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The event we’ve all been waiting for

Jackson Hole has been heavily discussed since the Fed’s supposed “dovish pivot” last month when it adopted a more data-dependent stance. While policymakers have pushed back against the idea of a pivot, markets have continued to price in a slower path of tightening.

Chair Jerome Powell could use his platform next week to join the chorus of policymakers highlighting the need for ongoing aggressive tightening, continuing the push back against the market narrative. But will he do that? The CPI data for July may allow for a softer approach, although it could be argued to be counterproductive given how high inflation still is and how much work there remains to do.

As ever with these events, it won’t take much to excite investors. Any hint at all that the central bank could be tempted to take its foot off the break, that inflation has peaked and will fall back towards target could be enough to fuel more optimism in the markets. The question is what happens if there is no pivot? Will investors be as open to a hawkish Powell as they will a dovish one?

US

The main event of the week will be the Jackson Hole Symposium.  The annual global central banking conference will feature Fed Chair Powell’s speech which may give some insight into how aggressive the Fed will be with tightening in September.  Many traders will remember Powell’s 2021 address which clearly showed him tripling down on his view that inflation was transitory.

Powell will reiterate the message that the economy still has forward momentum and that they are nearing the end of tightening. He may also try to drive the point that after they are done tightening, the Fed will keep rates steady for a while until inflation has clearly returned closer to target.

A wrath of economic data will be released, with the two big ones being the flash PMI readings and the second look at Q2 GDP.  Friday will be busy with the Fed’s preferred inflation gauge, and personal income data for July that is expected to remain steady while spending slows.

Election season continues with US primary elections in Florida and New York.

EU 

Economic data in focus next week, with surveys among the highlights as flash PMIs, GfK and Ifo are released. Europe is likely heading for recession and the surveys will tell us how fearful businesses in the bloc are ahead of what could be a troubling winter on the energy front. On that, energy will be a key focus as it will throughout the winter.

The ECB meeting accounts will also be in focus as traders fully price in a 50 basis point hike next month. Appearances from policymakers will also be closely followed, as ever.

UK 

Flash PMIs are the only releases of note next week while any commentary from BoE policymakers will also be closely monitored. Markets are currently pricing a strong chance of a 50 basis point rate hike next month although there is now an outside chance of 75.

Russia

Just industrial production data next week as traders weigh up how low rates are going to go. They’ve had little impact on the currency so far which remains more than 20% higher since the invasion.

South Africa

The SARB is in the midst of an aggressive tightening cycle and inflation data next week may shed some light on how much more is needed. The CPI number is expected to rise from 7.4% to 7.8%, well above its target range of 3-6%, while the core reading is expected to tick higher to 4.5% from 4.4%. Meanwhile, the unemployment rate is expected to rise from 34.5% to 35.7%.

Turkey

When inflation is running close to 80%, a bad policy move from the CBRT would ordinarily have been not raising interest rates, and aggressively at that. Naturally, that wasn’t enough for it even under these extreme economic conditions, so they instead cut rates by 100 basis points to 13% at their August meeting. In doing so, they caught forecasters everywhere off guard, despite none expecting them to do anything sensible in the first place. It takes something special for the CBRT to underperform even the lowest of expectations.

Switzerland

No data or scheduled appearances next week. We can never discount the possibility of a surprise rate hike given the SNB’s history of policy shocks.

China

On August 15, China’s central bank cut the one-year medium-term lending facility (MLF) and reverse repo rates by 10 basis points to 2.75% and 2.00%, respectively. This should lead to a reduction in the 1 and 5-year loan prime rates early next week.

China’s second-quarter GDP recorded positive growth of 0.4%, but the high cost of its zero-Covid policy and real estate bad debt may continue to limit China’s economic growth.

India

No major data or events next week.

Australia & New Zealand

The Australian and New Zealand dollars fell following the recent release of disappointing Chinese economic data for July. Australia and New Zealand’s largest export market is China, so the weak performance of Chinese economic data may be reflected in the trade data.  With inflationary pressures, the RBA may continue its hawkish pace of rate hikes, with the market widely expecting a 50 basis point hike to 2.35% at the September rate meeting, on top of the current rate of 1.85%. The short-term risks are the Fed, the recent fall in commodity prices and the weak Chinese economy. PMIs in focus next week.

