Week Ahead: 30th July 2018

Central banks and data deluge to drive August markets

As we start a new week the Vix index (Wall Street’s fear gauge) is sitting at 13.45, a notch below the average of the past 12 months, which comes in at 13.68. However, this figure is worth watching, as it could end the week significantly higher after one of the busiest weeks for economic and data and central bank meetings in some time. There are five central bank decisions due, key economic data releases from the US and China and some important earnings releases, which could determine the direction of index prices for some time.

First up, the central banks. The UK, US, Japan, Brazil and India all have interest rate decisions scheduled for this week. The UK, Brazil and India are all expected to hike interest rates (India and Brazil are expected to hike bank reserve rates), the BOJ is expected to tweak its yield curve control policy and potentially set the stage for a reduction in QE programme down the line. This leaves the Federal Reserve meeting as potentially having the least amount of drama, however, after Friday’s GDP miss, the market will be watching to see if there will be any change to guidance around future rate hikes. If there is any lowering in expectations of further rate hikes this year, even if it is slight, then we could see Treasury yields decline and the dollar slip.

GBP’s fate lies in Mark Carney’s hands

From an FX perspective, these central bank decisions have the potential to cause waves of volatility. GBP is roughly flat vs. the USD for July, however it is down nearly 8% since April when it peaked just below $1.44. Thus, one could argue that expectations of a rate hike from the Bank of England, has helped to stem GBP losses. Currently, the market expects a near 80% chance of a rate hike on Thursday even though inflation pressures are not rising and the economic data has been disappointing of late. While we expect the BOE to hike interest rates, arguing that the decade-low unemployment rate puts the economy at risk from overheating, there is still a chance that they may not hike rates, and even if they do it could be a close call. A failure to hike rates, or even a very close call in favour of a hike, could trigger another wave of GBP weakness, and potentially see GBP/USD drop back below $1.30.

Also worth noting is the BOE’s decision on what the UK’s neutral interest rate is, which is known as R*. This had been around 5% before the 2008 financial crisis, however, we now expect it to be around -0.5% to 0%, when adjusted for inflation, which would be 1.5%-2% for unadjusted rates. This decision could be more important for the pound in the long-run, since a higher number than this may trigger a pound resurgence, while a lower number could trigger a further sell off. Thus, the interest rate decision is not the only thing to watch at the BOE on Thursday.

The BOJ: Will it QE or will go now…

The second major central bank worth noting is the Bank of Japan, who will announce its policy decision Tuesday morning. There is growing speculation that the BOJ could prepare the market for either a future rate hike or an end to its expansive QE programme, due to falling profitability at Japanese banks. The last time that the BOJ expanded its QE programme back in 2014, the yen fell 1% in the first 10 minutes of the announcement. Any efforts to unwind Japan’s stimulus programme may trigger a sharp reversal in the yen and rising Japanese bond yields.

It could also trigger volatility in global asset markets. Rising yields usually weigh on equity markets, so Japanese and other Asian equity indices could experience a decline later on Tuesday. European bond markets could also experience some volatility since Japanese investors are large buyers of foreign bonds in the region. If Japan is moving away from QE and the yen rises, Japanese investors may find attractive buying opportunities for lower priced European assets.

However, we urge caution when waiting for the BOJ decision and the market may be getting ahead of itself, 10-year Japanese bond yields are at their highest level for over a year and the yen is also some 1.6% higher vs. the USD since expectations about this meeting started to infiltrate financial markets. The Japanese central bank is well-known for its conservative stance, thus there is a big chance that the BOJ will not tweak its policy during Tuesday’s meeting, which could see a reversal in Japanese bond yields and a weakening in the
yen.

Economic data to watch

Elsewhere, US labour market data is scheduled for release on Friday. The market is looking for a healthy rate of job creation for July at 193k, a lower unemployment rate to 3.9% and stable wage growth at 2.7%. If the data comes inline with expectations then we believe that the Fed may continue its policy of normalising interest rates. However, any weakness in the labour market report, particularly the wage component, may see the dollar come under pressure. Chinese PMIs are also due to be released on Tuesday morning. Any sign that the economy is slowing could trigger another wave of yuan weakness, which may weigh on Asian currencies in general.

Can Apple save the S&P 500?

Last, but not least, Apple’s earnings for its third quarter are also worth watching. Even if you don’t trade individual stocks, the earnings release for the world’s most highly valued company could have a big impact on the direction of US indices in the coming days. Its earnings are scheduled for release after the market closes on Tuesday and the market is expecting $2.155 earnings per share. Remember this number, as the fate of US indices could depend on whether the actual number is above or below expectations. The S&P 500 has fallen by more than 1% since Facebook’s share price dropped sharply after its earnings miss last Thursday.

Since Apple is such an important part of the S&P 500, and also of the tech sector, a miss for Apple’s earnings could trigger further equity weakness and a rotation out of the tech sector and into defensive sectors of the US equity market. If Apple doesn’t post positive earnings, then we may see the broader US equity space suffer, since the S&P 500’s rally this year has mostly been led by tech, although price action in the last few days suggests that market sentiment could be turning against tech as we move through the summer months.

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