Even though the last FOMC minutes are seen as more dovish than expected by the market, we cannot rule out a September rate hike… and definitely not a December one. However, in our opinion, the odds are now skewed toward December rather than September. Let’s quickly review the Fed’s thinking about inflation and the job market.
Let’s start with the good news, Fed members “agreed that labour market conditions had improved further” as unemployment rate reached 5.3% in June. However, several members are still concerned about the high number of workers not actively searching for jobs, together with a decline in the participation rate. In addition, increase in wage gains remained subdued. All in all, participants are confident that market labour slack will continue to diminish but the real threat to a September rate hike is inflation outlook.
Inflation is the major concern to Fed members and unfortunately the outlook does not look great. The minutes say that “Some participants expressed the view that the incoming information had not yet provided grounds for reasonable confidence that inflation would move back to 2 percent over the medium term” while "Some participants, however, emphasized that the economy had made significant progress over the past few years and viewed the economic conditions for beginning to increase the target range for the federal funds rate as having been met or were confident that they would be met shortly”. As you can see, Fed members are pretty much divided and do not have the same view about inflation outlook. Looking at the latest figures, July core inflation came in below expectations with a reading at 0.1%m/m versus 0.2% consensus and previous read (stable at 1.8y/y). Fed’s favourite measure, the PCE deflator, printed stable at 0.3%y/y while the core indicators came in at 1.3%y/y for June, flat compared to May. In our opinion, weak inflation outlook will retain the Fed from raising rate in September, we therefore favours a December rate hike. As Fed members put it: “Most judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point”.
Mexico: Q2 GDP (by Yann Quelenn)
The Mexican Q2 GDP will be released today. It is expected to come in at 2.0% year-on-year, down from the first quarter which printed at 2.5%. The Mexican peso is now at its lowest level ever against the greenback. It is currently trading at an average of 16.50 and we think that USDMXN will head further north.
The major issue is that Mexico is struggling to find investors for exploiting its huge oil reserves. Over the past twenty years, the country did not have the ability to invest in its own infrastructures. Therefore the country has been forced to open up its petroleum business to private and foreign investors. Unfortunately the country is hit by the lingering oil commodity prices. The WTI crude oil is now ready to hit $40 a barrel.
The peso has been constantly dropping against the dollar for four years. Then Banxico is trying to stabilize the currency. For example it auctioned $233 million Wednesday in order to prevent the currency to go even lower but for the time being the downside momentum on the Peso seems way too strong. It is also worth adding that the current strong demand for dollars lowers the Mexican currency as expectations about a rise in U.S. interest rate increase day after day. However we remain suspicious on a September rate hike. If it does not happen this would provide some relief to the Peso. However, this would only be temporary as expectations for December will grow. Mexico is not only struggling with its own economy but also with the high expectations that markets expect from the first world economy.
Banxico will decide about the overnight rate the 21st of September few days after the FOMC rate decision on the 17th. We do not think that the Central Bank of Mexico will increase its rate to prevent its currency to go lower as the Mexican Economy is really at stake. For the time being, attracting investors for Mexico is the primary issue. We remain highly bullish on the USDMXN that should reach 17 within the next few weeks.
Swiss tarde data (by Peter Rosenstreich)
More bad news from Switzerland. Today’s weak trade balanced showed that exports to Europe decelerated further while trade to Asia is now slowing (big decrease in exports to China and Hong Kong). Swiss trade balance in July rose to 3.74bn from a revised lower 3.51bn. Exports dropped -1.7% and imports slowed by -2.5%. Swiss economic outlook continues to deteriorate as growth in the Eurozone (Switzerland largest trading partner) has not offset the negative effect of a strong CHF. In addition, evidence that the demand slowdown in Asia is now effecting Switzerland. The Swiss luxury brands in Asia had been one of the resilient area. The SNB anticipates the economy to grow by “just under 1%” yet clearly there is increasing downside risk to this forecast. Unfortunately for the Swiss central bank there is limited options available to help revive its economic situation. We suspect that the SNB is now praying for September Fed rate hike. We remain bearish on the CHF against G10 as domestic economic condition looks weak and easy monetary policy will encourage use to fund policy divergence trades.