On August 17, the RBNZ met market expectations to raise interest rates by 50 basis points to 3.00%, the fourth consecutive rate hike this round. Next up is retail sales on Wednesday.

Japan

The Federal Reserve and the Bank of Japan’s monetary policy divergence continue to support the dollar’s strength against the yen. Events at Jackson Hole could further exacerbate these pressures or perhaps even alleviate them depending on how much the Chairman pushes back against the “dovish pivot” narrative.

BOJ Governor, Haruhiko Kuroda has previously said there is no consideration at all for a rate hike and no plans to extend the upper range of the yield curve control (YCC) of 0.25%.

Singapore

CPI and manufacturing data are in focus next week.

Economic Calendar

Saturday, Aug. 20

Economic Events

• Some UK trains are expected to be cancelled amid strikes by the National Union of Rail, Maritime and Transport Workers
• Italian politicians attend the annual Rimini meeting

Sunday, Aug. 21

Economic Events

• Singapore PM Lee Hsien Loong gives a National Day Rally speech
• German Chancellor Scholz due to speak
• Port workers at Felixstowe in the UK begin an eight-day strike

Monday, Aug. 22

Economic Data/Events

• China loan prime rates
• Taiwan unemployment, export orders
• UK Foreign Secretary Truss and former Chancellor Sunak hold hustings in Birmingham
• German Chancellor Scholz to meet PM Trudeau in Canada
• Austrian Chancellor Nehammer speaks about “The New Europe” at the Alpbach Forum

Tuesday, Aug. 23

Economic Data/Events

• US new home sales, Flash PMIs
• Australia Flash PMIs
• Eurozone Flash PMIs, consumer confidence
• Germany Flash PMIs
• Japan Prelim PMIs, department store sales
• Mexico international reserves
• Singapore CPI
• South Africa unemployment
• Thailand Bloomberg economic survey
• UK Flash PMIs
• Minneapolis Fed President Kashkari speaks at Wharton Minnesota Alumni Club
• ECB’s Panetta speaks at the Annual Congress of the European Economic Association at Bocconi University in Milan
• German Finance Minister Lindner speaks in Switzerland
• US primary elections in Florida and New York

Wednesday, Aug. 24

Economic Data/Events

• US durable goods, MBA mortgage applications, pending home sales
• Japan machine tool orders
• Mexico bi-weekly CPI
• Russia industrial production
• South Africa CPI
• Thailand trade
• EIA crude oil inventory report
• Riksbank Deputy Governor Floden speaks
• French President Emmanuel Macron has his first cabinet meeting after the summer break
• Italian caretaker Prime Minister Mario Draghi attends Rimini meeting

Thursday, Aug. 25

Economic Data/Events

• Kansas City Fed hosts its annual economic policy symposium in Jackson Hole, Wyoming
• US GDP, initial jobless claims
• Germany GDP, IFO business climate
• Japan PPI
• Mexico GDP
• New Zealand retail sales
• ECB publishes an account of its July policy meeting
• Bank of Japan board member Nakamura speaks in Fukuoka, Japan
• Bank of Finland’s Valimaki speaks about the European economy and monetary policy

Friday, Aug. 26

Economic Data/Events

• Fed Chair Powell speaks at Jackson Hole
• US consumer income, wholesale inventories, University of Michigan consumer sentiment
• France consumer confidence
• Italy consumer confidence
• Japan Tokyo CPI
• Mexico trade
• New Zealand consumer confidence
• Singapore industrial production
• Thailand forward contracts, foreign reserves, manufacturing index, capacity utilization
• UK energy regulator Ofgem announces new energy price cap for households

Sovereign Rating Updates

• Austria (S&P)
• Denmark (S&P)
• Belgium (Moody’s)
• Portugal (DBRS)

Summary

United States: Expansion Not Yet Heading to the Gallows

• An increase in real retail sales by our estimates and a rebound in industrial production in July offered evidence beyond recent jobs data that the U.S. economy is not yet in a recession. That said, with new orders in the manufacturing sector slowing sharply and housing activity continuing to tumble, data this week did little to change our view that a downturn in the coming quarters will be hard to avoid.
• Next week: New Home Sales (Tue), Durable Goods (Wed), Personal Income & Spending (Fri)

International: Diverging Paths for Inflation in Canada and U.K.

