With the can apparently being kicked just far enough down the road to push the Greek drama off center stage, the diverging monetary policies reemerged this week as a key force. Yellen and Carney’s comments underscore that less accommodative monetary policies are coming for the US and UK, while much of the rest of the high income countries (and many emerging markets) are still in an easing mode.
The dollar gained on all major currencies this week but sterling, which is up about 0.8% on the week. Carney’s comment yesterday that a rate hike will come into sharper focus at the end of 2015. Since the middle of last week, the March and June 2016 short-sterling futures contracts have sold-off sharply, and the implied interest rates have risen 20-23 bp. The backing up of interest rates has driven the broad trade-weighted sterling index to new highs since 2008. It has risen by more than 2% during this increase in rate expectations.
The near-term developments in Greece are constructive. European officials have agreed on a guarantee for non-EMU countries in the 7 bln euro bridge loan. Parliaments are approving the beginning of negotiations with Greece over a third aid package. The German vote is still pending. Despite some defects from both of the main coalition parties, and Schaeuble’s continued (since 2011) support for a Greek exit, will be approved by parliament.
The conditions then are in place for Greece to make next week’s payments to the IMF and the ECB. With the ELA being doled out again, Greek banks are set to open on Monday. More ELA is likely to be granted next week as well. This coupled with a rally in Greek bonds (where the domestic market has largely been shut as well for the past three weeks) will help support the banks. Capital controls will have to remain. The history of capital controls warn that when adopted, they tend to last longer than anticipated.
It is too early to reach hard long-term conclusions about Greece’s third aid package. European officials say the IMF’s role is essential, and the IMF says that Greece’s debt is categorically unsustainable, without significant debt relief. This is going to have to be worked out in the negotiations in the coming weeks. This fissure between the IMF and European officials has been exposed by the Greek referendum. Greece’s uncompetitive economy and debt challenges have been a recurring theme for a few decades and most, like ourselves, are skeptical that Europe has solved the problem.
In addition to Greece, the sharp drop Chinese shares had also pushed the divergence theme off center stage. With a panicked strong policy response, Chinese stocks have stabilized. The Shanghai Composite rose 3.5% today and 2% for the week. The smaller cap Shenzhen Composite rose 5% today and 7.6% on the week. The number of companies whose shares are not trading has been halved this week to about 635, according to reports.
The main feature of the North American session is the US CPI. The headline is expected to post its first year-over-year rise since last December. The core rate is also expected to tick up to 1.8% from 1.7%. Since last August, US core CPI has been between 1.6% and 1.8%. It tends to run a bit higher than the Fed’s target measure of core PCE deflator. In May the core PCE deflator stood at 1.2%, with the 3-month average at 1.3%. As we have noted, the Fed embraces the Philips Curve, which pushes the focus back to the labor market. The Fed has “reasonable confidence” that as labor market slack continues to be absorbed, wage pressure will grow (Yellen already see preliminary signs) and this will push up core inflation over time.
Canada also reports CPI today. The Bank of Canada cut rates this week, and left the door open to additional moves. However, unlike many other central banks that are easing policy, the Bank of Canada is not being driven by deflation concerns but growth challenges. This takes some of the potential thunder away from the CPI report, which is expected to see the headline rate rise to 1.0%(from 0.9%), while the core rate remains steady at 2.2%.
Into the weekend, it should not be surprising to see some profit-taking on long dollar positions. The euro can firm into the $1.0925-50 area. Today is the sixth consecutive session that the dollar has made higher highs against the yen. The dollar has averaged about JPY123.75 this week after averaging just below JPY122 last week. That said, the dollar has lost some momentum above JPY124, and a modest pullback seems likely ahead of the weekend. For its part, sterling tried but failed to record a new high for the week today. Here too a bit of profit-taking can see sterling ease back toward $1.5580-$1.5600. The implication is that is may see some pressure coming from the crosses.
Ironically, the Australian dollar is the second best performing currency against the dollar this week after sterling. It can recover toward $0.7420-40. The Canadian dollar is flat and can lick its self-inflicted wounds in narrow ranges, with the greenback likely to remain below CAD1.30 ahead of the weekend.