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Is There a Policy Shock that can Break the Summer Doldrums? - Global Exchanges

FICC Podcasts August 10, 2021
FICC Podcasts August 10, 2021

 

In this week's episode, we discuss the price action in foreign exchange over the last few weeks along with recent central bank signals. We also discuss a couple of the key monetary policy events upcoming later in August.


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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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Greg Anderson:

Hi, welcome to Episode 16 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my co-host Stephen Gallo and I will be discussing the price action in foreign exchange over the last few weeks, along with recent central bank signals. We will discuss some of the key central bank events upcoming in August. The title for this episode is: Is There A Policy Shock That Can Break The Summer Doldrums?

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 co-host.

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 commodities.

Greg Anderson:

We strive to make this show as interactive as possible, so don't hesitate to reach out by going to BMOCM.com/globalexchanges. Thanks for joining us.

Speaker 3:

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

Stephen Gallo:

Well, Greg, it's August 10, 2021. We're going to launch this podcast, and what we normally do is we look at what's been happening in the FX markets recently, but most major currency pairs are still stuck in a range. We have USDCAD, 1.24-1.26, basically; USD/JPY, still 109-111, more or less. EUR/USD looks a bit offered. I think there is a USD story in there, but there's also a carry story there too, with the Euro underperforming on the non-dollar crosses. But, look at USDRMB, still hovering just under 6.50. Basically, we've yet to see a definitive breakout in the major currency pairs. So, I guess, to sum up for the benefit of our listeners, what we want to accomplish with this podcast, as you hinted at in the intro, is to identify where there has been or where there might be policy shifts that the FX market can feed off of because the policy sphere is one of the first places to look as far as currency market drivers are concerned.

Stephen Gallo:

So, in other words, for an analogy here, even though the winds aren't blowing now and FX pairs aren't really moving all that much, has the captain of the ship changed the heading so that when the wind does start to blow again, the ship will be moving in a different direction on the compass? Is there a currency where you'd say that the captain has changed the heading?

Greg Anderson:

Yes, there is. And if you're wondering what that sound was, I pounded the table, and I don't do that very often, either literally or figuratively. The captain I will identify is Governor Orr of the RBNZ, and the currency is the NZD or kiwi, and I really liked the sailing analogy here. So let me just start by saying that the NZD/USD or Kiwi/USD exchange rate has been stuck in a major doldrums for two months. We've been between 69.71 ever since the June 16th FOMC. But while that exchange rate seemingly isn't moving, RBNZ Governor Orr has completely reoriented the headings of the good ship NZD.

Greg Anderson:

The first piece of that was ending the bond purchase program back in July. The second piece has been communicating an intention to hike to markets. Right now, the OIS market has about 29 basis points of rate hike priced in for the meeting next week on August 18th. Going back to when we entered the doldrums on June 16th, there were zero basis points priced into the NZD OIS curve for that particular date. So this is a relatively massive shift in headings. It's fascinating me that the currency seemingly hasn't moved.  But I will point out that maybe USD strength has masked the NZD move a little bit.

Greg Anderson:

For New Zealanders, the cross rate that matters most is NZD relative to the AUD. On that axis, AUD/NZD axis, NZD has gained about 3%. My typical rule of thumb is that the first rate move of a cycle, and I would say particularly when a central bank is going it alone, it should be worth about 5% for the currency. So while the rate hike is fully priced into the rates market, I'm not sure that it's fully priced into the FX market yet. It might be maybe halfway priced into AUD/NZD, but I would think that when the wind starts blowing again in FX, I would think we would see more gains in NZD relative to USD, and particularly on crosses with New Zealand's key trading partners in the Asia Pacific region.

Stephen Gallo:

A lot of great points in there, Greg. I just want to concentrate momentarily on one remark you made though, when you alluded to the stronger USD masking the NZD move. Is it possible that the RBNZ has moved the timing of the first rate hike of the cycle forward relative to what it was, say, forecasting earlier this year? In fact, one of the reasons for that is that the NZD hasn't been appreciating broadly or aggressively.