• Headline inflation in Canada may be showing signs of cooling down. Overall CPI decelerated to a 7.6% year-over-year pace in July, driven by falling gasoline and energy prices. While inflation in Canada may have peaked in July, price pressures in the U.K. have not yet abated. Headline inflation surprised to the upside, reaching 10.1% year-over-year. We expect U.K. inflation to remain elevated for longer, as another sizable increase in electricity prices is planned for October.
• Next week: U.K. PMIs (Tue), Eurozone PMIs (Tue), South Africa CPI (Wed)

Interest Rate Watch: The Fed Still Has More Work to Do

• We continue to look for the Fed to hike the federal funds rate another 75 bps at its September 20-21 FOMC meeting and to follow that up with a 50 bps hike in early November and a 25 bps hike in December. After that, we believe the Fed will take a break and see how the rate hikes it has implemented so far affect the broader economy.

Topic of the Week: China's Renewed Slowdown Prompts Surprise Rate Cut

• The combination of COVID containment policies and a struggling property sector has led us to revise our annual GDP forecast consistently lower over the course of this year, and as of now, we believe China's economy will grow a little above 3%. We also believe risks are tilted toward even slower growth than we forecast, and July activity data released over the past few weeks reinforces that view.

Full report here.

Who will save the global economy if the main engine of global economic growth, China, is slowing down? As growth in major global economies slows a result of high inflation, many hoped that China would come to the world's rescue.

Unfortunately, China is also suffering from its problems. To everyone's shock, the Chinese economy grew only by 0.4% YoY in Q2 of 2022, missing forecasts of 1% and slowing sharply from a 4.8% growth in Q1, recording the softest pace of expansion since a contraction in 2020, when the initial coronavirus outbreak emerged in Wuhan.

Yes, China's economy is still growing but at a much slower pace, making everyone concerned about the main driver of global economic growth. Goldman Sachs cut its forecast for China's GDP growth this year to 3% from 3.3%. That marks the third cut by the Wall Street bank since May.

What’s wrong with the Chinese numbers?

The devil in the details:

1. Industrial production grew by 3.8% in July, following a 3.9% rise in June, and strongly missed the forecast of 4.6%.

2. Retail sales rose by 2.7% year-on-year in July, below market estimates of 5% and after a 3.1% growth last month, pointing to slowing consumer spending.

3. Youth unemployment hit a new record in July, with unemployment among the 16 to 24-year-olds rising to 19.9%.

4. Property sales contracted 29%, deeper than the 18% fall in June.

5. Construction starts declined 45%, unchanged from June.

Is China's economy slowing?

The second-largest economy in the world is struggling with repeated lockdowns under China's strict zero-COVID policy, a worsening property and real estate crisis, the worst heatwave in 60 years with some provinces shutting factories to save power, and declining in demand and output.

China's economy is on a path for its slowest growth in decades. Its factories are selling less to the world, and its consumers are spending less at home.

1. Commodity says China is slowing

China's production affects the global economy directly through the prices of commodities, especially industrial metals. The main Chinese iron ore contract has fallen dramatically since its peak last year, while copper dropped sharply this year, a clear sign of weaker demand.

2. Housing prices decline

For decades, buying property was considered a safe investment in China, but now it's related to a lot of trouble. China’s new home prices fell for the 11th straight month in a row for the period ended on July 31, 2022.

The pace of homebuilding has not been this slow since 2009. The result is an extra supply of metals like Iron ore, metallurgical coal, and copper which are essential materials for construction.

3. Chinese oil refiners processing less crude

Chinese oil refiners have been processing 10% less crude oil since April due to the decline in petrol demand with weaker consumer spending and industrial output. China’s weaker demand for oil has been a counter move to the tight grip on global energy supplies caused by the war in Ukraine.

How did the People's Bank of China and markets react?

After disappointing economic data, the PBOC announced surprise and unexpected interest rate cuts to boost its struggling economy. But the tiny one-tenth of a percentage point last week is unlikely to help economic activity.

Chinese stocks in Hong Kong rallied for the 40 minutes between the PBOC announcement and the release of more data, then gave up all their gains and dropped more.

