Hold on a minutes

FOMC signals tapering is on the way

The overnight release of the FOMC Minutes provided some drama, with the committee members mostly lining up behind a tapering of quantitative easing sooner rather than later. Although caution was expressed about the potential impact of the Covid-19 delta-variant on the recovery, most of the discussion appears to be around timing. Views were split over starting into the end of the year or early next. That seems to be rather splitting hairs to me as to whether tapering commences in late Q4 or early Q1, which makes little difference; the fact is, Fed tapering looks likely to start in a few months.

The procession of Fed officials making up the FOMC who have made hawkish comments since the FOMC meeting, especially after the blockbuster Non-Farm Payrolls released at the start of August, would appear to swing the likelihood of tapering in December. Next week’s Jackson Hole Symposium may give markets more visibility on the Fed’s current thinking, and if not, the September FOMC meeting certainly will.

Of course, this does not mean that US interest rate hikes will also be arriving sooner than later. But the start of divergence of monetary policy between the United States and most of the rest of the world, notably Europe and Asia, will have implications, especially in the currency space. The US dollar continued its rally in Asia today, spiking higher in early trading. Most likely, that was because EUR/USD fell through 1.1700, triggering stop losses, but its strength is broad-based across the G-10 and DM space. With Europe and Japan on hold and QE-ing forever, both will be vulnerable in the medium to longer term.

With ASEAN interest rates at rock bottom, and with no room to think about tightening as delta rips through the region, will face challenges. Monetary policy running on empty across the region. However, going into Q4, if the US dollar keeps rising and the US bond market finally starts reacting to that new reality, moving US yields higher, much of Asia may find itself in a monetary bind. Although bulging with foreign currency reserves, it will be a tough choice by either running down those reserves intervening to protect their currencies or facing imported inflation. I believe that option two will win, with a bit of option one deployed tactically, aka South Korea, to keep everybody honest. Thus, I expect Asian currencies to weaken through Q4.

The first regional central bank to face that conundrum, and one that perpetually does, is Indonesia. Bank Indonesia releases its latest interest rate policy decision this afternoon. Indonesia’s recovery has taken and continues to take a massive hit from the wave of Covid-19 sweeping the archipelago. Don’t take the falling cases at face value; the pandemic has moved out of Java and Bali, and testing numbers have tanked. Although further monetary policy transmission via rate cuts likely has a declining marginal utility at these record low levels, BI will have one eye on the value of the rupiah (IDR). They said as much themselves at the last meeting, and I expect them to hold at 3.50% today and be on hold for the foreseeable future. BI will probably encourage local banks to get out there and lend. But as usual, the universe of credit-worthy opportunities at scale is somewhat limited. BI may provide some incentives to encourage banks to offset their rate bind. USD/IDR should continue bubbling under 14,500.00, but if it rises to BI’s line in the sand near 15,000.00 in the coming weeks, things will start getting interesting for the BI.

Australian Unemployment has just been released and given the scale of lockdowns across the country now, the data was surprisingly positive. 2,200 jobs were added in July, an excellent result in the circumstances. The Unemployment Rate fell to 4.60% versus 5.0% expected, a great result. Labour force participation remained steady at 66.0%, slightly lower than last month’s 66.2%. I’ll need to wrap a cold towel around my head to figure out how almost no change in jobs and steady labour force participation led to a 0.40% drop in unemployment. I’ll get back to you. The reaction to the data has been muted as local equities, and AUD/USD react to US dollar strength and spiralling Covid-19 cases in New South Wales and a disturbing increase in Victoria.

The data calendar is quiet today in Asia, Bank Indonesia aside, and pretty flat globally. Norway’s central bank could beat New Zealand to the finish tape and start rate hikes today; the market seems indecisive on this one. US Initial Jobless Claims, should they fall markedly from last week’s 375,000, could provoke more US dollar buying and equity sellers given the post-FOMC taper minutes mood.

One other thing that caught my eye in the last 24 hours was yesterday’s comments from China’s President Xi. President Xi outlined thoughts on what is described as “common prosperity” and what can only be described as redistributing wealth. Against the background of China’s regulatory interventions and Chinese company’s rocky IPO environment at the moment, this will be another dark cloud for China equity prices. The bottom fishing evident across equity markets yesterday in Asia has run out of steam quickly today, with Asia back to following the US lead. I will reiterate; eventually, Chinese equity prices will fall to levels that offset the multitude of governmental risks they now face. That process has not finished yet.

On one final note, it is Mrs Halley’s birthday next week. Our last attempt at exploring the island of Sumba was rudely interrupted by both of us catching Covid-19 (despite being vaccinated). It won’t be Sumba tomorrow, but we shall be heading to another more famous island (within Indonesia) tomorrow to support their economy, as she will not be denied her birthday. Like MacArthur, I shall return; on Monday, August 30th.

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