Greg Anderson:

Great point with your pointed question, Stephen. With New Zealand's small open economy, the exchange rate plays into the RBNZ monetary policy decisions a lot more than is the case for larger and more closed economies. The RBNZ probably looked at the current FX environment and concluded that it could get off the dime and start hiking here without triggering a massive appreciation. The RBNZ has been able to effectively reorient from behind the curve relative to inflation to now ahead of the G10 pack and done so quite adeptly. It's an impressive little sailing maneuver actually. So let me ask you, Stephen, are there any central bank captains in the currencies that you cover who have similarly exploited the moment to reorient the headings of their ships?

Stephen Gallo:

Yeah, thanks for the handout, Greg. So I want to focus briefly on the Bank of England's August monetary policy communications, which tilted ‘hawkishly’, but I point out a few things. The first is GBP/USD, also known in the FX market as cable. It's not at 1.45 or 1.50; it's between 1.35 and 1.40. So like the RBNZ, the policy implications for the exchange rate are somewhat limited from this August tilt from the BOE, and I think the central bank takes comfort from that. Secondly, all the BoE really did, all the tone from the BoE really did, at least, in my opinion, was given affirmative nod to what was largely priced into the Sterling OIS curve already for interest rate hikes. In other words, the bank didn't really communicate anything on policy that isn't already believed by the market to be possible over the next 12 months or so and the bank now has wiggle room to implement the first move up in the base rate by less than 25 basis points next year, if conditions play out at least as expected.

Stephen Gallo:

I think that figures into, I guess, what I would call my third angle on the BoE, which is the slow grind lower in Euro/Sterling, and that's obviously an important currency pair for Britain. What the bank has done is reaffirmed the slow grind lower in that pair, but it hasn't done anything to seriously tip the balance one way or another. Of course, with the BoE, a mitigating factor for the extent of any rate hikes from the central bank is the fact that the bank, through the Financial Policy Committee, can tighten credit policy for the banks without touching the level of interest rates, if that's what it deems necessary. So this is a flow of credit angle versus the cost of credit angle. The bank has that flexibility if it needs it.

Greg Anderson:

Hey, Stephen, with your statement that the slow grind lower in EUR/GBP is probably okay to the Bank of England. How far ahead of the ECB do you think the BoE would dare get without having to worry about triggering a bigger and unwanted Sterling appreciation?

Stephen Gallo:

They will be conscious of the ECB, Greg. There's no doubt about that, even if it's only from the angle of the impact of policy divergence on the exchange rate, as you pointed out. But the effective or operative difference during this cycle, I think, relative to the period following the global financial crisis is potentially going to be fiscal policy. 2022 and 2023 are going to be reasonably important years for the government to make good on its promises from the last election campaign. So the influence of fiscal policy on the economy is probably going to be an important factor of consideration for the BOE's policy response.

Stephen Gallo:

So with that, Greg, I think it's time to shift the focus onto the biggest ship of them all, the Fed. I get a sense that there is market hype building into the Jackson Hole Symposium. What's your spin on all of this?

Greg Anderson:

Yep, Stephen, the hype is building about Jackson Hole. To frame my thoughts on that issue, I want to go back to Powell's July 28th press conference after the FOMC. I'll admit, it was somewhat buried in the last third of a 45-minute presser, but he got asked a very pointed question on that issue. I'm going to read some excerpts from pages 18 to 19 of the transcript of the press conference.

Greg Anderson:

So a question from Michael McKee of Bloomberg TV. "I know a lot of people on Wall Street have basically felt you're going to lay out your taper plans at Jackson Hole. Is that the plan or are we not going to see anything until the fall?"

Greg Anderson:

Powell's response here, and I've cut it down to the key points on that question, but, "There's a range of views on what timing will be appropriate ... Today, I've given you what I can give you, because, again, this was the first really, I would say, deep dive on the issues of timing, pace, and composition. And it was a good meeting. And, but no decisions are made and I'm just not in a position to give you much guidance, really any guidance on the actual timing. I, uh, but I will say we're making progress. We expect further progress and we expect that if things go well, then we will, we will reach that goal. And when we reach it and the Committee is comfortable that we have reached it, then we will taper at that point. I really, uh, there's nothing I can say about Jackson Hole. You know, I'm, we're in the process of writing that speech and I'm going to give a speech. And, uh, but I wouldn't want to, uh, I wouldn't want to say what will be in it at this point."

