Why fiscal policy might slow Fed tightening

Wells Fargo’s John Silva always provides readers with an interesting angle in his US Interest Rate Weekly and this week he takes a look at the interaction between US monetary policy and fiscal policy, which could have implications for the pace at which the Fed can lift interest rates from current levels. The underlying source for this is technical (to do with the Fed’s new mechanism for setting a lower bound for the fed funds target range via repo rates), which combined with an expected pick up net Treasury issuance due to higher Federal spending, could force repo rates higher. This may result in the Fed pausing its rate hikes in order to account for the changing fiscal policy environment, Silva concludes.

CAD: Predicting the unpredictable man

BoC governor Poloz has earned a (partially) deserved reputation for vacillation this year after issuing conflicting statements on the state of the Canadian economy.  To be fair, he warned this market something like this would happen, writes Daniel Brehon from Deutsche Bank’s FX strategy team. Does that mean DB needs to reassess its 1.30 year-end forecast for USD/CAD given the current momentum in the FX market for a lower CAD? They will sit tight and wait for the dust to settle says Brehon. That’s because much of the bad news may have already been priced and indeed, the BoC may be on to something and ahead of the curve in predicting a recovery in 2016, given that markets generally have been slow to pick up on to the positive long-term growth and inflation effects of sustained depreciation in both Japan and the Eurozone.

The CNY/UST connection

US Treasury investors should keep a close eye USDCNY because it’s an important part of getting the direction of yields right, writes Morgan Stanley’s Matthew Hornbach. In this report MS discuss the connection between USTs and CNY, based on recent official data out of China that shows China selling large chunks of USD in June to buy CNY as the currency continues to trade at the top end of the band. There isn’t yet any data to prove that China has been selling USTs, that is just the conclusion that Morgan Stanley has come to. It’s a good theory though.

The El Niño effect: Food inflation is coming

We pick up on a theme we highlighted a month or so back that isn’t really being talked about as much as it perhaps should be. A stronger-than expected El Niño. Credit Suisse’s equity strategy team have produced this presentation: El Niño in 2015? Implications and Impact. In a nut shell, we should expect wetter weather and droughts across SE Asia, the Pacific region, Australia, Latin America and the US. Clearly this will have a negative impact on soft commodities (Wheat and palm oil as two prime examples), but from a macro perspective, its impact on food inflation could impact the inflation outlook more broadly. On energy, hydro-electricity could also be severely impacted, perhaps delaying the demise of coal as generators seek substitutes, not to mention oil. Credit Suisse provide an extensive series of screens of companies positively and negatively exposed to this event, an extensive array of charts and tables covering 35 pages.

Greece: Moving to the centre ground

The latest Greek piece from Deutsche’s George Saravelos focuses on the likely shift in the political settings of Greek politics. That is, a move from the left to the centre ground by the ruling SYRIZA party, which is likely to culminate in an early general election. There’s a lot of detail between the lines of the above synopsis and George’s detailed understanding of Greek politics provide insight into the shifting dynamics of Greek politics, and the court of public opinion. He touches on an interesting irony in recent political events; which is that there is now more political unity in Greece in support of the Euro leaders’ agreement than the first two programs, yet the governments commitment to program implementation is the weakest since 2010. And yet while Saravelos is probably one of the few analysts with a good feel for what’s happening on the ground, he adds that conditions still remain highly uncertain.

Betting on more QQE in Japan

We liked this piece from UBS because it appears to run against a consensus view that the BoJ won’t be announcing any further quantitative easing anytime soon. We’ve highlighted research previously that suggests tinkering around the edges. UBS reckon the market is underpricing further BoJ easing and that forms one of the key pillars of their views that USDJPY is headed higher in the second-half of this year. That’s because inflation is at zero and they’ll have to ease again, probably in October or November. We thought we’d also highlight a couple of stories yesterday that add some colour to the debate. Firstly, this Reuters piece that quoted Kuroda say he expected inflation to accelerate ‘’considerably’’ in the coming months, and a Bloomberg piece entitled: BOJ Moves Goalposts on CPI, Supports Policy Stability.

China’s well rehearsed capital account play

While we highlighted a piece yesterday on the partial opening up of China’s capital account, we wanted to highlight this piece from GavekalDragonomics which was published late last week, before the announcement to open up the interbank bond market to selected foreign investors. Gavekal know and understand China better than most, and in this piece Chen Long has written a great piece that helps us understand the China approach to capital account liberalization, because there’s a great deal of subtlety involved. Too key points made are that the progress the Chinese authorities have already made is very under rated, and the end game here is not full-flown liberalization. Like many things in China, the capital account will come under a regime of ‘’managed’’ convertibility, while still achieving its end goal of the RMB being recognized as a major global currency and the Chinese financial markets are of global significance.

EM liquidity may trump the Fed effect

Although EM investors still face challenges from the strong US dollar and an upcoming Fed rate hike, the reality of on-going Chinese monetary easing will prove more important than mild US tightening, writes CrossBorderCapital in the EM edition of its Tactical Style Selection report. CBC
 are specialists in liquidity analysis and how this can be applied to tactical asset allocation. Based on latest liquidity data, Emerging Markets collectively show over 70% odds of being either in the favourable Rebound or Calm investment regimes traditionally high return, falling-volatility periods.

Why the RBA underestimated the labour market

The main macro event in Australia this week will be tomorrow’s speech from RBA Governor, Glenn Stevens, because it might shed some light on why the labour market is performing better than the Bank had expected, writes NAB’s Chief Economist, Ivan Colhoun in the Australian Markets Weekly. The RBA seems to have underestimated the improvement in the non-mining sector which is more than offsetting the weakness in the mining sector. This is especially visible in the labor market, says Colhoun. And given that the impact of the last two rate cuts hasn’t yet flowed through to the economy yet, NAB believes the RBA has finished cutting rates at 2%. All ears on Stevens tomorrow.

Cracking open China’s capital account

It seemed to go broadly unnoticed last week, but China broke open its interbank market to selected foreign investors thereby removing most barriers to investing in China’s bond market. As Sean Darby from Jefferies writes, Chinese authorities could easily widen the Shanghai-HK connect to accommodate government bond trading that takes place through the Shanghai exchange, thereby completely opening up the capital account. Darby explains the size and scope of the domestic bond market, some pilot program that it will initially operate under and the crucial role it will play in restructuring the SOE sector and the growing NPLs in the banking sector.