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- Central Bank Bonanza - A Preview
Central Bank Bonanza - A Preview
There is a lot going on in the second half of this week. FOMC, BOE, BOJ, all within a 15 hour period. Three hours later the OPEC (JMMC) meeting starts, and we have Quad-Witching option expiries on Friday. Let's start with the main event.
FOMC - Go Big or Go Home?The Fed laid out their new FAIT (Flexible Average Inflation Targeting) framework at Jackson Hole. Now, the market craves further direction. Powell committed to allowing inflation to run higher, and letting it stay there for longer before even thinking about (or thinking about thinking about) tightening. What we have not heard, is how the Fed plans to achieve this.
Massive QE & low interest rates have only ever achieved below target inflation levels.
So, what's going to be different this time? Well, they have added some new tools since the pandemic.
Investment Grade debt markets have fully priced in the Fed's assistance.
Even though the Fed have only bought ā$3.6bn under the PMCCF/SMCCF so far, Blackrock (and others) are saying they don't see much more upside.
BlackRock joins a chorus of investors saying the bulk of the rally in investment-grade debt is over. https://t.co/HxtFLyGXogā Lisa Abramowicz (@lisaabramowicz1) September 8, 2020
The Main Street Lending Facility has been pretty awful. Only $1.3bln has been lent.
But these aren't going to move the needle on the main objectives.
The market is fully justified in asking...What more can the Fed do?
Doing nothing really isn't a good option.
Aneta Markowska, chief economist at Jefferies LLC said;
āMaintaining a policy status quo in this context would be akin to throwing in a towel, which would undermine the credibility of the new framework right out of the gateā.
It's hard to argue with that logic.Although the Fed haven't always followed a logical approach...
Let's quickly recap the process;
Via @ChrisWeston_PS
The Fed buy bonds, which drives down real yields, weakening the USD and leads to higher inflation expectations. These factors combined should cause:- Commodity Appreciation.- Equity Appreciation.
Which should then lead to those elusive (average) inflation targets being met (and full employment).
That's the theory anyway.
Expectations for the September meeting
We know that inflation targets will no longer be 2%, and the Fed will instead aim for "inflation that averages 2% over time".So far the offical language surounding this has been vague, much to the frustration of some market participants.
Some Fed members did offer their interpretations before the blackout period.
Barkin summed it up best:
"it is a judgement, not a formula or a rule".
Pretty clear that anyone looking for a definitive definition will be disappointed. How about the employment factor?
Powell covered that in his Jackson Hole speech;
Similarly, when the economy is robust, high employment, in the absence of unwanted increases in inflation or the emergence of other risks that could impede the attainment of the Committee's goals, will not by itself be a cause for policy concern.
ABN Amro offer some extra detail:
In the past, with full faith in the power of the Philips curve, the Fed would raise interest rates when unemployment fell below the estimated ānaturalā rate of unemployment (or NAIRU).
The idea in doing this was to pre-empt an expected rise in inflation.
Now, acknowledging the significant flattening of the Philips curve ā and the high degree of uncertainty around NAIRU estimates ā the Fed promises not to tighten monetary policy pre-emptively on the back of a low unemployment rate alone, if other indicators suggest unemployment could continue to fall or remain low without significant inflationary consequences.
One day, all of this may become relevant.
For now, it might as well be printed on a motivational poster.
The Fed's biggest challenge (and main objective)
To raise inflation expectations.
Inflation is something of a self-fulfilling prophecy.
If people believe it's real, they will act accordingly (i.e. they buy things today because they believe they will be more expensive in the future).
At the end of August, Vice chair Clarida said;
āIf policy seeks only to return inflation to 2 percent following a downturn in which the ELB [effective lower bound] has constrained policy, an inflation-targeting monetary policy will tend to generate inflation that averages less than 2 percent, which, in turn, will tend to put persistent downward pressure on inflation expectations and, potentially, on available policy space.
So, how can the Fed raise inflation expectations?
What will make the market believe that inflation is coming this time?As the saying goes...
Don't worry. The motivational pictures won't become a theme...The Fed are running low on ammo and credibility now.
