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The Long Road to Neutral - Global Exchanges

FICC Podcasts 08 juin 2021
FICC Podcasts 08 juin 2021

 

Disponible en anglais seulement

In this week's episode, Greg Anderson and Stephen Gallo talk about the long list of central bank policy meetings in June and what they may mean for FX markets over the summer.  


 

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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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*Disponible en anglais seulement

Greg Anderson:

Hi, welcome to episode 11 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my cohost Stephen Gallo and I will be talking about the long list of central bank policy meetings in June and what they may mean for FX markets over the summer. The title for this episode is, the long road to neutral.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's cohost.

Stephen Gallo:

In each weekly podcasts like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodity.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to B-M-O-C-M.com/globalexchanges. Thanks for joining us.

Speaker 4:

The views expressed here are those are the participants and not those of BMO Capital Markets, it's affiliates or subsidiaries.

Stephen Gallo:

Well Greg, we are on the 8th of June, 2021. We're getting close to winding down calendar Q2, and I have to confess that I'm in two minds about these central banks. And of course, I'm going to note that June is an exceptionally busy month for central bank rate decisions. We've already had the RBA. We look forward to the BOC and the European Central Bank this week. Next week, we have the all-important Fed rate decision and corresponding forecast revisions from Fed participants and following the Fed or the Swiss National Bank and the BOJ, and then the following week, the Bank of England. But going back to my earlier remark, I'm in two minds because the emergency portion of the pandemic is clearly behind us. Risk assets look very well supported. Financial conditions are very loose. We've got signs of excess demand from all this stimulus, but at the same time, we're still seeing unprecedented fiscal policy support and debt creation by governments. So how do the central banks handle all of this other than with great care? I guess that would be my question, Greg.

Greg Anderson:

I saw what you did there, Stephen. You knew that if you ended with, "How do the central banks handle this?" I'd say just one word, "Carefully." You rescued our listeners from that. Look, since you went through the central bank meetings chronologically, I'll try to keep with that and start with the RBA and BOC, which I have primary coverage for. On June 1st, the RBA, mostly punted ahead to their July 6th meeting. Governor Lowe indicated in his statement that that would be the date when they would communicate about their bond purchase program, which is presently slated to end in September. My best guess is that will announce a new bond purchase program that will run for, let's say three to six months after this one ends, but with a reduced or tapered amount of purchases. I think the RBA punted, because they wanted to be behind rather than ahead of the Fed on the taper topic.

Greg Anderson:

With regards to FX specifically, Lowe also did one subtle thing with this statement where in previous statements this year, he had talked about commodity prices being higher and Aussie being stronger. In the same paragraph, sort of linking the two, this latest time he separated the two thoughts into two separate paragraphs and in AUD he said, and I'll quote directly, "The AUD remains in the upper end of the range of recent years." So no linkage to commodity prices being the reason. I don't want to read too much into that, but it's an interesting subtlety for sure.

Stephen Gallo:

That's a really good synopsis and run through, Greg. I guess you used the taper word, which the RBA did not use. And a number of central banks refused to use the tape of word. But based on what you said about the RBA, do you think that the Bank of Canada can learn anything from the RBA, Greg?

Greg Anderson:

First off, no central bank is going to use the T word; take the E out of taper and it becomes a four-letter word. And I think every central bank will avoid using it along with other interesting four letter words. For the BOC this week, the interest rate announcement is the main thing, because there will be no MPR update or press conference. And for FX, the whole drama should center around how the BOC chooses to talk about (or not talk about) the FX move since the last meeting on April 21st. In the interest rate announcement from that date, this is what the BOC said, "The global recovery has lifted commodity prices, including oil contributing to the strength of the CAD." Look, that statement is 100% correct, that rising commodity prices are putting upward pressure on commodity currencies. But Lowe just showed the BOC a way to not lie, but at the same time, not appear to be apathetic to currency strength.

Greg Anderson:

CAD is up 4% since the last BOC meeting. And it lines up just about right with the 10% rally in WCS grade crude or the 10% rally in the broader Bloomberg commodity price index. But the question is, will the BOC continue to link the two or will it separate them like Lowe did and thereby do less waving of the green flag or full speed ahead flag for the CAD rally? That's the key issue for tomorrow. I think USDDCAD might move a big figure one way or the other, depending on how this subtle issue is dealt with. Keeping with the chronological order, I think you're up next with the ECB, Stephen.

