With the FOMC fast approaching, will there be a party?
Week Commencing Monday 7th September 2015
Overriding Market Themes
We start this week with the US, where payroll growth slowed in August as employers created 173,000 jobs, pushing the unemployment rate from 5.3 percent to 5.1 percent. Diving into the figures, businesses added 140,000 jobs last month, fuelled by a strong advance in both health, professional, business and leisure sectors. The government also saw the creation of 33,000 new jobs on both a federal and local level. Wage growth was also generally positive, with average earnings rising by 8 cent to an average USD 25.09 after initially dropping in June. This is all good news for the Federal Reserve which is seeking signs of faster wage growth that would indicate stronger inflation as it considers increasing its benchmark interest rate. Indeed, the report is the most significant the Fed will review before its September 16th meeting, where until recent market forces have suggested otherwise most pundits were expecting their first rate hike. Will the Fed hike? We now think this is unlikely, especially given the Chinese Yuan devaluation and the perceived strength of the US Dollar. That said, crazier things have happened!
Moving to Europe now, and the European Central Bank cut its growth and inflation forecasts on Thursday, warning of further trouble from China and paving the way for an expansion of its already huge 1 trillion EUR quantitative easing program. The new projections are a bitter pill to swallow, especially given it is signalling that the European recovery is hardly gaining momentum. Adding to uncertainty, the bank also said the forecasts were made in the first half of August. The worst of China's market volatility and the drop in oil prices came later, so the figures may still well be too optimistic. For the first time since the program’s inception, Mario Draghi signalled that the bond buying program may run beyond the September 2016, and the bank may adjust the size and scope of the program. The ECB now sees GDP in the euro zone growing 1.4 percent this year, below its previous 1.5 percent projection. The forecast for 2017 was cut to 1.8 percent from 2.0 percent.
Finally and moving back to home soil, Services growth expanded at its slowest rate for two years last week in another sign that the UK economy is losing some momentum. The PMI index of services activity dropped to a 27-month low of 55.6 from 57.4 in July. The fall in confidence was blamed by most market pundits on continued world markets and a harder landing in the world’s second largest economy, China. Sterling suffered on the back of the release, pushing Cable down to lows not seen for most of the year. The drop does however take some of the pressure off the Bank of England, as a slower pace of expansion across the economy naturally pushes back interest rate expectations in the near future. The bank had been signalling that it is ready to begin raising rates for the first time since 2007 by next February, a move which now appears to be delayed until at least the summer of 2016.
GBP This Week
Sterling has been one of the poorest performing G10 currencies since the Bank of England 6th August Inflation Report. The currency has depreciated about 2 percent against the USD and 3.6 percent against the EUR, with only the NZD and AUD weakening more. The combination of a relatively dovish inflation report, coupled with concerns about Chinese growth has and will continue to lead to a substantial repricing of the banks interest rate hiking path. In terms of data, July’s industrial production release on Wednesday should also weigh on the GBP, as we expect IP to drop 0.2% month on month (leading to a annual increase of a mere 1.0 percent), versus the consensus forecast of +0.1% month on month.
USD This Week
We expect the Dollar to consolidate at its current levels in the week ahead, especially give we do not have a huge swath of data expected to be released before the September FOMC meeting. The market is pricing a rough 30 percent chance of a rate hike, and given these probabilities we do expect some moderate downside risks to persist.
In terms of this week’s data, the University of Michigan’s consumer confidence number is expected to be released on Friday, where we are projecting a drop from 91.9 to 91.0.
EUR This Week
Again, we have a quiet week ahead for the Euro, allowing the markets more time to digest the prospect for further ECB quantitative easing. As discussed above, the ECB opened the door to a potential expansion of the program, which in the medium to long term should act as a EUR drag given the inherent supply and demand issues with asset purchase programs in general. As such, we expect further material EUR depreciation and recommend EUR sellers take advantage of current rates on GBP/EUR, especially in the near term.
In terms of data releases, we expect the consensus for final Q2 euro area GDP on Tuesday to be confirmed in at 0.3 percent for the quarter.