Will Jackson Hole live up to its reputation for policy news?
Divergent central-bank balance sheets favor the dollar
U.S. durable goods orders ex-transportation are expected to remain generally strong
Will Jackson Hole live up to its reputation for policy news? — The highlight of the 4-day Jackson Hole monetary policy conference will be speeches today by Fed Chair Yellen (at 10 AM ET) and ECB President Draghi (at 3 PM ET). The markets will be carefully watching those comments to see if they contain any policy hints. The Kansas City Fed’s Jackson Hole conference has acquired somewhat of a reputation for breaking important policy news, but the markets are not generally expecting much from this year’s meeting.
Still, both the Fed and the ECB are on the verge of significant policy decisions. The Fed needs to announce the start date for its balance sheet normalization program, which may start as soon as Oct 1. The markets are expecting the Fed to announce that start date at its next meeting on Sep 19-20.
The markets are actually more interested in handicapping the Fed’s next rate hike, which means the markets will be carefully watching Ms. Yellen’s comments for any indications of whether the recent decline in the inflation statistics might cause the Fed to defer its last rate hike of the year, or whether the Fed will charge ahead with another rate hike by December regardless of the soft inflation statistics. The market is discounting the chances of a Fed rate hike by December at only 44%.
Meanwhile, ECB President Draghi’s comments may have more potential to move the markets because the ECB faces a big decision on what to do with its QE program in 2018. The ECB has only officially announced that its 60 billion euro/month QE program will last through December, which means the ECB must notify the markets about its QE intentions for 2018 at either its next meeting on Sep 7 or the following meeting on Oct 26. The meeting after that on Dec 14 would be too late.
The ECB would normally want to give the markets as much notice as possible about a major policy decision, which would argue for a QE tapering announcement at its next meeting on Sep 7. However, ECB officials may defer that announcement in order to give themselves more time to decide exactly how they want to taper QE. The ECB in the account of its last meeting said that it wants to reserve as much policy flexibility as possible, which would argue for a delayed decision on QE tapering.
ECB officials also recently expressed worry that the euro might be showing too much strength. If the ECB were to take the dovish action of deferring the QE tapering decision until its October meeting, then the euro would likely take somewhat of a hit and give European exporters some relief.
Low inflation is a common denominator that is facing both the Fed and the ECB. The U.S. core PCE deflator fell to a 1-1/2 year low of +1.5% y/y in May-June from the 5-year high of +1.9% posted in Dec-Jan. Meanwhile, the Eurozone core CPI in July of +1.2% y/y was up from +0.7% in March but was still far below the ECB’s inflation target of just under 2%.
Divergent central-bank balance sheets favor the dollar — With this year’s sharp decline in the dollar index, there has been little talk about the underlying bullish factors for the dollar such as the Fed’s tighter monetary policy.
The ECB is about to taper its QE policy in 2018, which is a bullish factor for the euro since the ECB will at least stop permanently injecting euros in the banking system sometime in mid to late 2018. Nevertheless, the dollar still enjoys a favorable divergence in monetary policy versus the euro since the ECB is not likely to raise its refinancing rate from zero until perhaps 2019. The dollar also enjoys a favorable divergence in monetary policy against the yen since there is no end in sight for the BOJ’s QE program.
The nearby chart illustrates the divergent course of central bank balance sheets. The Fed’s balance sheet has been constant since late 2014 when the Fed ended its QE program. Moreover, the Fed’s balance sheet will start falling as soon as the Fed begins its balance draw-down program later this year. Meanwhile, the ECB’s balance sheet will rise at a slower rate in early 2018 as the ECB tapers its QE program and will then stabilize when the QE program ends. The BOJ’s balance sheet will continue to rise at least through 2019 as the BOJ waits for inflation to revive.
U.S. durable goods orders ex-transportation are expected to remain generally strong — The consensus is for today’s July durable goods orders report to fall by -6.0%, reversing most of June’s +6.4% increase on reversal of June’s surge in aircraft orders. Excluding transportation, durable goods orders are expected to show a +0.4% increase, improving after June’s small +0.1% increase. Meanwhile, July core capital goods orders (ex-defense and ex-aircraft) are expected to show a +0.4% increase after June’s weak report of unchanged.
Durable goods orders ex-transportation in general remain strong with a +6.9% y/y increase in June, the strongest year-on-year increase in more than 5 years. Orders have improved due to stronger overseas growth combined with the improved attractiveness of U.S. exports due to this year’s sharp decline in the dollar. Confidence in the U.S. manufacturing sector remains strong with the ISM new-orders manufacturing sub-index in July at the high level of 60.4 and the overall ISM manufacturing index at 56.3.