Economists are catching up with reality on inflation
Five big themes likely to dominate thinking of investors and traders in the coming week
1. Elusive inflation
Inflation remains elusive in both the United States and the euro zone, complicating efforts to normalise monetary policy after years of extraordinary stimulus. US inflation will get another reading on Sept. 14 with a Reuters poll of economists forecasting prices in August rose 0.3%. Stripping out the volatile food and energy components, core CPI is expected to rise 1.6% in the 12 months through August, still well below the US Federal Reserve’s 2% target. Are the economists getting better at forecasting inflation in the United States, the European Union or the G10 overall for that matter? The Citigroup Inflation Surprise index for the United States is showing the data is still coming in below forecasts. When the surprise index readings are negative or move to zero and inflation remains low, that means forecasters are catching up with reality and incorporating low inflation into their asset price calculations.
2. I’ll have some of yours
While the European Central Bank struggles with low inflation and a strong currency that exacerbates the problem, the Bank of England, which meets in the coming week, faces the opposite scenario – above-target inflation and a pound that some see falling to parity with the euro. Whether parity ever happens is unclear, but there are few obstacles on the chart, other than the 93.65 pence peak hit during sterling’s “flash crash” last October. Traders cite the possibility BoE policymakers might express concern about the weak pound’s impact on inflation for a slowing in the build-up of best against the currency. The possibility of parity may also play into the debate on the merits or otherwise of Britain’s choice to leave the European Union. August inflation data is due on Sept. 12 and is expected to show consumer prices rose 2.8% year on year, compared with 2.6% in July.
3. Don’t bank on rate hikes
If anyone needs a “normalisation” of monetary policy, it’s the banks. Earlier this year, as an improving global economy brought the prospect of steadily rising interest rates, investors scooped up bank shares in a big bet on recovery. Yet, as ECB President Mario Draghi made clear after its latest policy meeting, rate hikes, which have a major impact on lenders’ revenue and profits, remain a distant prospect in the euro zone. An index of bank stocks has underperformed the wider market. Not that everyone is giving up on banks. With euro zone growth picking up so, eventually, must interest rates.
4. China’s yuan – the safe trade
Is the yuan’s sudden surge driven by a bid for safe havens against North Korea’s nuclear threats? Or has the market taken on board the People’s Bank of China’s desire to root out depreciation expectations? The currency had its best monthly gains ever in August and has wiped out all of the 6.5% losses it suffered against the dollar in 2016. Its rise immediately after North Korea’s sixth nuclear test on Sept. 3 was two standard deviations more than average daily moves in the past year, far outpacing the gains seen in the yen and gold. Other Asian currencies are riding on the yuan’s coat-tails and the sharp appreciation has led to a rush of foreign money into Chinese stock and bond markets, raising questions about how far China’s SAFE, or State Administration of Foreign Exchange, will let the yuan rise before announcing some form of trading or capital flow restrictions. FX reserves rose $11 billion in August, suggesting the PBOC might have reined in the currency through some form of intervention. But it can’t do more without giving Washington the ammunition to complain about currency manipulation.
5. Run, ruble, run
Russia’s central bank will ponder a cut in its key rate to as low as 8.5% when policymakers meet on Friday, according to a senior official. The bank has already flagged that rate cuts are on the cards. But the ruble has enjoyed support from investors who were snapping up Russian treasury bonds on expectations the central bank would cut rates more than previously thought. Brazil’s 100 basis point rate cut on Wednesday has ramped up the pressure, leaving Russia in the top spot for the highest forward-looking real interest rate among major emerging market economies.