Stephen Gallo:

Yes, that's right, Greg. ECB up after the BOC. And what I would simply argue is that the ECB seems to have used a combination of its bond purchases in Q2 and ECB officials have used their rhetoric, their public remarks, to take some of the upside out of longer-term yields and some of the steepness out of various yield curves to the point that the FX and rates markets are basically priced for virtually zero discussion from the ECB concerning the exit strategy this week. The other thing worth noting is that with the Fed now talking about talking about tapering,or whatever it is they call it, remember, that at the April press conference, Christine Lagarde of the ECB went out of her way to say that the ECB would not move in tandem with the Fed on policy normalization. So if the ECB were to come in in this week and just simply flip the tables on all that, I think there'd be considerable upset in the bond markets and considerable volatility.

Stephen Gallo:

I guess the only thing I would add is that even though the ECB probably does not want to signal an important policy shift at this week's meeting, it may subtly indicate that there's scope for the central bank to moderate the pace of bond purchases in Q3 as we head into the less active more illiquid months of the year.

Greg Anderson:

Okay. So Stephen, has the ECB's view on inflation shifted with the numbers. And can you bring this all back to what it might mean for the Euro?

Stephen Gallo:

Those are both good questions, Greg. Well, first off on inflation, the ECB went out of its way at least once in the opening statement in April to describe the recent drivers of the move higher and CPI inflation as temporary. I think it will probably do that again. And that certainly gives the central bank flexibility to continue to respond with its asset purchases. But here's an important point, and if I were a European bond trader, this is what I would be really focusing on this Thursday. Is the ECB sending clear signals to the financial markets that it's going to be more comfortable or more willing to tolerate above target inflation for longer? That would be an important shift in the ECB's thinking. Now, we're waiting for the ECB strategy review, which is expected to finish later this year. But if the ECB were to start dropping hints that it's more open to above target inflation, that is something that could prevent some yield curves in Europe from flattening.

Stephen Gallo:

So it may keep some steepness built in to some of the relevant yield curves. As for the exchange rate and the Euro, look, I think based on what I've been mentioning regarding the ECB, I think for the Euro things cut both ways. So on the one hand, a supportive ECB, an ECB that's not rushing for the exit, it certainly restrains Euro appreciation - and we'll probably get at least one mention of attentiveness to the exchange rate from Lagarde on Thursday. But at the same time, I guess on the other hand, a supportive ECB also bolsters credit markets, it keeps spreads relatively tight. It supports the risk trade and therefore indirectly, it supports EURUSD. So I'm not looking for this ECB to be a range breaker for EURUSD I think we're going to be probably something like 1.250/1.2300 for the time being, unless of course we get some type of a breakout move in the USD.

Greg Anderson:

So I guess I'm up next with it's on the June 16th FOMC. As you noted at the outset, it is a meeting that includes an updated summary of economic projections. So we get new dots. In the last SOEP the median dot fell in 2024 meaning that the first Fed rate hike should according to the median participants be in 2024. However, there were 7 of 18 participants who put the first hike in 2023. So we just need two participants to pull their dots forward into 2023 and then the median moves forward into that year. I could easily see that happening. That's drama point number one to watch out for. The second thing that I think FX markets will be watching is whether the Fed raises the IOER rate by five basis points due to so many overnight rates being at basically 0.00.

Greg Anderson:

Previous IOER tweaks were announced at policy meetings so that Powell could explain them. But I point out that this is something that could be done separate from policy meeting and maybe will this time. I guess I'm a little skeptical that the Fed does anything on this issue. But I wouldn't run out and buy dollars if they did, because it wouldn't be a huge shock. The last thing to note, and this is something that might cause me to be a little less dollar bearish depending on the outcome is the whole taper topic. In April Powell reiterated that it was still too soon to talk about talking about dialing back because we can't say the T word, dialing back QE, but since then a couple of Fed speakers have talked about talking about it. Powell will inevitably get this question right at the outset of the presser.

