31 August 2020
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Jerome Powell announces historic policy shift

Fed Chair Jerome Powell announced an historic policy shift towards average inflation targeting at his address to the virtual Jackson Hole symposium on Thursday

By Daniel Richards

jackson hole

Fed Chair Jerome Powell announced an historic policy shift towards average inflation targeting at his address to the virtual Jackson Hole symposium on Thursday. The change of tack outlined in Powell’s address, which was accompanied by relevant documents, means that inflation of ‘moderately’ higher than 2% will now be tolerated for extended periods when following periods when price growth has undershot the target – what Powell termed ‘a flexible form of average inflation targeting.’ His speech acknowledged the flattening of the Philips curve in recent years – the inverse relation between unemployment and inflation – and ‘shifts  in estimates of the natural rate of unemployment’, implying that the Fed will not necessarily immediately act to dampen pressures as the unemployment rate falls, unless there is an accompanying and durable shift in inflation.  The change in approach from the Fed suggests that interest rates in the US – and by extension in the GCC – will remain lower for longer.  It also opens the way for the Fed to provide more monetary stimulus through asset purchases and other measures in the coming months, perhaps as early as September, particularly if Congress cannot agree on another round of fiscal stimulus.

US initial jobless claims were broadly in line with expectations in data released on Thursday, with 1,006,000 new claimants, marginally higher than consensus 1mn. In further troubling news for private consumption, personal spending grew just 1.9% m/m in July, down from 6.2% in June. Spending remains below pre-pandemic levels, and may well have slowed again in August after the expiration of the USD 600/week extra jobless benefit at the end of July.

The Eurozone’s economic confidence index climbed to 87.7 in August, from 82.4 in July and up from the low of 64.9 at the peak of the lockdown in April. The index beat expectations of 85.0, but it remains far off the pre-pandemic levels of 103 and a renewed rise in coronavirus cases in a number of key Eurozone economies could slow the nascent recovery.

Japanese Prime Minister Shinzo Abe resigned on Friday, ending several months of speculation regarding his health. He will continue to oversee the government until his successor is appointed in September. While Japanese equities closed lower, Asian markets were largely untroubled, and the expectation is that his trademark accommodative monetary and fiscal policies and structural reforms – Abenomics – will be continued, especially given the ongoing pandemic crisis.

The Dubai government has announced new rules for the establishment of new government-owned companies in a bid to limit competition between state-owned entities and the private sector. The move, announced by Crown Prince Sheikh Hamdan’s website, means that new government entities will only be allowed to be established if they can offer products or services of ‘strategic economic importance’, and will ensure a level playing field between the public and private sector.

In Qatar, the government has announced plans to the labour market, with a 25% hike to the minimum wage to USD 275/month which is scheduled to come into action in six months’ time. It also removed the requirement that workers get permission from their employers to change jobs.

Dollar index falls on Fed policy shift

Source: Bloomberg, Emirates NBD Research

Fixed Income

Treasury markets sank last week in response to the Fed outlining its strategy to target 2% inflation on average over a period and not linking upward moves in rates to a specific economic target being achieved. Most of the action was at the longer-end of the curve with the front end displaying little change. Yields on 10yr USTs added more than 9bps to settle at 0.7211% but spiked to more than 0.78% in early trading on Friday. The yield on the 30yr UST gained even more, rising by 16bps over the course of the week to settle at 1.5%.

Emerging market bonds continued to stally with the Bloomberg Barclays index of USD EM bonds falling by 0.25% last week. Spreads over USTs compressed to 357bps.

Press reports indicate that Bahrain may approach markets soon for a benchmark conventional and sukuk deal. Bahrain last tapped markets in May raising USD 2bn. We estimate that the country will record a budget deficit of 10% this year. Further, Bloomberg has reported that Dubai is in talks with banks for a sale of dollar-denominated Islamic bonds.

FX

Last week the US dollar showed few signs of any positive movement. The DXY index fell by around 1% as the market digested the announcement from Fed Chair Jerome Powell of a greater focus on  inflation, providing a boost to the dollar's competitors. USDJPY fell by -0.41% for the week to settle at 105.37, an area just outside the 38.2% one-year Fibonacci retracement of 105.41. 

The euro advanced by 0.9% overall to close at 1.1903, whilst Sterling soared to 1.3351, its highest point since 2018. Meanwhile the AUD and NZD recorded some of the best movement out of all the major currencies, advancing by 2.8% to reach 0.7365 and 3.1% to close at 0.6743 respectively. 

Equities

The resignation of Japanese Prime Minister Shinzo Abe at the close of the week prompted a -1.4% sell-off in in the Nikkei and -0.6% in the Topix on Friday. However, Asian equities were otherwise untroubled, with most majors closing higher on Friday, and positive on the week. The Shanghai Composite closed up 0.7% w/w.

The positive trend was carried in most major global indices save the FTSE 100 which closed -0.6% lower than a week previous even despite BoE Governor Andrew Bailey telling the Jackson Hole symposium on Friday that central banks ‘are not out of firepower.’ Elsewhere in Europe the DAX and the CAC gained 2.1% and 2.2% respectively, while in the US the S&P 500 and the NASDAQ continued to hit record highs, gaining 3.3% and 3.4% w/w. The blue-chip Dow Jones, which underwent a reshuffle at the start of the week, gained 2.6%, putting it in positive ytd territory for the first time since February.

Commodities

Hurricane Laura swept through oil markets last week but despite being one of the strongest ever storms to hit the US Gulf coast, Laura failed to shake benchmark prices out of their trading range that has been in place for the last two months. Brent futures added 1.6% to settle at USD 45.05/b while WTI closed just short of USD 42.97/b, a weekly gain of 1.5%. Volatility in oil markets continues to shrink with 30-day vol in Brent futures near its lowest level in the past year.

Forward structures also seemed to shrug off the impact of Hurricane Laura with time spreads in both WTI and Brent futures closing weaker. Front month (1-2 month) spreads in WTI closed last week in a contango of USD 0.32/b, their widest level since the end of July while Dec 20/21 spreads closed at more than USD 2/b in contango. In Brent markets Dec spreads held onto the wide contango of almost USD 3/b for 20/21, extending a persistent downward trend that has been in place since May.

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Written By

Daniel Richards Senior Economist


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