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Week Ahead – ECB on Deck as Stimulus Debate Heats Up

Financial markets want to know if the Fed is committed to a sustained inflation overshoot. The bond market flattener trade suggests many market participants think we have seen the peak in yields. Inflationary pressures are showing no signs of easing just yet and the market will soon look to test the Fed’s patience. The dollar has been stuck in a tight trading range since the middle of June but that could soon change if the rest of the world shifts to a tightening mode more quickly than the Fed.

The upcoming week is filled with many catalysts that stem from a deadline to finalize a bipartisan infrastructure package, persistent global delta variant concerns, widespread inflationary pressures, central bank rate decisions, and a busy week of earnings results. The main event will be the ECB rate decision and press conference. This will be the first meeting since their strategy review that aimed for a slightly higher inflation target. It appears that a divide is growing in the ECB over stimulus guidance, a sign that the hawks will be strongly push for tightening in the fall.

All eyes will be on England after UK PM Johnson has decided to move forward in lifting most pandemic restrictions on July 19th. The UK has had one of the best COVID-19 vaccination campaigns in the world, with more than 46 million people having received at least one dose of coronavirus vaccine. BOE’s Saunders noted that withdrawing stimulus measures may be appropriate soon. Deputy Governor Ramsden stated “envisage those conditions for considering tightening being met somewhat sooner than I had previously thought.” Currency traders will pay close attention to BOE’s Haskel on Monday to see if the bank is quickly shifting to taper mode.

Country

US

Wall Street had a very choppy trading week after a mixed start to earnings season, a dovish semi-annual monetary policy testimony from Fed Chair Powell, and fading confidence from the US consumer.  When the dust settled the dollar was stronger, Treasury yields were lower, but confidence in risky assets started to wane.  The second week of earnings will provide a broader look into several sectors of the economy, which might support the argument that inflation is looking more persistent.

Wall Street will closely follow every development with the bipartisan infrastructure proposal on Capitol Hill.  Senate Majority Leader Schumer will try to deliver on his ambitious timeline to get this bill passed.   A key procedural step should occur on Monday and that could set up an initial vote on Wednesday for the $579 billion infrastructure deal.

With the Fed entering the blackout period ahead of the July 29th FOMC policy decision, it is a busy week of economic data, but nothing like the past one. On Monday, the NAHB housing market index is expected to tick higher to 82, still well off the highs seen at the end of last year.  On Tuesday, both Building Permits and Housing Starts should post modest gains, a sign the housing market isn’t ready to cool.  Thursday is all about weekly initial jobless claims and if the rate of decline can speed up.  Friday is all about the flash PMI readings which should show steady activity in both the manufacturing and service sectors.

EU

The ECB holds its monetary policy meeting on Thursday, and the central bank is widely expected to implement significant changes in monetary policy. The July meeting was expected to be a non-event, but the release of the ECB’s strategy review last week has the markets buzzing since the Thursday meeting should provide more clarity on how the bank plans to implement this new strategy.

At the presentation of the strategy review, ECB President Christine Lagarde said that there would be a review of forward guidance to align it to the strategy review. This means that we could see some important changes in forward guidance at the meeting.

The strategy review has changed the inflation target from “below, but close to 2%”, to “2%”, and also stated that the bank is willing to accept “a transitory period in which inflation is moderately above target.” The ECB is likely to incorporate these changes in its forward guidance.

The ECB is unlikely to increase the size of bond purchases through the Pandemic Emergency Purchase Programme at this meeting but may indicate that these purchases will be increased in September.

On Friday, Germany releases July PMI reports. Manufacturing PMI is forecast to come in at 65.0, while the estimate for Services PMI stands at 60.0 points. Both of these estimates are indicative of strong growth.

UK

On Monday, the government is scheduled to lift all Covid restrictions, with mask-wearing and social distancing optional but not mandatory. However, there is opposition from health officials who fear the move could lead to a surge in Covid infections. As well, the mayor of London has said that passengers on public transport will still be required to wear masks.

BoE member Jonathan Haskel will deliver a speech at the University of Liverpool School of Management, on the topic “Will the pandemic scar the economy?”

On Tuesday, U.K. Business Secretary Kwasi Kwarteng testifies before a parliamentary committee on how to protect the nation’s steel industry following the massive collapse of Greensill Capital.

The week finishes on a busy note. The consensus for UK Retail Sales for June is 0.4% MoM and 9.8% YoY. The July PMIs are projected to remain well into expansionary territory, with a forecast of 62.0 for Manufacturing PMI and 62.5 for Services PMI.

Emerging Markets

Russia

On Friday, the Bank of Russia holds a policy meeting. The central bank may tighten policy and raise interest rates by 75 basis points or more, with inflation running well above the bank’s target of 4.0%. In June, the bank raised rates from 5.0% to 5.5% 

South Africa

South Africa releases June CPI on Wednesday. The consensus stands at 4.8% YoY, down from 5.2% in May.

On Thursday, the South African Reserve Bank is expected to keep interest rates unchanged at 3.50%.

Asia Pacific

China

The afterglow from last Friday’s RRR cut has quickly faded. China data this past week appeared to show the economic recovery slowing. Washington DC is ramping up the anti-HK and Xinjiang and adding more China tech companies to the entity list. Additionally, China announced tighter supervision of property developer debt levels and continues broadening its China-tech clampdown.

Unsurprisingly, China equities are struggling to maintain gains in this environment with Covid-19 swirling around the rest of Asia adding to the gloom. The PBOC has moved to a weaker Yuan bias and slighter softer policy and that means that China’s one and three-year Loan Prime Rates will remain unchanged this week.