FOMC Minutes Stole Some of Jackson Hole’s Thunder
• There are two highlights for the week ahead, the preliminary August PMI and the Fed’s virtual Jackson Hole confab.
• The spreading Delta mutation and the policy response provides broad context. The return to “normal” is being delayed and there is some concern about demand, which helped drive oil prices to three-month lows.
• The PMI poses some headline risk, and some moderation of activity is anticipated.
• The FOMC minutes from the July meeting confirm that the Federal Reserve will most likely reduce the pace of its bond purchases later this year, barring a new and significant negative shock. The news helped the dollar extend its recent gains.
• The September 2022 Fed funds futures has a hike nearly fully discounted.
• Three emerging market central banks meet. Hungary will most likely hike, and Israel will stand pat. South Korea may be the most interesting, and while a rate hike is coming, Q4 may be a more likely timeframe.
There are two highlights in the last full week of August that will draw the attention of investors: the Federal Reserve’s symposium (Jackson Hole) and the preliminary August PMI reports. Still, the 800-lb gorilla in the room remains the virus. For many countries with limited access to vaccines and/or low vaccination rates, the calls in some Western press to just live with it sounds callous and disconnected. Vaccine hesitancy in the US appears to have been dealt a blow by the recent surge of cases that are taxing several states’ hospital capacity. The number of virus cases in the US has roughly doubled in the past two weeks.
The supply chains are again being strained. This can mean higher prices to distribute the scarcity, but also delays and other disruptions. Some early August survey data already is picking up on this. Encouraged by a few disappointing economic reports, some economists are shifting growth projections from Q3 to Q4. Several high-profile businesses have postponed their return to the office. The preliminary PMI data posed headline risk but the market is looking further afield, and many recognize the fluidity of circumstances and the anecdotal reports of some moderation of economic activity due to the virus. The drop in oil prices to three-month lows, despite US inventories falling to their lowest level since January 2020 is partly a reflection of those concerns over demand.
Fairly or unfairly, voters will blame leaders for the handling of the pandemic. Even before the collapse of Afghanistan, US President Biden’s support softened, and many attributed this to the surge in the contagion. France has protested for six consecutive weekends against French President Macron’s push for Covid-19 vaccination cards. Hundreds were arrested in Berlin last week to protesting the restrictions that were imposed earlier this month. There have also been US protests over vaccine requirements and/or passes.
Two G7 members, Germany and Canada, hold national elections in September. Germany is going to choose Merkel’s successor. She has been Chancellor since 2005. Laschet, the head of the CDU, has thus far been an inspiring candidate. For the first time, the polls suggest it is possible that the Social Democrats, who have been the junior partner to Merkel’s CDU in four of the last six governments, alongside the Greens and the Free Democrats could forge a coalition. Still, it seems very fluid and the evolution of the virus in the coming weeks could be important.
Canada’s Prime Minister Trudeau surprised no one with his call for snap elections on September 20. Trudeau’s gambit is that the inoculation effort offsets the rocky start of the vaccine rollout and the combination of fiscal and monetary support overcomes whatever misgivings some parts of the electorate may have on other issues, and allow the Liberals to regain the parliamentary majority lost two years ago. The Canadian dollar, which was at four-year highs at the start of June, up around 6% for the year, has weakened in the past two months and is now down about 0.2% for the year, giving exporters some relief.
Given the dominance of the Liberal Democratic Party in Japanese politics, the winner of its leadership contest in September will most likely be the next prime minister. The national elections must be held by October 22, four years after the last one. Prime Minister Suga’s support has sagged below 30%, which is seen as a key threshold, but the hurdles to a leadership challenge are high. Lastly, Norway is not a G7 member, but it goes to the polls on September 13. Norway’s central bank remains confident that the economy has turned the corner and it reaffirmed its intention to hike rates when it meets 10 days after the election.
The Fed’s Jackson Hole confab has been a focal point of speculation looking for a hint of a tapering announcement since early this year. News that neither ECB’s Lagarde nor the BOE’s Bailey will be attending helps underscore the domestic emphasis. Indeed, it seems nearly binary: either Fed chief Powell suggests the central bank is nearing a tapering announcement or he doesn’t. The FOMC minutes from July leave little doubt about it. Most FOMC officials anticipate that tapering before the end of the year will be appropriate.
