It’s another down day for the dollar. The extremely flat US yield curve – flattest it’s been since the 2008 Global Financial Crisis – has been keeping the dollar from rallying. Does the flattening yield curve signify market fears of a recession? Or does it simply indicate that the market has confidence in the Fed and believes that it’s likely to continue to raise rates, which should keep inflation under control going forward?
There’s been no big change in inflation expectations over the last several weeks, which leads me to think that it’s the latter – confidence in the Fed.
That’s also the signal from the Fed funds futures. The implied rate forecasts from the Fed funds futures have gradually been moving higher, implying that the market is starting to believe the Fed’s own rate forecasts more.
Given that the flattening yield curve is a vote of confidence in the Fed and not a signal of impending recession, I think it should be a reason for the dollar to rally, not weaken.
However, the market seems to be focusing on yield differentials. That’s the only explanation I can see for why USD/JPY should have moved lower when the market is seeing a revival in risk sentiment. The correlation between USD/JPY and Tokyo stocks is near the highest it’s been in over 20 years, and yet with stock markets all around the world rallying, USD/JPY fell.
CAD was the biggest winner despite a stunningly badfigure for wholesale trade sales – down 1.2% mom instead of up 0.6% as expected (previous: +0.4%). The Canadian Foreign Affairs Minister said there had been “good progress”. Mexico made a proposal that the US was bound to reject in response to an unacceptable US proposal. Apparently there was some progress in lower-level issues in the NAFTA talks, although the main obstacles remain.
A big day in Europe and in the US today. In Europe, the focus will be on UK Chancellor of the Exchequer Philip Hammond’s Autumn Statement to Parliament. This is the budget for FY2018, which will include revised economic forecasts for growth and the fiscal deficit.
This is the first budget after the snap election in June 2017. Forecasts for growth are likely to be revised down, which means that the forecasts for the deficit should widen. The fiscal situation will therefore be quite tight already. Furthermore, the Conservative Party maintains a narrow majority in Parliament only with the help of a small party from Northern Ireland, and that party has agreed only to support the government on legislation pertaining to Brexit and national security.
On the contrary, there has been considerable clamor in Britain for an “end to austerity.” One might argue that the central government is running an austerity program, since current receipts now exceed current expenditures, as the lines in the graph below show. But overall the public sector is still running a deficit (green section) so it shouldn’t be said to be imposing “austerity” – it’s more accurate to call it “less profligacy.” (Note that public sector net borrowing, the green area, is not just the difference between revenues and spending and thus doesn’t correspond exactly to the difference between the two lines).
The problem for UK Chancellor of the Exchequer Philip Hammond will be to keep the borrowing on the downtrend that the Conservatives have promised, while at the same time increasing spending – and all with revenues forecast to fall.
The budget has many macro- and micro-economic effects that will be discussed at length in the press afterwards and should, over the longer term, affect the pound. The immediate question for the FX market though is simple: whether the budget helps or hurts the government’s already low popularity. If it’s poorly received, it could add to the problems that the Conservatives are already facing. That would tend to embolden the rebels in the party and make a revolt more likely, which would be negative for the pound. On the other hand, if it’s well received, it could shore up Prime Minister Theresa May’s popularity and give her a stronger hand in negotiating Brexit with her own party as much as with the EU. Which will it be? We’ll have to wait and see.
In the US, the big indicator of the day is the durable goods figure. The headline figure is expected to show much less of a rise than in the previous month, because of a fall in airplane orders. Also, after three months of relatively strong growth, the key figure for core capital goods orders (specifically, “capital goods new orders non-defense ex aircraft and parts”) is also expected to be lower – but still positive. Often after a few months of growth we get a negative month, so I would rate these figures – not great, but still positive - fairly good in context and therefore judge them to be mildly positive for the dollar.
Next is the EU consumer confidence figure. Consumer confidence has been rising steadily on the back of relatively strong growth and falling unemployment rates (plus no major debt crises). The figure is expected to rise further, which could be slightly EUR-positive.
The US Department of Energy’s weekly crude oil inventory figures are expected to show a decent drawdown. But that’s already in the price after the American Petroleum Institute (API) reported an enormous drawdown. The API figures have shown wild fluctuations; up 6.5mn barrels last week, down 6.4mn barrels this week.
The minutes of the November 2017 FOMC meeting will be closely scrutinized as usual. It’s assumed that they will raise rates in December 2017. There were very few changes in the statement following the meeting from the statement following the September 2017 meeting, which implies that there were few changes in views, either.
One of the main points of contention within the FOMC is about whether wages will pick up and drive an increase in inflation. The minutes of the September 2017 meeting said that “(m)ost participants” expect wage increases to pick up as the labor market strengthens, while “a couple of participants” thought this was already starting to happen. Since then, wage growth slowed down (see graph).
There is also the crucial question of whether low inflation is temporary or a new trend due to changes in the economy. As the first graph below shows, since the Global Financial Crisis ended, lower unemployment has been associated with lower inflation, the exact opposite of what economic theory suggests. But the second graph suggests that this trend may have reversed from 2015 and that the textbooks may be right after all. Where do the Committee members stand on this debate?
While “many participants” continue to expect the tightening labor market to lead to higher inflation and “many” thought the undershoot in inflation was due to one-off factors, “(s)ome participants discussed the possibility that secular trends, such as the influence of technological innovations on competition and business pricing, also might have been muting inflationary pressures and could be intensifying.” This is another key debate that investors will be monitoring through the minutes. The more the Committee members think low inflation is a result of secular trends, the less likely they are to push for higher rates.
Early morning on Thursday 23rd November 2017 in Europe, the final estimate of German GDP will be announced. But since it’s almost never revised, that will be more of interest for the details of the figure than for anything market-moving.
This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.