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Price action slows ahead of Fed decision

Markets are looking essentially directionless as traders batten the hatches ahead of this afternoon’s Federal Reserve decision. The dollar is seeing some selling, but is holding near a two-week trade-weighted high against high-beta currencies and the euro, equity futures are mixed, and Treasuries are broadly flat. 

North America

Today’s biggest macroeconomic event will occur around 1:30 this afternoon, when the Bank of Canada is scheduled to release a summary of deliberations from its early July meeting. I kid: most market participants (including myself) will likely be too busy shotgunning espresso ahead of the Fed decision to pay it much heed – and Governor Macklem has already told us that policymakers debated staying on hold before deciding to hike rates in response to signs of economic overheating.

At 2:00, the Federal Reserve will deliver what could prove to be the final rate hike in this policy cycle. Chair Jerome Powell is likely to maintain a hawkish rhetorical bias while shifting the central bank onto a data dependent footing, emphasizing signs of persistent strength in labour markets and the economy even as he acknowledges progress toward the central bank’s inflation objective – but we suspect investors will revert to type in reading his words through dove-tinted glasses, setting the stage for some turbulence during the post-decision news conference.

Tomorrow morning, the Bureau of Economic Analysis will release its first estimate of second-quarter growth. Forecasters think output expanded more slowly between April and June, with the economy growing at a 1.7-percent annualized pace, down from 2 percent in the first three months of the year – but idiosyncratic changes in business investment, inventories, and exports could generate some unexpected results.

Friday will bring personal income and spending numbers, with the consensus expecting to see a continued moderation in consumer demand driving a deceleration in the Fed’s targeted inflation benchmark. The core personal consumption expenditures index is seen rising 0.2 percent in June over the prior month, up 4.2 percent over last year. The central bank’s preferred wage price measure – the Employment Cost Index will follow shortly thereafter, with markets anticipating a 1.1-percent increase in wages and benefits in the second quarter, with an easing in pressures helping assuage worries about an incipient wage-price spiral in the US economy.

Europe

On a trade-weighted basis, the euro is down almost 1.3 percent this week, with investors expressing increasing scepticism on the European Central Bank’s monetary tightening trajectory. Yesterday, the central bank said corporate loan demand had fallen to the lowest on record last quarter, with more weakness expected in the months ahead as credit conditions continue to tighten. This added to Monday’s appallingly-weak purchasing manager index numbers in suggesting that central bank is about to hike rates into a profound slowdown and triggered post-traumatic stress disorder in traders who experienced similar episodes in 2008 and 2011.

Tomorrow’s European Central Bank meeting will be similar to the Fed’s in that it won’t be what policymakers do, but rather what they say that is most meaningful for markets. A quarter-point hike is fully priced in, but considerable uncertainty remains around whether President Christine Lagarde will bow to the dwindling number of hawks on the Governing Council by explicitly signalling more to come – or if she will move to a more data-dependent footing and open the door to a pause at the September meeting. European yields broke lower last week after typically-hawkish Council member Klaas Knot told Bloomberg that an autumn hike would “at most be a possibility, and by no means a certainty” – and we suspect Lagarde will follow suit with similar language.

The pound remains rangebound below the 1.30 mark as investors hedge their bets ahead of the Bank of England’s August 3 meeting. After implied market expectations solidified around a half-point move in mid-June, investors are now closer to assuming a quarter-point hike – but the landscape could shift again if global yields move in sympathy after this afternoon’s Fed decision, and technical positioning suggests the currency could try to make a break higher on any improvement in relative rate differentials. 

Asia Pacific

Implied volatility has ratcheted up around tomorrow evening’s Bank of Japan meeting, with some market participants hedging against a reappraisal of the central bank’s long-standing yield curve control policy. As discussed in yesterday’s missive, we don’t think Governor Ueda is likely to announce any major changes after having spent the last few months saying that inflation pressures won’t be sustained – but the monetary mischief-makers at the Bank of Japan have a long history of wrong-footing markets, so nothing can be ruled out.

Oil prices are up incrementally on expectations for more stimulus from Chinese authorities after a meeting of the Communist Party politburo resulted in a series of pledges to boost consumption and reduce strain on local governments.Although the measures proposed – “countercyclical” policy to lift consumer demand for vehicles and electronics, monetary easing and reduced restrictions on property developers – fell short of overall market expectations, the direction of travel has supported forecasts for a modest recovery in growth and energy consumption by year end.

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