Powell has promised advanced warning to investors before changing the pace or composition of the Fed’s purchase. This is to minimize the chances of a market disruption like the “taper tantrum” of 2013. At the same time, strategically, it is important that the Fed maintains a maximum amount of flexibility. Given calendar considerations, and the fact that after the September meeting, the Fed has two more meetings, November and December, indicating in September that it will soon be ready to adjust its bond purchases maximizes the Fed’s room to adjust to incoming data, if necessary. That said, our idea that the burden has shifted from needing more and better data to barring a downside surprise the Fed will reduce its bond purchases appears confirmed by the July minutes.
Moreover, consider that at the June FOMC meeting, 7 of the 18 Fed officials saw a hike in 2022 as likely being appropriate. Given the two months of more than 900k growth in non-farm payrolls and other labor market indicators, like weekly jobless claims (new pandemic lows), it would not be surprising if a few more officials were swayed to push a 2023 hike into 2022. In order to do so, the bond-buying must have ended some time (a few months?) before the increase in rates.
Several Fed officials have suggested a quicker tapering than was the case last time, and some opined that it could be over around mid-2022. Assuming tapering begins in December, the average pace over seven months would be about $17 bln. However, officials will likely want to frontload it a bit to allow for a gradual conclusion.
The Fed funds futures strip has nearly priced in a hike at the September 2022 FOMC meeting. Again, recall that the contract settles at the average effective rate (weighted-average) of Fed funds during the month. Assuming that in the first 21 days of September, until the FOMC meeting concludes, the fed funds rate remains at its current effective average of 10 bp. Then, the Fed hikes the target 25 bp, and the effective rate averages 35 bp in the last nine days of the month. This produces an average of about 17.5 bp for the month. The September 2022 fed funds futures contract settled last week at 16 bp. By our calculations, the December 2022 contract has a 25 bp hike fully discounted and a very small chance of a second move by the end of next year, as two of the 18 Fed officials “dots” anticipated in June.
In the past, Fed officials have suggested they wanted the central bank’s balance sheet to only hold Treasuries, and some officials share our concern about buying mortgage-backed securities when the housing market is strong and house prices are rising at a record pace. This has spurred some speculation that the Fed could accelerate the tapering of MBS more than Treasuries. Powell himself played down the direct connection between the Fed’s purchases and house prices. The July minutes suggest that there is no majority favoring MBS tapering sooner or quicker than Treasuries.
Of course, some officials want to see another jobs report before feeling comfortable to take another step toward tapering. A week after the Jackson Hole confab, the Bureau of Labor Statistics will release the August employment report. The early call is for non-farm payrolls to rise by around 750k. Although slower than the last couple of months, it would still be regarded as strong. It would raise the three-month average to nearly 880k, the seventh consecutive month it would have accelerated. The average this year, through July, has been 617k. Other details, like a further drop in the un- and underemployment rates, would also make some officials more likely to support a formal tapering announcement next month.
Three emerging market central banks meet next week. Israel’s is first on August 23. Inflation is near 2% year-over-year and the base rate 10 bp. However, the central bank is under no pressure to hike rates. The surge in covid cases may temper growth which the central bank projects to be 5.5% this year. The shekel reached seven-month highs earlier this month and the central bank has indicated that the $30 bln intervention fund, announced in January, is nearly exhausted but that the central bank is not limited to it.
Hungary’s central bank meets on August 24 and this is little doubt that it will deliver another rate hike. The base rate has doubled this year to 1.2% in two moves (June and July). Another 30 bp hike is expected in August. Although CPI eased in July for the first time this year (4.6% year-over-year from 5.3% in June), it was primarily due to the base effect. In fact, the base effect works against further improvement in the coming months. After next week’s likely move, the central bank is expected to hike rates two more times this year.
South Korea’s central bank meets on August 26. The outcome is a closer call than the other two. The central bank governor has indicated intentions to raise rates this year. Inflation is above target, financial risks are perceived to be growing. However, the record covid wave is likely to encourage the central bank to wait for an opportunity in Q4. The market has one hike priced in over the next three months and two in the next six months. After falling to its lowest level since last September, the won began recovering in the middle of last week following the implicit threat by the finance ministry to intervene. The finance minister warned that the won overshot to the downside and officials were “closely monitoring” the market.
Bannockburn Global Forex