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When words speak louder than actions

When words speak louder than actions

Richard Conway Weekly bulletin July 2019
Markets are convinced that policy changes are on the way from the world’s major central banks, which has led to significant shifts in pricing. With the efficacy of many traditional policy tools in question, the old adage appears to be operating in reverse – words can now speak louder than actions.
Powell’s testimony to congress

Perhaps the clearest steer on future central bank policy has come from the Fed. Chairman Jerome Powell and his fellow Governors provided markets with a reasonably explicit signal for the direction of future interest rates at their June meeting. The Fed’s latest ‘dot plot’, which charts where members see rates going over the near-term, suggested further rate hikes this year were unlikely, with a cut a possibility – sharply down on the March outlook.

At his Congressional testimony last week, Powell doubled down. The Fed is now expected to push through at least one “insurance cut” this year. In the Chairman’s words, this would be a pre-emptive move, intended to lean against headwinds from global trade worries and their second-order effects on consumer confidence and aggregate demand.

Is the Chair attempting to fix expectations?

It would be the first cut in a decade for the US central bank, which has spent the last four years mechanically inching up its benchmark Fed Funds rate.

While Powell was unclear on the size of insurance cut needed, many seem to think this would mean at least one 25 basis point adjustment, if not two. Markets are pricing in a more bearish view still, with cuts of perhaps twice that size expected by the end of 2020.

Given this disconnect, there may be some method behind last week’s testimony. By providing greater clarity on the outlook for rates, and additional context to the June dot plot, Powell may be attempting to nudge expectations upwards and bridge the gap between policy guidance and market pricing.

Lessons for policy

Central bankers in the UK and the Euro Area are both contending with similarly pessimistic views and a widening gap between official guidance and market pricing. Most have stuck to the tried-and-tested, softly-softly form of forward guidance that has been the mainstay of central bank communication over the last 10 years. Few have fixed their colours to the mast in the same way as the Fed.

Should this more explicit flavour of forward guidance prove popular, expect to see it taken up with earnest elsewhere.

Economic data releases

The main data point of the week came before markets had opened in the West with the release of Chinese GDP data, which grew by 1.6% for Q2 or 6.2% YoY. That the world’s second largest economy can expand at the same pace over a quarter as the UK can in a year is a sobering fact.

UK unemployment data is due on Tuesday. Consensus is pointing to a slight uptick in wage growth to closer to 3.5% and for the headline jobless number to remain at 3.8%. We also have the influential German ZEW survey and US retail sales and trade data later in the day.

Euro-area and UK inflation figures will arrive on Wednesday morning. Little change is expected on either headline measure but expect any surprises to influence markets. Canadian inflation figures are due later in the day, with consensus suggesting a jump to 2.6% from its current 2.1% level.

Thursday will see the release of Australian unemployment numbers and UK retail sales, while Friday will round out the week with UK public sector net borrowing figures and the University of Michigan’s closely watched consumer sentiment gauge.

For more information, please contact Richard Conway, Director at Chatham, at rconway1@chathamfinancial.com.


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