Markets Look For Clarity On Fed Regime Shift

Market movers today

Preliminary euro area HICP figures are due. After inflation surprised on the upside in July, we expect a very low reading for core inflation (our call: 0.2%) due to seasonal factors that relate to postponed summer sales periods in France and Italy. That also means we might see headline inflation dipping into negative territory for the first time since May 2016. However, as this is mostly due to base effects and government initiatives (German VAT cut), it should not create too many concerns at the ECB for now and inflation will likely rebound in September.

We also have July unemployment figures out of the euro area, while in Germany we will get a glimpse of the labour market report for August. PMI manufacturing data for August is also released for a number of European countries.

In the US, we will look out for FOMC member Brainard’s comments on average inflation targeting (at 19:00 CEST) and August ISM manufacturing figures. PMIs suggest another strong print.

The 60 second overview

Fed. In his speech yesterday, Fed vice chair Clarida more or less echoed Fed chair Powell stating that the Fed will not tighten monetary policy just because the labour market is tight but also that the Fed will not follow a ‘mechanical rule’ despite now aiming at overshooting 2% inflation for some time. Clarida also mentioned that he thinks inflation expectations are to the low side. Despite rising breakeven inflation rates in the US, inflation expectations remain too low if investors really believed the Fed is able to create 2% inflation, which puts pressure on the Fed to deliver something to build up credibility in the new regime right away.

Equities. The Wall Street rally took a breather yesterday after China threw a wrench into the efforts to buy TikTok. However, it still left S&P 500 with a fifth straight month of gains, as investors bet on central banks keeping the stimulus taps open for years to come. Asian stocks edged higher this morning after a strong Caixin PMI manufacturing reading boosted the mood.

FI. There has been a modest rise in European yields as well as modest spread widening between the core-EU and the periphery. 10Y US Treasuries is also stabilising at 0.7% after last week’s comments from Fed chair Powell regarding the new US policy regime with an average inflation target. The market still needs more information on how this policy will be implemented. Comments from one Fed official yesterday indicated that yield caps may be employed.

FX. NOK and EUR gained vis-à-vis SEK, USD and JPY yesterday on an otherwise quiet day in FX markets. Most notably EUR/USD rose to the highest level since 2018 close to 1.20 and EUR/NOK briefly fell to a new cycle low below 10.40. Overall, it is more-or-less a continuation of the trend seen over the past week.

Nordic macro and markets

The Danish government yesterday presented its budget proposal and revised forecast for 2021. The government proposes a structural deficit of 0.5% of GDP in 2021, the biggest deficit allowed under the budget act. That creates space for increased spending and/or tax cuts, but the government is primarily reserving that for a DKK9.2bn ‘war chest’ to be spent on health care or unspecified measures to support jobs and businesses. The government will need the support of several other parties to pass the budget, and negotiations traditionally last for months (see more in Danish government raises forecast and presents budget).

In Sweden we receive August PMI Manufacturing numbers, which should continue to improve somewhat or stabilise at the current level. Particularly interesting will be to see if there are any changes in the inflow of export orders since the latest COVID-19 outbreaks in the euro area.

Earlier this morning we released Danske Bank’s Boprisindikator (Housing Price Indicator) regarding the price trend for tenant-owned flats in Stockholm municipality, which showed a price increase of almost 2% in August (up 1.96% m/m and 1.0% m/m in seasonally adjusted terms). In Sweden overall, the entire decline caused by the COVID-19 pandemic has now reversed. However, Stockholm lags behind somewhat and is still down around 1% compared with the price level in February.

In Norway, the PMI has been pointing to a much gentler recovery in manufacturing than in other countries. To some extent, this probably has to do with the drop in activity in March/April not having been as steep, but it could also be a result of low inflows of new orders and high levels of uncertainty in oil-related industries. According to the latest oil investment survey, however, activity should now be picking up, so we expect the PMI to climb well above 50 in August.