Markets on edge ahead of rates and more earnings

Summary

Caterpillar is the latest giant manufacturer to warn about trade conditions as stock markets pause ahead of policy decisions.

FX in focus

A new 13-month yuan low comes ahead of monetary policy announcements in Japan, the U.S. and the UK, setting up a potentially active week for forex. To an extent, directions are all but decided as renminbi’s persistent drift helps keep the greenback on course for a second straight monthly gain. Still, currency market patterns so far on Monday show there’s no open and shut case. Euro buyers are seeing renewed confidence after Friday’s minimally tarnished U.S. GDP failed to decisive break the $1.16 handle. The path of least resistance continues to look lower. Wednesday’s Fed statement will not be accompanied by economic projections or a press conference, reducing reasons for markets to discover new dollar-buying inflections. But we need only look at two-year bund/Treasury spread falling to a multi-decade low for a reminder that euro hurdles are still formidable. CFTC data showing longs declined to an almost even balance suggests large speculators are beginning to swim with a more bearish tide too. The euro to is on course for a fourth straight month lower.

BoJ’s busted flush

Likewise, it’s difficult to read too much into a thin yen offer, as it embarks on a potential third straight weekly rise. However, the Bank of Japan, the first policy setting to announce this week, has largely shown its hand: it floated a QE re-think then had to redouble bond buying after panic ensued. One special market operations was most clearly conducted just last Friday, though there are signs of further attempts to cap JGB yields on Monday. Under these circumstances it would be incongruous for the BoJ to confirm a move towards the exit from some of its QQE policy as early as Tuesday. Reduced inflation forecasts are the likeliest guess after CPI’s recent cratering. More detail of its yield curve rationale is also probable. An easier path lower for the yen is implied but safety seeking bids that have done much to underpin the currency for much of the month are very much around on Monday.

Nothing “neutral” about BoE

One seemingly clear-cut case of currency momentum would appear to be sterling. Economists almost unanimously forecast a 25-basis point Bank of England rate rise on Thursday. Even here though, waters are murky. The central bank intends to reveal further technical details of the thinking behind its need to tighten during a phase of ambivalent economic strength to prevent an inflation overshoot. For the first time, the Bank will reveal its “equilibrium” (or “neutral”/”natural”) rate. Governor Mark Carney said in May that a range of estimates would be provided and that these would change over time. In providing them, the risk is more, rather than less confusion. Nevertheless, in between times, markets are almost bound to gravitate towards any neutral rate that points to further tightening. The context in which this new form of guidance is being introduced is also telling. As ever, there’s no precise way to calibrate how sterling may move, but GBP/USD notably touched $1.4376 ahead of expected tightening in April. It may be that even a return to $1.33 would under-price the number of hikes implied by the BoE’s current neutral horizon.

Investors cautious

With so much to watch in foreign exchange and policy and after the latest yuan fall—albeit it was contained compared to earlier in July—perhaps it’s little surprise investors are hanging back from large position taking. In Europe, a wave of less than satisfactory quarterly releases also capped risk appetite. What’s more, sharp corrections in shares of Twitter and Facebook were the biggest challenge for some time to a prevailing bias for fast-growing internet technology groups. Unresolved trade tensions could complicate the re-emergence of more evenly balanced holdings, including less cyclical sectors and more ‘value’-seeking styles. Guesstimates of how the rising dollar may tax revenues, increasing outflows and tightening dollar conditions will also limit reallocation to emerging market strategies that have also been in demand in recent years. A third high-beta avenue in vogue has marked noticeable tops in June and July. The U.S.’s Russell 2000 index for lower-capitalised companies repeatedly stalled near record highs just under 1710. One big takeaway then is that trade concerns are the key perception risk alongside signs of the first corporate economic impact from large industrial earnings so far.

Caterpillar challenged

Caterpillar is another case in point. It also beat forecasts with robust second quarter growth, but the group’s commentary will keep questions about how sustainable growth could be going. Caterpillar shares were pointing higher at last look after a near 20% fall for the year. The group seemed to reaffirm earlier comments that it had seen the “high water mark” in pricing power as raw materials costs rise. The largest manufacturer of construction equipment warned that rising demand has proved to be a mixed blessing, with a “sharp increase in demand” contributing to “supply chain challenges”.