It’s been a quiet couple of weeks in markets with most of the action happening in FX. The Euro keeps on going from strength to strength and is now trading above $1.19. The upward trajectory of the Euro is the opposite of what the market was expecting – that is, a stronger USD against all major currencies.
A similar series of events is playing out in the 10-year US government bond market, which has experienced a bond prices rally as yields fall. These are strange events given the current environment of rising interest rates, tighter labour markets and higher inflation. I don't think that the rally in US bonds will last. Although I may be eating my words in a few weeks’ time.
Yellen’s red flag to Trump
Janet Yellen made an interesting speech at Jackson Hole last week, during which she praised the regulatory reforms implemented since the global financial crisis. She also made an implicit plea to lawmakers not to roll the changes back. This is like a red rag to a bull when it comes to Trump, who has made the rolling back of such regulation the centre-piece of his presidency.
Interestingly, her speech didn't contain a single reference to the risks that the current level of asset prices pose to financial stability, let alone any mention of the outlook for monetary policy.
At the same conference in Jackson Hole the European Central Bank (ECB) President Draghi was similarly tight-lipped on his outlook for monetary policy. He backed Ms Yellen's warning against winding back financial regulation, and said that free trade was needed to boost growth and deal with the fallout of ageing societies. Policy makers, it seems, have opted for "co-ordinated silence" on monetary policy.
Mr Draghi was neither hawkish nor dovish on the Euro and Eurozone, and his failure to "talk down" the Euro (despite the ECB's well-documented concerns about its strength) added to the bullish mood surrounding the currency.
There is a real fear of “stressing” market conditions ahead as various central banks prepare to release key quantitative tightening messages. This includes the US Federal Reserve in September and the ECB, which will probably come gradually over the rest of the year.
Stressing times ahead
A sharp fall in crude oil supply during the last month provides further evidence that the market is finally rebalancing. However, supply levels are unlikely to fall as quickly as the market had hoped thanks to the US shale industry which has ramped up production by more than expected. This helps explain the somewhat muted response of the oil price to the decreasing inventory.
Further, output in Nigeria and Libya has increased since the start of the year and it’s enough to offset almost a third of the supply cuts by the rest of OPEC and its partners. At the same time, compliance with the output cuts by other OPEC members is deteriorating.
Positive China data
This Thursday will see the release of China’s "official" manufacturing PMI, with the Caixin/Markit figures to follow on Friday. I expect both indices to have picked up in August. This will give support to the Aussie Dollar and our equity market.
Most early measures of Chinese activity point to growth having risen this month and recent moves in industrial metal prices are consistent with a slight rise in manufacturing activity.
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