by Bill O’Grady and Kaisa Stucke
[Posted: 9:30 AM EDT] Financial markets are quiet again this morning, with the focus mostly on policy. The ECB meets on Thursday. Although there is a need for the bank to have a wider range of bonds to buy to maintain QE, the Germans are uncomfortable with easing the rules that would allow the ECB to buy lesser credits. We suspect the ECB will need to adjust its rules at some point but probably doesn’t have the consensus for this week’s meeting. Both the Fed and the BOJ meet on September 21. San Francisco FRB President Williams gave a speech in Reno yesterday, offering mixed messages. On the one hand, he suggested that rates should rise. On the other, he called for the consideration of a higher inflation target and a slower pace of rate hikes. The Fed seems to be leaning toward a rate hike but is also trying to keep the terminal rate, the rate where the rate hike strategy would cease, at lower levels. We suspect some of this may be about raising rates to give the bank room to ease in a recession, a rather odd policy (raising rates increases the odds of a recession). At the same time, calling for a lower terminal rate would probably prevent the dollar from rising sharply, which is also a policy goal.
Meanwhile, mixed messages abound from the BOJ as well. Reuters is reporting that there is a three-way split among the BOJ board members. According to the report, about one-third of the nine-member board wants to stand pat, one-third wants to lower rates further into negative territory and one-third wants to expand QE. Governor Kuroda is said to support the negative rate option. According to The Nikkei newspaper, PM Abe supports expanding QE by purchasing foreign bonds. It seems Abe believes that it would be permissible as long as the goal of foreign bond purchasing is to support economic growth and not specifically to weaken the JPY. We suspect Japan’s G-7 partners would disagree with this characterization. In fact, foreign bond purchases would have the same impact as currency intervention even if the goal is something else. Still, foreign bond buying would likely be effective in boosting Japanese asset markets and would weaken the JPY, which is, by itself, a form of monetary stimulus.
China’s foreign reserves fell $15.9 bn in August to $3.19 trillion, the lowest level since 2011. Although China has been trying to clamp down on capital flight, there is a steady drop in reserves that mostly tracks the continued weakness in the CNY. Chinese authorities seem to be willing to tolerate the outflow as long as it remains contained.
Finally, the WSJ is reporting that OPEC is interested in raising prices (although we haven’t seen anything yet that would suggest production cuts), but there is concern about allowing prices to rise near $70 per barrel because that might trigger a resurgence in shale oil production in the U.S. Instead, the cartel is signaling it is more comfortable with oil holding in a $50 to $60 range. Although we are comfortable with this range, we expect prices to test the low $40s or high $30s in the short run due to seasonal factors. The WSJ reports that the end of the summer driving season finds the U.S. market still oversupplied, which probably means prices will remain soft until winter sets in.