Week Ahead in FX: PBOC Inaction Triggers Global Market Sell Off

USD Weakens as China Fears Cloud Fed Rate Hike Outlook

The People’s Bank of China (PBOC) did not flex its monetary policy muscle over the weekend. The market had expected a reaction to the fall in the local stock market from the central bank. There was some speculation over the weekend that the PBOC would announce new stimulus measures, but instead the Chinese government will allow pension funds to invest in the stock market. The decision was met with disappointment by global markets and started a huge sell off across the board.

The two biggest outcome of China’s lack of action are the impact it could have on the Federal Reserve’s interest rate decision in September and the lower demand expectations hitting commodity prices. The economic indicators on deck this week will do little to address the market’s main concerns as all eyes, investors and central banks alike, are focused on China awaiting a new round of stimulus. The USD has lost traction versus the EUR, GBP and the JPY as safe haven flows and growing doubts about a September Fed rate hike increase.

Tuesday, August 25
10:00am USD CB Consumer Confidence
Wednesday, August 26
8:30am USD Core Durable Goods Orders
Thursday, August 27
4:30am GBP Second Estimate GDP
8:30am USD Prelim GDP
8:30amUSD Unemployment Claims
ALL DAY Jackson Hole Symposium
Friday, August 28
8:30am USD Goods Trade Balance
ALL DAY Jackson Hole Symposium

September Fed Rate Hike Further in Doubt

The minutes from the Federal Open Market Committee brought little insight as the market had fundamentally changed from the time when the Fed policy members met to last week when the notes were released. The China stock market rout deteriorated quickly and is now another dark cloud to add to the list of potential Fed interest rate hike stoppers. Employment continues to be the strongest pillar of the U.S. economy, but it cannot continue to improve forever as there is only so much it can go before hitting a ceiling. Other indicators have been mixed with retail sales recording volatile prints and the effects of a strong USD ballooning the U.S. trade deficit.

Fed members are still optimistic about one or even two rate hikes before the end of the year, yet those statement have not been recalibrated with what the market now knows about China. Former U.S. Treasury Secretary Larry Summers issued comments warning the Fed about what he considers a premature rate hike as it could risk the central bank fulfilling its three main objectives.

The Chicago Mercantile Exchange FedWatch tool will not be updated until later today, but up until yesterday it showed a 24% probability of a September rate hike, followed by 31% in October, and 49% in December. These probabilities are likely to be lower as futures positions changed during the course of the day.

Jackson Hole, Wyoming will host central bankers and policy makers from around the globe starting Thursday for the annual Federal Reserve Bank of Kansas City annual symposium. Fed Chair Janet Yellen will not attend, which will take away some of the potential impact, but the Fed has moved away from announcing major changes with Jackson Hole as the backdrop. The annual symposium rose in prominence as Chair Alan Greenspan and latter Ben Bernanke delivered major policy decision announcements, but as Bernanke’s term was ending he steered the Fed away from Jackson Hole announcements. This is trend that continues with Yellen.

The FX market will be caught between speculation and damage control until central banks, with the PBOC at the top of the list, expected to announce pro active measures to deal with lower demand and growth forecasts.

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