A turn­ing point for Europe

NBK WEEKLY RE­PORT

Kuwait Times - - BUSINESS -

The sec­ond half of 2017 seems to be tak­ing the shape of non­con­sen­sual Fed mem­bers views over the cur­rent state of the US econ­omy. Whether St. Louis Fed Bullard re­it­er­at­ing his views that “the cur­rent level of the pol­icy rate was ap­pro­pri­ate given the cur­rent macroeconomic en­vi­ron­ment, some Fed mem­bers have started doubt­ing the idea that US in­fla­tion is re­li­ably re­turn­ing to­ward the set tar­get. Over the size of the Fed bal­ance sheet, there at least seems to be a con­sen­sus to be pru­dent to an­nounce a bal­ance-sheet ad­just­ment any­time soon and any de­ci­sion is likely to be pushed to­ward the end of the sum­mer.

With the mar­ket more and more un­con­vinced about a much higher ter­mi­nal Fed Funds rate in the US and with a hon­ey­moon pe­riod likely to con­tinue in Europe, we are likely to wit­ness a con­tin­u­a­tion of the US dol­lar melt­down in the sec­ond half of 2017, with a risk of higher lower yield­ing cur­ren­cies that have been shunned in the past three years. Should mar­ket ex­pec­ta­tions about ECB tight­en­ing rise much fur­ther as they did this week, this would likely tighten fi­nan­cial con­di­tions in the Euro area and push the cur­rency higher against the Dol­lar. More global cen­tral banks seem to be jump­ing on the tight­en­ing wagon by chang­ing their view. Whether the Bank of Canada, the Bank of Eng­land and the ECB; all­have helped weak­en­ing the US dol­lar by send­ing the Euro, Cana­dian dol­lar and Pound higher this week.

On the foreign ex­change side, the US dol­lar in­dex ex­tended its re­cent losses al­most day by day af­ter re­cent prospects of mone­tary tight­en­ing emerg­ing at both the Euro­pean Cen­tral Bank and the Bank of Eng­land. The in­dex lost 1.56% of it’s value dur­ing the week. The DXY de­pre­ci­ated to its weak­est level since Oc­to­ber 2016 on Thurs­day, fall­ing to 95.50. The dol­lar was on course for its worst quar­ter in seven years on Fri­day, re­cov­er­ing only marginally against ma­jor peers. The in­dex opened on Mon­day at 97.254 and ended its weekly ses­sion at 95.66.

Last week, the sin­gle cur­rency be­gan its up­ward mo­men­tum on Tues­day when ECB’s Pres­i­dent Draghi pre­sented an op­ti­mistic view of the Eu­ro­zone econ­omy, and put a pos­i­tive spin on in­fla­tion, stat­ing that “de­fla­tion­ary forces have been re­placed by re­fla­tion­ary ones.” More­over, Draghi men­tioned that the loose mone­tary pol­icy was needed for now, but would be grad­u­ally with­drawn once in­fla­tion moved higher. The EUR/USD on Thurs­day was el­e­vated to new highs for the year at 1.1445. The pair opened the week at 1.1196 and closed on Fri­day at 1.1427.

In terms of the Bri­tish Pound, the GBP/USD started the week at 1.2739 and was in con­sol­i­da­tion mode un­til Wed­nes­day. The Ster­ling pound gained sup­port on Wed­nes­day by the head of the BoE Mark Car­ney who stated that that rais­ing in­ter­est rates in the UK in the next few months could be­come more ap­pro­pri­ate and tol­er­ance for higher in­fla­tion from the MPC could soon start to dis­ap­pear. At the end of the week, GBP/USD soared to 6 weeks high amid grow­ing ex­pec­ta­tions that in­ter­est rates could soon rise, while po­lit­i­cal un­cer­tainty fol­low­ing the elec­tion fades. In Com­modi­ties, oil has de­liv­ered a 5% gain this week, with prices gain­ing sup­port from govern­ment data that showed a drop off in US gaso­line sup­plies, which have pre­vi­ously re­mained stub­bornly high, leav­ing to a close firmly above $45.

