The US dollar is mostly consolidating the losses suffered yesterday at the hands of a Fed-watching journalist opining that the Federal Reserve is likely to continue to reference a "continued time" in terms of low rates following the end of QE. That journalist, John Hilsenrath, allows however for some modification of it.
This is consistent with our argument that plays down the sense of urgency that many observers have expressed. Moreover, we also suggest that, as was the case in March, whatever tweaks in the language that do take place, Yellen is still likely to underscore in her press conference that it does not reflect a change in the Fed's intentions.
We also link the "considerable time" reference to the Fed's assessment of "significant under-utilization" in the labor market. We warn of the risk that the improvement in the labor market slows. The weekly initial jobless claims put in the cyclical low nearly two months ago. Non-farm payrolls themselves peaked in April (304k) and have been down two consecutive months (July and August). While it is well-appreciated that August's initial estimate is often revised higher, what is less well recognized is that in six of the past nine years, jobs growth in September is lower than in August.
The Federal Reserve provides updated forecasts, and will extend them into 2017 for the first time. We do not expect significant changes in the macro forecasts. The Federal Reserve has consistently under-estimated the improvement in the unemployment rate, which is likely to be tweaked lower. The 2017 forecasts are likely to reflect the Fed's medium term targets, though it is interesting to note that the Fed's tightening cycle, which we still expect to begin mid-2015, is expected to be finish with the Fed funds rate a little above 3% mid-2017, according to a news poll from before Jackson Hole in late-August.
While the FOMC statement, forecasts and press conference could pose headline risk, we do not expect it to change expectations very much going forward regarding the timing or magnitude of Fed tightening. Given tomorrow's Scottish vote, the ECB's TLTRO and the SNB meeting the price action may be contained, though given the extent long dollar positioning by the short-term market, the pain trade remains a weaker dollar.
Before the FOMC meeting the US will report August CPI figures and the Q2 current account. Headline inflation is expected to be flat, while the 0.2% rise in the core rate will keep the year-over-year rate steady at 1.9%. The current account deficit is expected to have widened slightly to about $113.5 bln (from $111.2 bln in Q1). These reports typically are not the stuff that moves the foreign exchange market.
More broadly speaking, bond and stock markets are mostly higher. The Nikkei is an exception as it posted a minor loss. Hong Kong and China's markets advanced, helped by the PBOC's injection of liquidity provision to large banks that is roughly the equivalent to a 50 bp cut in required reserves. Although observers called this a form of quantitative easing, we see three factors motivating the use of standby facilities: weak data and softer inflation, the national holiday the first week in October, in advance of which it typically provides liquidity, and a large IPO pipeline (reports of around 10 offering next week), which drains liquidity.
The Dow Jones STOXX 600 has not recorded a higher close since since September 4. That streak is set to be broken today. The index gapped higher as European shares responded to the late US rally yesterday. Telecoms and information technology are leading the advance that has lifted all 10 sectors. The 0.8% advance in the MSCI Emerging Markets equity index also snaped a nine day losing streak.
There were two macro-news stories today. The first is the UK employment data and MPC minutes. There were no surprises in the latter as Weale and McCafferty, external members of the MPC, dissented again in favor of an immediate hike. They warn that the low inflation reads are the transitory effect of a strong currency. We continue to think a Q1 '15 rate hike is the most likely scenario. The employment report was a bit stronger than expected. The claimant count fell 37.2k. The consensus was looking at a 30k decline and July was revised to show a greater decline than initially estimated. The ILO measure of unemployment slipped to 6.2% from 6.4%.
Average weekly earnings rose 0.6% in the 3-months year-over-year through July. It was negative in June. Despite the nominal improvement, in real terms (adjusted for inflation) earnings are still falling. Another metric that will get scrutinized by economists is the dramatic slowing of the employment increase from 167k in June (three-months-over-three-months) to 74k (consensus was 120k). This is the lowest since June 2013 and is the third consecutive decline.
Sterling staged an outside up day yesterday, trading on both sides of Monday's trading range and than closing above Monday's high. It managed to fill the gap created by the sharply lower opening on Sept 8, after the YouGov poll showed the independents in Scotland with a slight lead. Sterling is going into the referendum at an eight-day high. We has suggested potential toward $1.65-$1.66 on a "no" vote. Although many observers play up the risk of a Quebec-like situation where a small rejection of independence does not provide investors with much closure, we are not convinced history will be repeated in Scotland. Scottish independence leaders have repeatedly argued that this is a once-a-generation opportunity.
The other macro development was Sweden's Riksbank minutes. They were a bit more dovish than anticipated and the krona has under-performed as result. Governor Ingves seems increasingly marginalized after having been outvoted in favor of a 50 bp cut recently. His deputy, who had sided with him, has defected and now says that the repo rate may need to stay low for longer than currently implied in the central bank path.
Lastly, we note that the French government barely survived a vote of confidence yesterday. The challenges for the government are likely to intensify. The immediate focus is on Hollande's press conference tomorrow. Then on Friday, Moody's is due to update its credit ratings for the country. The risks of a downgrade, which would match the S&P rating, have increased. The 2015 budget is the next major political battle. Large asset managers, including reserve managers, continue to see French bonds has higher yielding bunds, but in recent days the French debt market has under-performed. France's 2-Year yield is the only core euro area country that offers a positive nominal yield.