HK50 remains under pressure and may revisit May lows around 19080. The pair USDCNY has been up by more than 8% since February.

Cable extends sharp fall after eventual break of pivotal 1.20 support, pressured by growing concerns about inflation-growth puzzle which boosts fears that the economy is heading into recession and fresh hawkish comments from Fed policymakers.

Soured sentiment adds to bearish technical studies, completing negative near-term outlook, as the pair is on track for a weekly close below psychological 1.20 level and for the biggest weekly loss since the first week of September 2020.

Bears eye 2022 low at 1.1760 (July 14), violation of which would risk deeper fall and retest of pandemic low at 1.1410 (March 2020).

Oversold daily conditions give initial warning that bears may face headwinds on approach to key 1.1760 support, with limited upticks expected to remain below 1.20 level (psychological /daily cloud base) and offer better levels to re-enter bearish market.

Res: 1.1900; 1.1936; 1.2000; 1.2062
Sup: 1.1760; 1.1700; 1.1634; 1.1556

Exceptionally tight labour market conditions showed no sign of loosening in June. And next week’s Survey of Payrolls and Hours (SEPH) is expected to reinforce that message. Employment growth has slowed—as small outright declines in already-reported labour force surveys for June and July showed. But that has more to do with a shortage of workers than a lack of hiring demand. Job vacancies (reported in the SEPH data) were over a million in April and May. That’s double the annual average of 540,000 in 2019. Job postings from indeed.com were still running almost 70% above pre-pandemic levels in June, before ‘slowing’ to more than 60% higher in July. Wage growth, unsurprisingly, has accelerated—particularly in the accommodation and food services sectors which accounted for an outsized 20% of the rise in unfilled jobs from pre-pandemic levels. SEPH’s fixed weight index of average hourly earnings rose to 4.9% in the three months to May, almost twice the average 2.3% pace of growth over the five years before the pandemic.

We expect elevated demand for workers, especially in the close-contact and travel industries, to continue through this summer. Beyond then, consumer spending will slow more significantly across a widening array of goods and services as inflation and higher interest rates cut into household purchasing power. There’s still substantial excess demand in job markets to keep unemployment low in the near-term, but aggressive Bank of Canada rate hikes will soften consumer appetites and, we expect, also start to cool overheated labour markets in the second half of the year.

Week ahead data watch:

Advance wholesale and retail data for July should offer a first glance at domestic production growth in Q3. Declines in manufacturing sales over May and June likely extended into July, given sharply lower prices for petroleum and coal products.

U.S. personal consumption expenditure likely held flat in July, as stronger sales volume offset lower prices at pump stations.

Macroeconomic indicators this week pointed to further headwinds for the global economy. In the US, the New York Empire Manufacturing Index slumped to -31.3 (from 11.1) in August, the lowest level since slump after the first Covid-19 lockdown. The sharp drop was driven by weaker current conditions, while the expectations index improved slightly. The current Empire level implies US Manufacturing PMI clearly below 50, in line with what the new orders index predicted already in July.

Also in Europe, there were weak indicators with the German ZEW expectations diving further during August to the lowest level since October 2008. The ZEW signals further declines in PMI ahead and increasing recession risk in the German economy, which is also our base case for the second half of this year, see Research Germany - Zeitenwende, 25 July. Our forward looking macroeconomic model, Macroscope, this week also pointed to further weakening momentum in the global economy across regions over the next six months, see MacroScope: rising recession risks, 18 August.

On the inflation front, UK CPI inflation surprised to the upside creeping above 10% in July. The UK is thereby joining the "club" of countries, mostly in Eastern Europe and emerging markets, with double digit inflation rate. We think this highlights the need for Bank of England (BoE) to continue to frontload rate hikes, although a looming recession may curtail its hiking intentions into next year. The EUR/GBP cross initially moved lower on the back of the print, but later rebounded amid weak global risk sentiment.

Another central bank that is upping its policy rate hikes is Norges Bank, which yesterday as expected carried out a 50bps rate hike. The move comes after the upward inflation surprise in July. The central bank dropped its specific forward guidance for the September meeting, just indicating that the policy rate "will most likely be raised further in September". We expect the Bank to raise its policy rate at that meeting by 25bps against market expectation of a bigger 50bps move.

