Drivers in the Week Ahead
There are seven items that will be on the radar screen of global investors in the week ahead.
1. There is confusion over Fed policy. Despite the leadership (Bernanke, Yellen and Dudley) demonstrating their unwavering commitment to use heterodox monetary policy in an attempt to promote a stronger economy in the face of household de-leveraging and fiscal consolidation, many have read the FOMC minutes to imply an early end to the $85 bln a month in long-term asset (MBS and Treasuries). That December meeting was historic not because it marked the beginning of the end of QE, but the exact opposite, the nearly doubling monthly purchases and the adoption of macro-economic guidance (6.5% unemployment and 2.5% inflation) before rates are lifted.
2. A few elements of the recent price action strikes us as important: The euro, Swiss franc, and sterling bounced off key trend line supports and this points to further recovery gains are the sharp decline seen in the first few days of the new year. The yen remains on a weakening trend. Japanese government encouragement may slow when the dollar nears JPY90. The dollar-bloc currencies and many of the more liquid and freely accessible emerging market currencies, including the Mexican peso, South African rand and the Turkish lira, also appear poised to trade higher against the US dollar. The VIX posted an unprecedented large decline last week and the S&P 500 closed at new 5-year highs. The higher risk appetites have also weighed on core bonds and lifted the European peripheral bonds, especially Italy and Spain. This in turn tends to be positive for their financial sectors. It also reduces the pressure on Spain to seek a formal aid package from the EU and trigger the ECB's Outright Market Transaction program.
3. The ECB meets on Thursday. According to reports, a majority of the governing council favored a cut in December. The unchanged outcome was a function of a concession to the Draghi and the German representatives, according to the same reports. With the PMI readings pointing to a continued contraction, and private sector lending contracting for three months, it is tempting to expect the ECB to cut the refi rate by 25 bp. However, we suspect the ECB will stand pat again. The weak economic data was largely within ECB expectations and price pressures appear to have increased into the year-end period. If the regional economic data does not improve substantially, a rate cut in the coming months possible.
4. The Bank of England meets on Thursday. It is less likely than the ECB to change rates or announce a new gilt purchase program. The BOE seems content to monitor the progress of the Funding-for-Lending Scheme (FLS), which appears to have boosted some mortgage lending. More interesting on Thursday will be the National Statisticians recommendation for changes in the the Retail Price Index. Like the US, the UK is considering changing the inflation calculation used with an eye toward lowing government obligations (in the US case Social Security benefits and in the UK inflation-link bonds and some pensions).
5. The immediate focus in Japan is on monetary policy. The BOJ meets Jan 21-22. It is to review the 1% inflation target it adopted a little less than a year ago. The government hopes it will raise it to 2%. In fact, as ironic as it may seem, the BOJ can preserve its relative independence by capitulating to the government's demands in some form. This will mean the government is less likely to change the BOJ's charter. Sometimes losing a battle allows one to win a war. The BOJ will participate in a meeting the government is hosting this week to begin coordinating its policy response to what is sees as a economic emergency. The Council of Economics and Fiscal Policy will likely discuss ways finally overcome the 15-year old scourge of deflation. Late in the week, Japan is expected to report a November trade deficit, but an overall current account surplus.
6. China's monthly data dump begins in the second half of the week. On balance, we expect more evidence that the world's second largest economy has stopped slowing, even if the lift is still modest. Renminbi loans may have increased slightly in December from November's almost CNY523 bln pace. An increase in both exports and imports would also lend credence to ideas that there is an underlying improvement taking place. A CPI around November's 2% would maximize the official room to maneuver.
7. Highlights from the other emerging markets include a likely 25 bp rate hike by Poland's central bank. Thailand and South Korea's central bank also meet in the week ahead, but on balance, no change in official rates are expected. Indonesia's central bank meets and it may narrow the rate corridor by lifting the floor (FASB) 25 bp to 4.25%, but keeping the key rate steady at 5.75%. Lastly, while we noted the expectation for improved Chinese imports and exports, India does not look as fortunate. The fall in India's exports and imports will likely result in a larger trade deficit.
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