EC September Market Commentary

The US dollar was driven to new highs for the year in recent weeks by a combination of another signal that the Federal Reserve was still on track to taper before the end of the year and concerns about global aggregate demand. The spread of the contagion has exacerbated the slowdown already seen in parts of Asia. China's efforts to curb steel output and recognition that the US infrastructure initiative may be smaller than expected were separate sources of pressure on industrial commodities. In addition, the partial closure of Chinese ports, and factory shutdowns in Vietnam and elsewhere, are disrupting supply chains. China's August Composite PMI fell below the 50 boom/bust level for the first time since February 2020.

Re-stocking could help moderate the slowdown projected as the fiscal and monetary stimulus in the high-income countries move past their peaks, pent-up demand is satiated, savings drawn down, and excesses from several quarters of rapid growth are unwound. While the US debt ceiling issue has not been resolved, some income support programs, including emergency federal unemployment compensation, end early September. Also, the UK's furlough program that absorbed part of the wage bill expires at the end of September.

The shortage of semiconductor chips continues to hobble the auto sector. Even some companies that had fared well in the early days are adversely impacted by the extended shortage. Volatile weather of floods, droughts, heat, fires, hurricanes, and tornados are additional exogenous shocks. In some areas, like Louisianna and Mississippi, hospital capacity to deal with disasters has been absorbed by the high cases of covid viruses. The UN's Intergovernmental Panel on Climate Change issued in early August warns climate change is proceeding faster than scientists previously projected. The Federal Reserve joined the Network of Central Banks and Supervisors for the Greening of the Financial System at the end of last year. More than 75 other central banks are members as well.

China's economy has slowed, and the PBOC responded in July with a cut in reserve requirements. However, it has not cut interest rates, and the market does not expect it to. Rather, another cut in reserve requirements is seen to be more likely in Q4. In addition, China's strong stance on issues that resonate among the high-income countries, from data collection and the power of some internet companies to the re-invigorated anti-trust, may be deterring domestic and international investors. However, it will take some time to determine whether it is tactical or what appears as capricious actions discourage asset managers and slow China's integration into the global capital markets. Early indications point to the former rather than the latter. 

In March, the ECB ratcheted its bond-buying efforts under the Pandemic Emergency Purchase Program and will review the decision at the September 9 meeting. More important than the amount purchased is its signals for its future course. Most likely, it can kick the decision to the December meeting. The PEPP is to run until the end of Q1 22. Without increasing the "envelop," it could extend the program. Stretching it out might offer a workable compromise with the more hawkish members while buying time to see the evolution of the virus, fiscal policy, and the economy. That said, news that the preliminary August CPI jumped to 3.0% may offer the hawks powerful ammunition. German inflation (3.4% year-over-year in August) is higher than the eurozone aggregate. Countries with less price pressures (e.g., Italy 2.6%) gain competitively over Germany.

The minutes from the July FOMC meeting confirmed that it can begin reducing its bond-buying by the end of the year, barring a new significant downside shock. Inflation is well above 2%, and nonfarm payroll growth has averaged 830k in the three months through July. Another 750k are expected to have been hired in August. At the conclusion of the FOMC meeting on September 22, the Summary of Economic Projections (dot plot) will be adjusted. In the June reiteration, only seven of the 18 Fed officials thought a hike in 2022 would be appropriate, and two thought two hikes might be. Judging from the Fed funds futures strip, the market has nearly priced in a hike at the September 2022 FOMC meeting but only has a small chance of more than one move next year.

Powell used his Jackson Hole speech to remind investors and businesses that there are different criteria for hiking than tapering. Officials want to avoid the market getting too far ahead and prematurely tightening financial conditions. On the other hand, around the same time as the Federal Reserve slows its bond purchases, the US Treasury will likely begin reducing its issuance, as the expenditures slow and revenues recover with the strengthening economy. Still, investors are aware that the previous attempts to reduce the Fed's balance sheet (2011, 2015, 2018) have coincided with a correction in stocks.

Several emerging market central banks will continue their monetary tightening cycle in the month ahead, including Russia, Brazil, and the Czech Republic. After hiking in July and August, the central bank of Mexico may pause. There are only a few central banks for which the next move is likely easier policy. It is clear that Turkey's Erodgan wants to see lower rates, but the central bank is holding off as inflation remains high. The August CPI report is due September 3. It needs to rise by less than it has any month this year if the year-over-year rate is to ease from July's 18.95%. 

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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