In financial markets the clear winner was the USD while both equity markets and rates markets traded mostly sideways. We published our new FX Forecast Update this week, FX Forecast Update - USD to shrug off recession fears, 17 August, and see USD strength continuing with EUR/USD falling below parity over the next 12M due to Europe suffering from an energy related negative terms of trade shock and further tightening of global financial conditions.

Looking into next week, a key focus will be August flash PMIs out in most western economies on Tuesday. In Europe, further declines - as also signaled by ZEW - will probably be in store, as the energy crisis is taking its toll on demand in manufacturing and services and recession fears are rising. In the US, lower gasoline prices and rebound in real incomes may support service sector demand. Look also out for the US personal expenditure data on Friday. The Jackson Hole Symposium will take place from Thursday until Saturday. Here Federal Reserve officials may outline their view on monetary policy amid a weakening economy.

Full report in PDF.

In Research China: The risk of a Taiwan war and what it implies - part 1, 11 August, we looked at the risk of a Taiwan war. In this follow-up we consider the implications, both of a possible war and of the rising tensions.

Apart from being a human tragedy with significant loss of lives, we believe a war on Taiwan would trigger a deep global recession through the effects from sanctions, huge disruption to supply chains as well as from a sharp rise in uncertainty due to the risk of a war developing into WWIII.

While we do not expect a war in the short term, the heightened tensions itself and risk of a war on a 5-10 year horizon, will also have implications. Companies will increasingly consider how many eggs they have in the China basket and de-globalisation and decoupling trends will see an extra push. On the geopolitical front we move faster towards what could resemble a new Cold War between the West and China/Russia, albeit a different Cold War than the first, as the world will stay more connected economically and the rest of the world is reluctant to choose sides. This leads to a multipolar and more fragmented world.

Full report in PDF.

After seeing UK inflation accelerating to double digits earlier this week, pound traders may now turn their gaze to the flash UK Purchasing Managers Indices (PMIs) for August, due to be released out on Tuesday at 08:30 GMT. With the preliminary GDP data revealing contraction in the second quarter of the year, traders may want more clues on how the economy has been faring thereafter.

Are the UK PMIs headed towards contractionary territory?

There are no forecasts available at the time of writing for any of the three indices, but it is worth mentioning their July prints. The manufacturing PMI slid to 52.2 from 52.8, while the services one fell from 54.3 to 52.6. The composite index declined as well, to 52.1 from 53.7. Although all three of them remained above the boom-or-bust zone of 50, they’ve been trending lower since March. Therefore, combined with the BoE’s warnings over a recession, investors may be biting their nails in anticipation of whether the PMIs will get closer to the 50 line, or even fall below it.

Market raises forecasts on interest rates, but pound keeps falling

At its latest gathering, the BoE raised interest rates by 50bps to 1.75%, retaining the option to act more forcefully if deemed necessary. That said, officials maintained warnings over the UK economy entering recession, saying that this could happen this quarter and last for a whole year. That’s maybe why the pound stayed under pressure even after the UK became the first major economy to experience double digit inflation.

On Wednesday, the July CPI data revealed that the headline rate jumped to 10.1% from 9.4%, while the core rate, which excludes the volatile items of energy and food, rose to 6.2% from 5.8%. This suggests that prices are not rising only due to Russia’s restrictions of gas supplies, and that’s maybe why market participants were quick to raise their bets with regards to future rate hikes by the BoE. They now see the bank rate peaking at 3.75% in May next year, while ahead of the data, they were expecting it to peak at 3.25% in March.

How big is the risk of a UK recession?

Maybe the pound failed to capitalize due to traders staying worried over recession risks rather than trusting the BoE relieving them from the pain of very high consumer prices. Yes, the employment data for June pointed to a labor market remaining tight, but although wages accelerated, real wage growth remained well into the negative territory. What’s more worrisome, during the first quarter of the year, the real disposable income of households slid by the most since we have data for.

The market’s concern is also visible in the UK government bond market. Although yields have been in a steady uptrend due to the BoE’s actions, the difference between the 10- and 2-year yields turned negative this week for the first time since 2019 and continued well below the level hit then. The last time we saw the 10yr/2yr spread being that low was back in 2008, during the global financial crisis.