They can either be "just like the others" (at 0% and QE forever), or they can shock the markets into taking them seriously.
At this point, their credibility is so low that no-one is even considering them doing anything outside of the norm.
Markets do not expect a rate hike until at least 2024.
Goldman are looking at 2025. ABN Amro;
All in all, we judge a reasonable base case to be that rates stay on hold until 2025-27.
An optimistic scenario ā where inflation is sustained at 2.5% on average from 2022 ā could bring this forward to 2023-24.
However, a negative scenario where the Fed fails to get inflation above 2% on a sustained basis implies rates being pinned at the effective lower bound
indefinitely (a Japanisation scenario).
All of this assumes non-expansionary fiscal policy.
This is a key point.
What we are seeing here is that the Fed are essentially monetising debt.
They're funding the government through 'printing'.
Generally governments would issue debt to the market and investors would buy it.
But not anymore - your central bank is the best bid here...
This is one of the larger upside risks for inflation.
The BOJ did not monetise the Japanese government.
Perhaps this is how Japanification can be avoided?
If the Fed continue down this road, it could certainly encourage expansionary fiscal policy and stoke inflation.
However, the economy is outperforming the Fed's projections so far.
This table from GS already factors in the Fed's preference to underestimate their projections.
A number of Fed officials have recently stated that they prefer to wait for greater clarity about the outlook.
Goldman are more bullish on the economy than the estimates above.
If the Fed don't act now, then will the data continue to improve (and paint them into a corner)?
There is a high risk of market disappointment here, with no signifcant action or guidance before the next meeting in November.
If the market is not satisifed, the dollar should rally, especially against the higher beta currencies.
The focus will then switch to the fiscal stimulus bill and upcoming U.S. elections.
Right, onto the next central bank.
Bank Of England Preview
Nothing much is expected.
There will be a statement released, but no press conference.
Brexit tensions have recently come to the fore again, prompting some commentators to predict a response from the BOE.
With the government furlough scheme set to expire at the end of October, and a no-deal Brexit "looming", our base case is that the BOE stands pat at this meeting More QE?
The most recent tranche of Ā£100 billion was announced at the June meeting.
Year to date, QE announcements have totalled Ā£300bn, and around Ā£230bn has been bought so far.
The BoE is expected to enlarge its QE programme by a further 100 billion pounds in November, however.
Negative Rates?
Not yet.
Interest rate futures have priced in a 10bp Bank Rate cut to zero by year end, and are moving to price in negative rates by February next year.
In summary, this meeting is more likely to be a signalling exercise, setting the scene for further action in November. It is also worth monitoring any update to the projections from the last meeting.
As ING noted;
Unemployment is likely to grow through the autumn, and potentially more than the central bank's forecasts back in August (7.5%).
Exactly where the jobless rate peaks will in large part depend on whether the Treasury adds targeted support to industries that are still unable to open due to Covid-19.
The implication is that the economy is likely to take longer to recover than the Bank had previously anticipated.
We think it may not be until late-2022 or beyond until all of the lost output has been regained.
The BoEās August forecasts assume this would happen by the end of 2021.
The UK treasury is working on something to offer targeted support for the worst affected industries, and get people back into work.
It is hard to envisage the BOE making any drastic policy decisions before November.
BOJ Preview
There's never really much to say about the BOJ meetings. No change is expected, and they will continue buying pretty much everything they can.
They may slightly upgrade their forecasts but that doesn't change much.
What will be far more interesting is any hints towards further blurring of the lines between between government & the central bank.
The BOJ is mandated by law to achieve price and financial system stability, but does not have a target on jobs growth as the U.S. Federal Reserve does.
As the pandemic crushes the economy, however, the BOJ has already detached its policy moves from the price goal.
Deputy Governor Masazumi Wakatabe said earlier this month the BOJ may need to focus more on jobs in guiding policy.
Kuroda is likely to reiterate the BOJās resolve to work hand-in-hand with the government in cushioning the economic blow from the pandemic with a huge dose of fiscal and monetary support.
But there is uncertainty on how long the honeymoon will last with a dearth of policy tools seen binding the BOJās hands if it comes under renewed pressure to ramp up stimulus, analysts say.