Fed voices con­cerns about as­sets val­u­a­tions lev­els

Fed Chair Yellen didn’t give any in­di­ca­tions this week whether the cur­rent pol­icy tight­en­ing has changed, say­ing “we’ve made very clear that we think it will be ap­pro­pri­ate to the at­tain­ment of our goals to raise in­ter­est rates very grad­u­ally.” The caveat was when she said that as­set val­u­a­tions, by some mea­sures, “look high, but there’s no cer­tainty about that”. In par­al­lel, Fed Vice Chair­man Fis­cher said that ris­ing val­u­a­tions in eq­ui­ties and other seg­ments of the global mar­ket are partly ex­plain by a brighter eco­nomic out­look, but also by el­e­vated risk ap­petite. Fis­cher also warned against com­pla­cency. “So far, the ev­i­dently high risk ap­petite has not led to in­creased lever­age across the fi­nan­cial sys­tem, but close mon­i­tor­ing is war­ranted.”

No con­sen­sus over the cur­rent state of the econ­omy

On the cur­rent state of the econ­omy, San Fran­cisco Fed Pres­i­dent Wil­liams said that “the US econ­omy has re­gained, and even sur­passed, full em­ploy­ment bench­marks. “Al­though our in­fla­tion rate is still some­what be­low our 2% medium-term tar­get, I and my col­leagues on the Fed­eral Open Mar­ket Com­mit­tee ex­pect us to reach that goal in the next year or so”.

On the lesser bright side, Philadel­phia Fed Pres­i­dent Harker also was on the wires, say­ing he thought the cen­tral bank may have to re­think its plans for hik­ing in­ter­est rates if US in­fla­tion con­tin­ues to wane. “My fore­cast is for the ceas­ing of rein­vest­ment of bond prof­its this year and pos­si­bly one more rate in­crease, but if we start to see in­fla­tion con­tinue to de­te­ri­o­rate ... then I would re­visit that. We have to be open to that.”

Bleak data

The US con­sumer con­fi­dence in­dex rose to 118.9 in June, up from 117.6 pre­vi­ously while es­ti­mates were for 116. The im­prove­ment was driven by the present sit­u­a­tion com­po­nent, which in­creased to 146.3 from 140.6, while the ex­pec­ta­tions in­dex de­clined to 100.6 from 102.3 last month. The Rich­mond Fed man­u­fac­tur­ing in­dex also rose to 7 in June, up from 1 in May and above the con­sen­sus es­ti­mate for 5. Look­ing at the de­tails, the sub­com­po­nents for ship­ments and new or­ders in­creased. Em­ploy­ment was rel­a­tively flat On the brighter side, US first quar­ter GDP was re­vised up to a 1.4% while con­sen­sus was for a 1.2%. This is twice the growth rate of the orig­i­nal print for the first quar­ter, which came in at 0.7%. There were re­vi­sions through­out the re­port but the big­gest change­was in con­sump­tion, which was re­vised up to 1.1% from 0.6%. In­vest­ment was lower from 4.8% to 3.7%, mostly re­flect­ing business spend­ing.

EUROPE & UK Chang­ing Tone at the ECB

This week, ECB Pres­i­dent Draghi de­cided to rock the boat say­ing that “the global re­cov­ery is firm­ing and broad­en­ing” and that a “key is­sue fac­ing pol­i­cy­mak­ers is en­sur­ing that this nascent growth be­comes sus­tain­able”. How­ever, he said that “in­fla­tion dy­nam­ics re­main more muted than one would ex­pect”, cit­ing ex­ter­nal price shocks and more slack in the la­bor mar­ket. Draghi thinks that these ef­fects are only tem­po­rary in na­ture and “should not cause in­fla­tion to de­vi­ate from its trend over the medium term”. In par­al­lel, ECB Gov­ern­ing Coun­cil mem­ber Jens Wei­d­mann was more up­beat say­ing that “cit­i­zens must be able to rely on the Gov­ern­ing Coun­cil to ex­pe­di­tiously end its ex­pan­sive mone­tary pol­icy if it is nec­es­sary from the point of view of price sta­bil­ity”.