Pound breaks below 1.20 dollars. Is more trouble on the cards?

So, with all that in mind, lower PMIs, especially if any of the indices falls below 50, could spell more trouble for the British currency. Pound/dollar already fell below the 1.2000 psychological hurdle yesterday, which may have invited more bears into the game, encouraging them to push even lower in case UK data keeps disappointing. They may aim for the July 14 low of 1.1760, the break of which would confirm a forthcoming lower low on the weekly chart and probably set the stage for larger declines, perhaps towards the low of March 20, 2020, at around 1.1400.

Alternatively, improving PMIs may result in some pound buying, or better say, some short covering. Pound/dollar could rise back above 1.2000, but with the fundamental picture staying gloomy, this may be just a dead cat bounce before a new round of selling. For the outlook of this pair to change, a break above the key resistance zone of 1.2295, accompanied with notable improvement in UK economic data, may be needed.

The Eurozone economy may have notched up impressive growth in the second quarter, but conditions have started to deteriorate rapidly in the third quarter. The flash PMI estimates by S&P Global due on Tuesday will reveal whether business activity improved or slumped in August. Investors will likely be paying particularly close attention to Germany – Europe’s largest economy – as it is the most vulnerable from the energy crunch, which is showing no sign of easing. The euro, meanwhile, is headed for parity versus the US dollar after crashing below its sideways range.

From bad to worse

Things just seem to be getting from bad to worse in Europe this year. If the war in Ukraine wasn’t enough to derail the bumpy recovery from the pandemic, the worst drought in 500 years and the real prospect of energy rationing certainly could. Business confidence is plunging amid headwinds from multiple fronts, with stagnating growth in China being the latest.

There has been some relief at least from lower oil prices. As more of the price decline in crude oil gets passed on at the pump, and to a lesser extent, in electricity prices, this should provide a substantial boost for both consumers and businesses. However, Europe’s dependency on natural gas, and specifically, on Russian gas, means the energy crisis on the continent could outlast the surge in oil prices.

PMIs are ringing recession alarm bells

The negative risks have already started to materialize as Eurozone manufacturing activity contracted in July for the first time in two years, while the situation was even worse for Germany, with both the manufacturing and services sectors shrinking last month according to the PMI survey.

August’s flash estimates are unlikely to offer much respite in the run of gloomy headlines. The Eurozone’s flash manufacturing PMI is expected to decline from 49.8 to 49.0, while the services print is forecast to drop from 51.2 to 50.5. This would put the composite PMI at 48.8, signalling the start of a broadening decline in economic activity.

In Germany, the forecasts are notably more dire as the composite PMI is predicted to fall from 48.1 to 47.4, in what could be the beginning of a long and steep contraction.

Within reach of parity

The euro, which had been trapped between the $1.01 and the $1.03 levels for much of July and August, has just dived below this range and is at risk of breaching parity from a poor set of PMI figures. A rerun of July’s 20-year trough of $0.9950 slightly above the 261.8% Fibonacci extension of the June upleg now looks probable.

Alternatively, the euro could rebound towards its 50-day moving average around $1.0275 from any positive surprises in the PMI readings, as long as it can clear the hurdle of the 161.8% Fibonacci just beneath $1.02.

Whether the euro can again bounce off the parity mark will likely depend on the two big variables: what will happen to natural gas prices and supply, and how will the European Central Bank respond to the escalating gas crisis.

Can the ECB halt the euro’s decline?

The ECB’s hawkish tilt in July was pivotal in cementing support in the $1.01 region. Policymakers will probably maintain their pledge to rein in inflation when they meet on September 9. But hawkish soundbites may not be enough this time round.

The chances of tensions between Russia and Europe easing anytime soon are remote. Hence, the coming winter will almost certainly be difficult for countries that rely heavily on natural gas for their electricity needs, regardless of whether Moscow decides to completely cut off supplies, and rationing is looking increasingly unavoidable. A further slowdown in China’s economy would also deepen Europe’s woes, especially for German exporters.

Against such a backdrop, it’s hard to see how a recession can be averted, and more importantly, how the ECB can sound convincingly more hawkish than the Fed and put a floor under the beleaguered euro.

