose by over 1 mln, compared to forecast for a 2 mln draw. Brent and WTI futures are down about 3.5% over the last two sessions, led by the front-month contracts. In other words, some of the deep backwardation in the curve has been taken out.

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