āHaving played the firefighter role as Abeās chief cabinet secretary, Suga may pressure the BOJ to ease if the yen spikesā and hurts Japanās export-reliant economy, said Ryutaro Kono, chief Japan economist at BNP Paribas.
āBut the BOJ will find it hard to cut interest rates as that would hurt regional banks and risk triggering a credit crunch.ā
The mounting cost of battling the pandemic may also force the BOJ to gobble up more government bonds, pushing it closer to debt monetisation and putting its independence on the line.
āIf the government keeps spending at the current pace, Japan may soon face the question of how to sustainably finance its huge fiscal deficit,ā said Yasuhide Yajima, chief economist at NLI Research Institute. āThat may test the BOJās now cozy relationship with the government.ā
New PM Suga has stated that there is "no limit" to the amount of bonds the government can issue.
BOJ's "Uber-Dove" Kataoka has been a lone dissenter to the BOJās decisions to maintain its interest rate targets. He argues that rate cuts are needed to pre-empt rising deflationary pressure.
There is no support for his stance at present.
OPEC+ JMMC Meeting
It's a pretty bleak outlook for oil at the moment.
Earlier this week, the IEA revised down its forecast for global oil demand in 2020 by 200,000 barrels per day and noted that a draw on abundant oil stocks in June (after three months of builds) had faltered in July.
OPEC also cut its outlook for demand in 2020 by 400,000 bpd from its previous report, saying world oil demand would fall by 9.46 million bpd this year.
OPEC+ meetings are always littered with sources. I'll C&P some recent "sourced" comments via Reuters here;
OPEC and allies such as Russia are unlikely to announce further curbs to oil output this week despite a price drop, sources told Reuters, and will extend the period for countries like Iraq and Nigeria to compensate for earlier overproduction.
OPEC and allies, a group known as OPEC+, have been reducing production since May to support oil prices after global demand plunged in the wake of the coronavirus pandemic.
In the latest round of cuts, OPEC+ has been reducing output by 7.7 million barrels per day or around 8% of global demand, while asking Iraq and others to pump below their quota in September to compensate for overproduction in May to July.
Three OPEC+ sources said the group will likely extend the compensation period into October and November to allow Iraq and others to catch up with their targets.
Five OPEC+ sources said a virtual meeting on Thursday, known as the joint ministerial monitoring committee (JMMC), was also unlikely to recommend changing output targets despite Brent prices falling below $40 per barrel in recent days.
āI hope this is short lived. The market may have been overreacting in the past few days,ā one OPEC delegate said.
Compliance with oil production cuts in August among OPEC+ members was seen at around 101%, two OPEC+ sources told Reuters on Wednesday.
Likewise, hedge funds (and speculators) have been reducing their long positions.
Yesterday's larger than expected private inventory draws, and production shut ins caused by recent hurricanes have put a floor under oil prices for now.
As long as members remain committed to production cuts, oil prices should remain stable at these levels, and continue to push higher once demand recovers.
Until then, it's hard to see oil pushing too much higher, and there is always a risk of producers entering into price wars to secure market share.
This is a good summary from Samir.
#OOTT My read of the oil market right now
- COVID is making a new small wave
- India sees rising COVID cases. This impedes imports
- Global refinery runs are still well off target
- Jet fuel & gasoline demand picking up
- OPEC+ production not much of a concern but USA still isā Sam (@Samir_Madani) September 10, 2020
I also believe that if we make it through the ungodly episode called 2020, there's no stopping us in 2021 as spring will see a greater deal of optimism and consumption.
A vaccine may be a lot closer by then, but the real key to oil consumption is physical distancing.
Thank you.ā Sam (@Samir_Madani) September 10, 2020
...and to round things off
Quad Witching Friday
Quadruple witching refers to the once-a-quarter date when stock index futures, stock index options, stock options, and single stock futures expire.
The event occurs on the third Friday of the final month of the quarter, so March, June, September and December, and typically brings increased volumes as traders close out positions or roll them over.
Here's Bloombergās Dani Burger explaining this in June last year.
