We know the material damage done from Harvey and Irma both in terms of lost activity and the subsequent rebound will be all over the economic data in coming months and quarters. Thankfully Irma’s damage should be much less than feared. Putting aside the awful human toll, we don’t believe though it will influence what the FOMC will decide on. We also will likely see wages rise in an area that has already experienced a shortage of workers, that being construction. If you have the skills, there is now plenty of work for you in Texas and Florida. Thus, rebuilding in these two states will be pulling workers and resources from other states. As for any inflationary impact, inflation breakevens for both 5 yr and 10 yr time frames are at one month highs but still remain near the middle of the one year range. At 1.70%, the 5 yr breakeven compares with the one year average of 1.75%. The 10 yr breakeven is at 1.81% vs the 12 month average of 1.85%.
Continuing Mario Draghi’s attempt last week at verbally weakening the euro, ECB Governing Council member Benoit Coeure threw his voice into the ring by saying “exogenous shocks to the exchange rate, if persistent, can lead to an unwarranted tightening of financial conditions with undesirable consequences for the inflation outlook. Against this background, the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring.” Mr. Coeure seems to be referring to a move in the euro from $1.40 to $1.05 and now back at $1.20 as some “exogenous shock.” Perspective please. Since 1999 when the euro started trading, the average exchange rate has been $1.21. Voila.
We heard from some other ECB members, particularly Klaas Knot who heads the Dutch central bank. He said “prolonged monetary easing comes with diminishing returns, especially in a situation of very low interest rates. The longer the ultra loose monetary conditions persist, the larger this risk. Since loose monetary policy has stimulated risk taking in financial markets, asset prices can grow out of sync with real economic developments.” You’d think I wrote that speech for him but I didn’t. Either way, all else equal, we are getting tapering news in October. Plan accordingly. Also, ECB Governing Council member Ardo Hansson reminded everyone today that “the process of normalization of policy stance is very gradual and in fact, it has been already started.” As a reminder, in April monthly purchases fell by 20b euros.
The full trading day after China essentially put a brake on the relentless rally in the yuan which was up almost every day for 3 ½ weeks, the yuan is having its sharpest one day percentage decline since February. Eliminating the reserve requirement that banks need to set aside for FX forward contracts that are bought for non bank clients is sort of the back side of the ‘counter cyclical’ measures the PBOC initiated back in late May that precipitated the rally since that led to Friday’s move. The Chinese don’t like one way moves, the don’t like disorderly moves. They like order, they like 2 way markets, they don’t want a currency that is too strong or too weak. They also have to overlay this desire on top of an economy that continues to face a massive debt bubble, the government’s attempt to slow the pace of debt accumulation at the same time they want to grow at 6.5%. The market response was pretty much contained to the FX market as interbank rates were little changed while the Shanghai comp was up by .3%.
The US dollar weakness in the very short term might be taking a pause. As a bear on the dollar this year I acknowledge this and maybe a contra trend rally is upon us. That said, I expect further dollar weakness to follow any consolidation.
The uneven delivery of Japanese economic data continued with the better than expected July machine order print of 8%, double the estimate. It does though follow 3 months in a row of declines and is extremely volatile month to month. It also follows a downward revision to capital spending plans in Q2. For Japanese markets, it was all about the yen which is weaker on the heels of the yuan move and that led to a 1.4% jump in the Nikkei which as of Friday was basically flat on the year.
The only thing of note in Europe data wise was the better than expected Italian industrial production print for July which was up .1% m/o/m vs the estimate of down .4%. The y/o/y gain of 4.4% was the 2nd best of the year. Strong growth (relatively speaking), low inflation is the theme in Europe which is the best kind. If the ECB gets what it wants we’ll see higher inflation, less growth and much higher interest rates.