Greg Anderson:

And I think he will acknowledge that the Fed did talk about it. However, I think he will say that the Fed will continue to talk about it for several more meetings and then give the market a lot of notice before beginning to taper, oops, bad word. He won't say that, but he will say that the Fed will give the market plenty of notice before beginning to dial back the pace of asset purchases. I doubt you will be specific about a timetable, but he will get the talk about talking about issue out of the way that my grammar checker hates so much.

Stephen Gallo:

Yeah, maybe on that point, Greg, I'll just chime in regarding the Swiss National Bank because their quarterly monetary policy decision on June 17th is just a day after the Fed's is announced. And when it comes to looking at what the Swiss National Bank is doing or signaling with its interventions or its monetary policy stance, I sometimes think it's better to look at the sight deposit data of commercial banks and base money (or M0), rather than the FX reserve data, because the FX reserve data can be impacted by valuation changes in financial markets. What do the sight deposit and base money data show us? Well, they show us that in January and February combined it looks like the SNB was quite a bit active in terms of intervention to weaken the CHF. It backed off in March and then it picked up slightly in April and May, but probably to a lesser extent than it was active in January and February.

Stephen Gallo:

So I think when we put the year to date data together, we get the picture that the SNB is still active. The year over year changes in sight deposits and base money - they're still positive - but it's moving away from aggressively intervening. And I guess that kind of makes sense. On the one hand, the SNB's policies can fuel domestic financial stability risks in Switzerland. So, the SNB’s firepower is not endless. On the other hand, it looks like the major central banks are gradually, gradually, very gradually moving away from their aggressive stances. The Fed is talking about talking about tapering and at least in the short-term, it's unlikely that the ECB is going to drastically accelerate its pace of QE. So I think that explains why the SNB has been behaving the way it's been behaving.

Greg Anderson:

The BOJ comes in about 18 hours after the SNB on the 18th. While I'm sure the BOJ wishes it could intervene in FX like the SNB, it can't, nor can the BOJ do anything with its target overnight and ten-year rates. So I can't see this meeting as a market mover. I guess if the Olympics were to get canceled prior to the policy meeting, the BOJ might do something to come up as sympathetic. But that seems like such a low probability eventuality at this point that it's not really worth talking about. And that brings us to the BOE on the 24th, Stephen. Is there any reason we should be bookmarking that meeting other than that it is there?

Stephen Gallo:

Well, Greg, you mentioned the Bank of England, the BOE slowed its weekly bond purchase pace in May. But the important point I think I would make here is that it kept its target of £875 billion for the stock of QE unchanged after the May decision. And it's expected to hit that target a bit later this year. At that point, it will probably pause quantitative easing and start prioritizing forward guidance on interest rates. And if I look at the Sterling Overnight Index swap curve, it looks to me like the market is on the verge of pricing in the first 15 basis point rate hike, which would take the base rate back up to 25 basis points sometime in Q3 of 2022. So the back end of 2022. Now, if that were the case, it's only 15 basis points. But if the BOE did move in late 2022 with its first rate hike, that would suggest it's going to go ahead of what the Fed has recently been signaling.

Stephen Gallo:

So I don't think the BOE is going to go out of its way to be hawkish at the June meeting. The other issue, worth mentioning is just the fact that the UK Government's fiscal support plan for the economy is still a work in progress. Now we've already had the budget laying out, expenditure targets, et cetera from the treasury this year, but there may be an update to that in the autumn. The treasury may put out new targets or forecasts for expenditure. That may be something that the BOE would want to implicitly plan around. So in that case, we may have to wait until Q3 or Q4 from a more definitive signal from the bank of England.

Greg Anderson:

What do you think Stephen, have we run on long enough?

Stephen Gallo:

Yes, Greg, I think we should cut it just here. As always, lots of thanks to our listeners. We really appreciate you listening in. We look forward to having you tune in again for episode 12 next Tuesday, the 15th, which will be one day before the June FOMC rate decision. Bye for now.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Speaker 2:

This show and resources are supported by our team here at BMO, including the FIC Macro Strategy group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 4:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Inc., and BMO Capital Markets Corporation. Together, BMO who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell, or to buy, or subscribe for any particular product or services, including without limitation any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It not constitute a recommendation or suggestion that any investment or strategy referenced here in may be suitable for you.

Speaker 4:

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Speaker 4:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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