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Fed and ECB speak not showing much enthusiasm for policy easing anytime soon

20 May 2019Economics

Fed and ECB speak not showing much enthusiasm for policy easing anytime soon

  • Fed speak shows little enthusiasm for "insurance" rate cuts – (1) Fed's Kashkari (one of Fed's most dovish members) - is not ready to talk about cuts and adds: "we should wait, and I'm not in favor of cutting rates either as an insurance cut or because of some recent weakness in some of the data … There's a cost to us shifting our policy position around that much. I'm not sure that cutting rates would do much to inflation expectations"; (2) Fed's Brainard (also dovish) - Fed should take advantage of trade war inflation – ie look the other way if prices move higher. "For example, suppose that an unexpected increase in core import price inflation drove overall inflation modestly above 2.0% for a couple of years. The Federal Reserve could use that opportunity to communicate that a mild overshooting of inflation is consistent with our goals and to align policy with that statement. Such an approach could help demonstrate to the public that the Committee is serious about achieving its 2.0% objective on a sustained basis."
  • And neither is ECB speak – (1) ECB's Weidmann - there is "no need to postpone normalization if outlook allows". He also pours more cold water on tiering saying "net effect of tiering could be negative for banks" and once again warns about trade wars - "US auto tariffs would hit German carmakers hard"; (2) ECB's Coure adds to Weidmann's views on tiering - "If the fall in bank profitability becomes a problem for the transmission of monetary policy -- that is to say for the capacity of banks to lend to and stimulate the economy -- at that point it can become a problem for us. Today we don't think that is the case."

Strong US economic and earnings results helps drive stocks, yields and USD higher overnight

  • US data overnight – (1) April housing starts solid but outlook uncertain - rise to 1235k in April from 1168k in March while building permits increase to 1296k in April from 1288k. Housing starts show a solid bounce-back but building permits indicate that future prospects are somewhat more uncertain with single-family permits dropping to the lowest level since November 2016 and have fallen each month for the last 5 months. (2) The Philadelphia Fed Business Outlook for May sees a headline beat at 16.6 (vs 9.0 consensus) with shipments, prices paid and employment all higher while initial jobless claims for April are better than expected, coming in at 212k (vs 220k consensus).

Latest Brexit developments not encouraging for sterling

  • PM Theresa May and the 1922 Committee conclude their meeting overnight with headlines suggesting they have agreed to set a timetable for her departure in June after she puts her Brexit Withdrawal bill for a fourth (and final) Meaningful Vote in the week of June 3.
  • The leadership process is likely to take up much of the summer, with the goal of installing a new PM by the time of the Conservative Party Conference on September 29. Other headlines emerge at a similar time, confirming the worst kept secret in Brexit discussions – Boris Johnson (a hard line Brexiteer) confirms he will run for leader when PM May leaves office. COMMENT: The elevation of Boris Johnson as UK PM would likely be be bad news for sterling as it will significantly raise the odds of a "No Deal" Brexit in October.

Australia - labor market evidence supports a rate cut

  • Employment increases strongly in April…up 28.4k (and above Citi's 5k forecast and 15k consensus) though all part-time driven but still showing employers are adding jobs at a solid pace with the YoY employment change increasing from 2.4% to 2.6%, well above the long-run average of 1.9% over the forty year history of the monthly Labor Force series.
  • However, the rise in unemployment rate from a revised 5.1% in March to 5.2% in April and accompanying rise in underemployment from 8.7 to 9.0% suggests spare capacity in the labor market has increased…and this is what matters for monetary policy. For the RBA, the key phrase from last week's policy guidance on the labor market is "further improvement" – which is on employment but not on the unemployment rate, the most important single indicator the RBA uses to assess the labor market. Citi analysts think this makes the increase in the unemployment rate a necessary condition for a future rate cut though they continue to expect the RBA to cut 25bp in August (not in June). Note that Aussie rates are now pricing a 19bp of cut in June, with a further 18bp priced into August. Markets await a key note speech from RBA Governor Lowe next Tuesday.

China - slower growth and easing bias amid soft domestic momentum and renewed external headwind

  • Citi analysts now see material downside risk to their growth forecast for China and expect the government to step up policy efforts to support domestic demand. The earlier GDP forecast at 6.6%YoY was based on the assumption that a framework trade deal between the US and China would be reached in 2Q and would lift most existing punitive tariffs. Reassessing the trade headwinds and considering the still sluggish domestic demand, Citi analysts now see more downside risks to the previous forecast and expect a GDP growth ~6.4%YoY for 2019E.
  • However, the government is also likely recalibrate its policies with the PBoC expected to revert back to an easing bias with additional RRR cuts, broad-based or targeted, becoming more likely as are liquidity injections via OMOs and MLFs, although interest rate cuts are unlikely for now. On the fiscal front, targeted measures to stimulate auto and durable goods consumption may become a reality in 2H.
  • This is an extract from the Daily Currency Update, dated May 17, 2019. Please approach a Citigold Relationship Manager if you would like more information.

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