With the summer coming to a close, Fed officials will head to Jackson Hole for their annual symposium. Financial conditions have loosened lately despite the forceful rate increases, which is counterproductive for the central bank. If they push back, that could spell trouble for risk assets but good news for the dollar. 

Fed summer camp

The top brass of the Federal Reserve will head to the central bank’s summer retreat in Jackson Hole, Wyoming on Thursday to discuss monetary policy. This venue has been used in the past to signal major policy shifts, so it is seen as an unofficial policy meeting.

Fed officials are caught in a bind. Despite raising interest rates at the speed of light, their actions didn’t have the desired effects. Yields on government bonds have pulled back and stock markets have rallied with a vengeance since June, ignoring signals from policymakers that they are far from declaring victory on inflation.

As Chairman Powell pointed out, Fed policy is transmitted mainly through ‘financial conditions’, which is essentially a code phrase for bond yields and stocks. The central bank needs tighter financial conditions to slow down the economy and tame inflation, but they have been loosening instead.

That’s a problem for the Fed. Inflation is still running at 8.5% and looser financial conditions mean it might stay hot for longer. In turn, that would require more monetary tightening to compensate, putting unnecessary pressure on an economy that is already stalling.

As such, the Fed could push back, either by hyping the prospect of another three-quarter-point rate increase in September that markets currently see as a coin toss or through its balance sheet. The process to reduce the balance sheet has already started and will ramp up next month, with $95 billion in securities rolling off per month as they mature.

If Powell and his colleagues want to tighten financial conditions, all they would have to say is they are having conversations on this topic. It would be a hint that the pace can be ramped up further through active sales of bonds or mortgage backed securities, instead of the current passive rolloff.

A more forceful tone could dampen the comeback in equity markets and simultaneously add fuel to the US dollar, which continues to steamroll its opponents. The energy crisis has ravaged the euro, the Bank of Japan’s refusal to tighten policy has crippled the yen, and the implosion in China’s property sector has dismantled the commodity currencies.

There’s also a barrage of US data releases, starting with the S&P Global PMIs for August on Tuesday, which will reveal whether growth and inflationary pressures continue to cool off. Other releases include durable goods orders on Wednesday, the second estimate of GDP for Q2 on Thursday, and the core PCE price index on Friday.

European horror show

The past few weeks have been dreadful for the European economy, with the energy shortage pushing natural gas prices on the continent to new records while an intensifying drought in Germany dried up rivers and made it harder to transport supplies.

It’s been a horror show for German industry, whose entire business model used to rely on cheap energy. With gas prices so incredibly high, many companies are uncompetitive and perhaps unprofitable. And if Europe’s powerhouse is struggling, other countries won’t escape unscathed - the supply chain is too interconnected.

Traders will look to the latest PMI business surveys, due out on Tuesday, for an assessment of the damage. Forecasts point to a further cooling of the Eurozone economy in August, with the manufacturing index sinking deeper into contractionary territory and the services print just barely staying in expansion.

If anything, the risks seem tilted towards disappointment considering that European companies also have high exposure to China, where economic growth is evaporating at an astonishing pace. That could curb bets for a three-quarter-point rate hike by the ECB next month, something investors currently assign a 45% probability to, and spell more trouble for the euro.

The latest relief rally in euro/dollar was rejected by the 50-day moving average and if the Fed indeed strikes a hawkish tone next week while business surveys highlight the Eurozone’s economic problems, there could be another battle around parity.

British PMIs eyed too

The United Kingdom will also get a glimpse at its own PMI surveys for August on Tuesday. It has been a gruesome year for sterling so far, which is underperforming even the war-stricken euro despite the Bank of England raising interest rates at every meeting.

Although the UK doesn’t import much energy from Russia directly, it is not immune to the energy crisis either. The trade trade deficit has blown up as a result and since the UK also runs a large government deficit, sterling has become very sensitive to any shifts in global risk sentiment.

In other words, the main variable for the pound moving forward might be how stock markets perform, since investors already have a good idea of what the BoE will do. In this sense, the risks seem tilted to the downside. Equities have rallied dramatically since June but mainly due to expanding valuations - earnings growth is not impressive and economic data keeps losing momentum.

It might have simply been one epic short squeeze, which seems to be running out of fuel.