In the run-up to the Fed Powell’s Jackson Hole address, several regional Fed members highlighted the case for the Fed to start reducing asset purchases in the near future as they assessed that the conditions of substantial further progress toward the goals of maximum employment and price stability are met. The Fed chair took a more balanced, dovish approach. He agreed on inflation. Still he remained of the view that most of the current spike in inflation will likely prove temporary. On maximum employment he remains more cautious but agreed that, if the economy develops as expected, a reduction of asset purchases could start this year even as the spreading of the delta variant deserves further monitoring. Important for markets, the Fed Chair signaled a disconnect between the reduction of asset purchases and the start of raising policy rates :‘The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test’. Powell’s balanced approach convinced markets that monetary policy stimulation is here to stay for quite some time. US yields declined 2 bp for the 2-y, 5 bp for the 5-y and 4/3 bp at the longer end of the curve. Interesting, real yields again nosedived (10-y declined 8.75 bp). This also pressured the dollar. EUR/USD closed near 1.18. The Trade-weighted dollar (DXY) dropped to the 92.65 area and nears the 92.47 support area. The fallout from the decline in US yields on European interest rate markets was modest. German yields eased up to 1.5 bp for the 10-y. The prospect/hope that any reduction in policy normalization will develop in a gradual manner propelled the S&P (+0.88%) and the Nasdaq (+1.23%) to all-time record levels. European equities gained 0.25%-0.50%.
This morning, sentiment on Asian markets remains constructive, but gains are rather modest given the strong, Powell-inspired gains in the US on Friday. The dollar (EUR/USD 1.18) and US Treasuries maintain Friday’s losses.
Later today, the EC confidence data and German August inflation data will be published (expected at 3.40% Y/Y). They are a precursor for tomorrow’s EMU inflation which is expected to rise further north of 2.0% (2.7% for headline). An upward surprise might fuel the debate on the pace of ECB PEPP purchases going into next week’s ECB meeting. Later this week, the focus will turn to the US ISM’s and the labour market data. On interest rate markets, we look out whether some decoupling between the US and Germany/EMU can persist. The 1.38% area remains first strong resistance for the US 10-y yield. After Friday’s ‘correction’, the -0.40/-0.38% resistance for the German 10-y yield is still within reach. A similar reasoning applies to EUR/USD. Friday’s rebound was mainly USD weakness. However, strong German/EMU inflation might also support the single currency. A sustained break of 1.1805 would bring the 1.1909 correction high on the radar.
The National Hurricane Center said the category 4 storm Ida made landfall in Louisiana, near New Orleans. While the NHC later downgraded Ida, it still labels it an extremely life-threatening storm. Most of the city and other parts of the state have to deal with power outages. Ida pushed gas futures higher (+14% since Wednesday’s close), while the impact on oil prices remains limited for now even with 96% of the Gulf Coast area’s production down following evacuations of offshore platforms. That represents some 15% of total US output. West Texas Intermediate oil prices opened stronger around $69.5/b but are currently around $1 cheaper, trading again in line with Friday’s levels.
IMF chief economist Gopinath in an interview with the Financial Times warned that emerging markets cannot afford a situation where you have some sort of a tantrum of financial markets originating from the major central banks. Gopinath specially referred to the Fed’s plans to scale down net asset purchases soon. EM are specifically vulnerable with the pandemic still raging and higher inflation risking to feed into inflation expectations. Several of them already started hiking rates. Gopinath endorsed Powell’s efforts to separate the start of a hiking cycle from scaling down purchases. That way, tightening of dollar financing conditions and potential reversals of capital flows can hopefully be avoided as net purchases are dialed back towards zero.