Risk Appetite Ebbs Ahead of BOE Decision

The FOMC delivered no surprises. Policy settings were kept unchanged, as expected. Powell stressed that the Fed is not out of ammo and that there is plenty more it can do to stimulate the economy. He stressed that the Fed is prepared to adjust its asset purchases as appropriate. He admitted that its Main Street Lending Program needs tweaking to make loans more available, adding that it can be scaled up if appropriate. Powell said that more fiscal support is likely to be needed and that Fed officials expect it.

The Fed updated its forward guidance to incorporate its new policy framework. “The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.” This is about as explicit as outcome-based forward guidance can get and yet it still leaves the Fed with a lot of wiggle room. The phrases “moderately exceed” for “some time” are suitably vague and so it’s not a mechanical Taylor Rule by any stretch. That’s good news, in our view.

The Fed released its updated Summary of Economic Projections.  2023 was added to the forecast horizon and the Dot Plots see steady policy for another year. Growth forecasts were also updated and are pretty much in line with OECD forecasts released earlier today. Of note, the new projections see core PCE at 2% in 2023. We think that’s way too aggressive and risks hurting the Fed’s credibility on the new framework before it even gets started. Think about the BOJ, who has to keep pushing out its timeframe for hitting its 2% target year in and year out. The only thing we can think of is that the forecast is meant to portray the new framework. That is, the Fed is saying it won’t hike in 2023 even though it sees inflation hitting the target that same year.

US Curve, Breakevens, Real Yields, 2020

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It’s worth noting that August retail sales disappointed yesterday.  Headline sales rose 0.6% m/m vs.1.0% expected and a revised 0.9% (was 1.2%) in July, while ex-autos rose 0.7% m/m vs. 1.0% expected and a revised 1.3% (was 1.9%) in July.  The so-called control group used to calculate GDP fell -0.1% m/m vs. an expected gain of 0.3% and a revised 0.9% (was 1.4%) in July.  With enhanced jobless benefits running out in July, this really can’t be a huge surprise and is likely the beginning of the weakness that we’ve been warning about. Enhanced benefits extended by executive order in August are starting to run out now. Consumption makes up two thirds of the US economy.

Fed manufacturing surveys for September will continue to roll out.  Philly Fed business outlook is expected at 15.0 vs. 17.2 in August.  Empire survey was reported Tuesday and came in at 17.0 vs. 6.9 expected and 3.7 in August.  These are the first snapshots for September and will help set the tone for other manufacturing data.  August IP was also reported Tuesday and rose 0.4% m/m vs. 1.0% expected and a revised 3.5% (was 3.0%) in July. August building permits and housing starts (+2.0% m/m and -0.9% m/m expected, respectively) will be also reported today.

Weekly jobless claims will be reported.  Initial claims are expected at 850k vs. 884k the previous week, while continuing claims are expected at 13.0 mln vs. 13.385 mln the previous week.  Adding regular and PUA initial claims shows nearly 2 mln are newly filing for unemployment every week and that’s not so good.  Similarly, regular continuing claims have stabilized around 13 mln but PUA continuing claims have risen sharply to almost 15 mln, the highest ever.  The total of the two is approaching 28 mln and also points to trouble.  The August jobs data were solid, but the 1.371 mln jobs gain continues the sequential loss of momentum seen across most US economic indicators.

Brazil central bank left rates unchanged at 2.0% but introduced some additional dovish guidance. The bank said that it “does not intend to reduce the monetary stimulus unless inflation expectations, as well as its baseline scenario inflation projections, are sufficiently close to the inflation target.” It also sees the current rise in inflation as temporary. The communique reaffirmed the bank is not in any rush to hike rates, while also making it clear that “the remaining space for monetary policy stimulus, if it exists, should be small.” It also made it clear that fiscal trajectory will be a key variable for any adjustment to the current level of stimulus – as it should be. The bank has delivered 450 bp of cuts since mid-2019, on top of the previous cycle of 775 bp of cuts between late 2016 and 2018. The yield curve continued to steepen with rates rising as much as 10 bp yesterday.

Brazil CB Rate and Inflation, 2015-2020

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The Bank of Japan left its policy settings unchanged but upgraded its economic assessment. The bank said the economy “has started to pick up with economic activity resuming gradually,” though adding conditions remain severe vs. what it described as “extremely severe” previously. Despite recognizing the recovery, it’s pretty clear that the BOJ will keep on the current policy track until the 2% comes into sight. According to its July forecasts, that target won’t be reached until well after FY2022 (where it sees inflation at 0.7%). The bank will release updated macro forecasts at the next meeting October 29.

The bank reiterated that the focus now will remain on working with the government to ensure the private sector continues to rebound. At this point, the bank is letting fiscal stimulus carry the load and so we are in a wait and see period in terms of monetary policy.  Indeed, we suspect that incoming Prime Minister Suga will look to shore up his credentials with another round of fiscal stimulus before year-end. We note that the yen tends to gain on BOJ decision days. Of the six held this year before today, it has gained on four of them and now looks to tack on a fifth. UDF/JPY is trading at the lowest level since July 31 and is on track to test that day’s low near 104.20.

EM FX YTD Performance, 2020

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Bank Indonesia kept rates on hold at 4.0%, as expected. Perhaps the most interesting development was the Governor Warjiyo’s defense of the bank’s independence, amid political pressure to change its mandate (please see our recent report on EM Central Bank independence). We now believe that the threat to the bank’s credibility, along with the recent depreciation of the rupiah, raises the bar for any further easing by the BI. Local assets were little changed.