Stephen Gallo:

Greg, you're sounding more like a central banker every day. All right, so Greg, read between the lines, break it down for me. What was Powell implicitly saying there with all of that?

Greg Anderson:

Here's my read between the lines of what Powell said. Basically, he said the FOMC is a committee. We don't have a broad agreement as a committee on when to taper yet. It will probably take several meetings to reach an agreement, and I'm not going to get ahead of my committee. Stephen, I would also point out that Powell is navigating the big ship Fed through some really tricky waters right now. One of the things that makes the waters so tricky is that his term ends in less than six months and it's not clear whether he will be reappointed as the captain of the ship for a second term. There are also several empty or soon to be vacated seats on the FOMC. So for Powell to reorient the headings of the ship now without broad committee agreement and without knowledge of committee composition in a few months from now when the Fed will actually have to start sailing in the direction that Powell sets, if he sets a new direction, I don't know. He's got a really tough job right now, that's for sure. I guess, I personally don't tend to think we'll see anything path-defining in his Jackson Hole speech.

Stephen Gallo:

Greg, not to cut-off the old important Fed conversation because it is important, but it's not the only big ship out there. So can I just briefly cover the PBOC and USD/RMB?

Greg Anderson:

Yes, please do. The PBOC is always an important player in FX, but it seems like we've gotten mixed signals from them. So I've got to ask you, which way are they pointing that big ship? Are they going to be easing or tightening?

Stephen Gallo:

Well, Greg, my angle on China for most of the year has been the extent to which it has operated as a counterweight to what other global central banks have been doing, and that's partly a function of how 2020 played out for China and the rest of the world. It's a function of other things too, but that's one of the main ones. But to sum up, when most, if not all, of the central banks were strictly in full on easing mode earlier this year, the PBOC was engineering a slower pace of credit growth. More recently, in Q3, as other central banks have made noises about policy normalization, the PBOC has eased off a bit by implementing the Triple R cut earlier this quarter.

Stephen Gallo:

What's the gist here? The economy is stimulus-dependent, to a degree, just like everyone else's, but policymakers don't want to go too big or they'll have to clean up a big mess later on. So what has happened? They've loosened credit policy a bit in Q3, but they've also parked dollar China, the other avenue through which the PBOC sets policy. So the RMB isn't depreciating broadly either. So loosened credit policy a little bit, eased off on the policy normalization, but they've parked USD/RMB.

Greg Anderson:

So Stephen, the Chinese equity market is massively underperformed at MSCI world this year. How big of a issue do you think that is for the PBOC?

Stephen Gallo:

It's important, Greg, but I wouldn't want to leave the impression that it's entirely an unintended consequence of where policymakers have steered the ship. They're not solely focused on the equity market, but it's an important variable and it's important signal to the global economy. It's not an unintended consequence, basically, of where they have steered the ship. I think, policymakers don't want to be responsible for excessive gains and that's probably one reason why Chinese A-shares are where they are. But, again, it's important to note that they've eased off a bit on policy normalization and that may put a floor underneath asset prices.

Greg Anderson:

Stephen, I think we've gone through the most pertinent undercurrents in the FX market right now. Maybe we should end it here?

Stephen Gallo:

Yeah, let's wrap it up Greg, and just to tie everything together, we started this podcast by trying to identify where the policy sphere or how the policy sphere could cause a range break in the FX market. But I think based on all of the angles that we've put on the table, I think the conclusion we have to come to is that currency moves and big realignments and exchange rates are really important, and that's why central banks are pretty comfortable with low volatility in the currency markets.

Greg Anderson:

Stephen, I think you're right. So, for markets, that means that the catalyst for breaking out of the doldrums probably isn't going to come from the policy sphere.

Stephen Gallo:

All right, that's a wrap, Greg. Listeners, we want to thank you again, as always, for your listenership and for joining us. Until next time, 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.

Greg Anderson:

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

Speaker 3:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Incorporated, 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.

Speaker 3:

Notwithstanding 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 does not constitute a recommendation or suggestion that any investment or strategy referenced herein may be suitable for you. It does not take into account the particular investment objectives, financial conditions, or needs of individual clients.

Speaker 3:

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Speaker 3:

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Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy

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