We have to make it clear that we are guided by mone­tary pol­icy con­sid­er­a­tions alone and that the fi­nance min­is­ters have to cope with ris­ing fi­nanc­ing costs of pub­lic bud­gets” when ECB ex­its its “very loose mone­tary pol­icy.” He added that the ECB coun­cil hasn’t dis­cussed a pos­si­ble ex­ten­sion of the bond-buy­ing pro­gram and that the ECB should look at the “exit from the very loose mone­tary pol­icy” if eco­nomic growth and in­fla­tion de­velop as ex­pected.

Europe’s man­u­fac­tur­ing on Fire

French real GDP grew more than ex­pected in the first quar­ter and rose 0.5%, up from 0.4% pre­vi­ously and above es­ti­mates for 0.4%. With this fig­ures, the ex­pected growth of 1.5% for the whole of 2017 would be the strong­est since 2011. More­over, the pre­lim­i­nary man­u­fac­tur­ing PMI also sur­prised to the up­side and rose to 55 in June, while the ser­vices PMI de­clined to 55.3, down from 57.2. None­the­less, the PMI data sug­gests that the French econ­omy con­tin­ues its re­cov­ery. A break­down showed that firms ex­panded their pay­rolls the most since Au­gust 2008.

In Germany, the pre­lim­i­nary man­u­fac­tur­ing PMI de­clined less than ex­pected to 59.3 in June, down from 59.5 in May whereas con­sen­sus was for 59. Strong de­mand from Europe, Amer­ica and Asia trans­lated into growth in new or­ders for the sixth time in seven months. New or­ders grew at the fastest pace since March 2011. More­over, the ser­vices PMI de­clined more than ex­pected to 53.7, down from 55.4 and be­low the con­sen­sus es­ti­mate for 55.4.

Rais­ing rates at the worst time?

Ac­cord­ing to Bank of Eng­land Gover­nor Car­ney, the MPC may need to be­gin rais­ing in­ter­est rates in the com­ing months. “Some re­moval of mone­tary stim­u­lus is likely to be­come nec­es­sary if the trade-off fac­ing the MPC con­tin­ues to lessen and the pol­icy de­ci­sion ac­cord­ingly be­comes more con­ven­tional.”

To re­it­er­ate the point, BoE’s Chief Econ­o­mist An­drew Hal­dane said that “we need to look se­ri­ously at the pos­si­bil­ity of rais­ing in­ter­est rates to keep the lid on those cost of liv­ing in­creases. For now we are happy with where the rates are, we need to be vig­i­lant for what hap­pens next.” He noted that weak pay growth has re­peat­edly sur­prised the BoE. He added that pol­icy mak­ers are watch­ing for signs of a pickup in wages and that weak pro­duc­tiv­ity is help­ing to sup­press pay. He re­it­er­ated that any pol­icy tight­en­ing will be lim­ited and grad­ual.

On the eco­nomic data side, the GfK con­sumer con­fi­dence in­dex fell to -10 in June, lower than the con­sen­sus es­ti­mate of -7 and down from -5 in May. It was the low­est read­ing since last July’s -12 shortly af­ter the UK’s EU ref­er­en­dum. Ac­cord­ing to the re­port, “strong con­sumer spend­ing has propped up the econ­omy since last June, but now the twin pres­sures of higher prices and slug­gish wage growth are squeez­ing house­hold fi­nance and adding to wide­spread fears of a Brex­itin­duced eco­nomic slow­down.

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