Welcome back to FXDD’s On the Daily- our daily research updates on markets and economies. Here’s what we have been watching in economic and financial data over the last 24 hours:

  1. Global economic momentum trends are lower, led by US downside surprises. Today, we are waiting for UK’s monthly GDP to see if it confirms the global trend (our models imply continued slowing). Overall, it is worth noting that the divergence between the US vs. Global Economic Momentum seems to be widening- with the US at 29% and Global at 45%. Therefore, the global economic backdrop for risk seems to remain positive, but the US backdrop is tightening to more dangerous territory. The closer we get to the 25% level for US Economic Momentum, more conservative we become.
  2. This is a busy week for central bank policy. We have a slew of speakers this week from the BOE, ECB, and Fed at various different events. Further, we have the ECB making decisions on monetary policy. We don’t expect significant movement from the ECB- however, we think the meeting will offer significant clarity on what the Governing Council is thinking in light of recent hawkish comments from several members. With EU growth having peaked in our models, we don’t think the current hawkishness will be sustainable. Given the precarious nature of the EU recovery, we expect hawkishness to be persistent in commentary- but unlikely in the ECB’s policy.
  3. Looking at global markets on a trending basis, markets like rising growth/expansionary themes over contractionary ones. At the same time, the dollar continues to battle its way upwards, at the center of global capital flows. US stocks have started this week weaker- which we think of as an opportunity to add risk incrementally. The commodity complex is generally weaker, alongside a dollar bid.

Overall, it’s a busy week for markets! We will need to stay sharp this week and watch all these prospective changes. For now, we continue to think the major themes of US stocks higher and dollar surprising to the upside will continue- but we are continuously updating our views. Let us look at some of our data updates and then discuss the upcoming ECB meeting in a little more depth:

Let us start with our tracking of global economic momentum:

Next, we show our Market Environment Monitor, which aggregates the growth and inflation signals from major global investment markets to tell us what the current market environment is, i.e., expansion, inflation, deflation, or stagflation:

Then, we show our proxy for capital flows using our Currency Bloc Monitor, which aggregates exchange rate moves across 48 currency pairs into major regions or Blocs. We show the evolution of these Currency Blocs over time:

Finally, let’s set the stage for this weeks’ ECB meeting. The ECB’s MPC members are debating extensively over rate guidance, revealed the July meeting minutes of the ECB. Many of them are dissatisfied with the new strategy undertaken by the central bank in July 2021, where it disclosed a shift in its inflation target from “less than equal to 2%” to a 2% target. The bank stated that this was a strategy that would be easier to communicate to the financial markets. However, many policymakers within the governing council feel that this strategy understates the risk of inflation, while others think that the rise in inflation is transitory. The Eurozone annual inflation rate is expected to surge to 3% in August 2021, from 2.2% in July, which would be the highest in almost a decade. The German HICP rose 3.4% in August, a 13- year high, as economic recovery and supply shortages put upward pressure on prices.

Return to normalcy is shaking up the consensus among ECB policymakers regarding a looser monetary policy. A flurry of comments since the last week of August 2021 has particularly been on the hawkish side:

  • Governing Council member and Austrian central bank governor Robert Holzmann said in an interview on August 31 that Europe is now in a situation where the ECB can think about reducing its pandemic-related special programs. He also said that in the meeting in September, a slowdown of the PEPP purchase in Q4 will “definitely” be discussed.
  • The Governor of the Bank of France and governing council member Francois Villeroy de Galhau has remarked that the ECB should consider the improvement in financing conditions since the last meeting. According to him, the ECB certainly has more room in its monetary policy strategy to adjust monthly purchases according to the financing conditions, “unlike the US Fed.” He stressed tapering but didn’t think that any urgency was needed.
  • Both Villeroy de Galhau and Holzmann have not been in favor of raising the interest rates. A premature rate hike could mean an earlier end to net purchases without an extraordinarily high and persisting inflation rate. It will also remove all hopes of increasing APP buying to provide a financial cushion when PEPP purchases end in March 2022.
  • Bundesbank President and Chairman of the Board of the Bank for International Settlements, Jens Wiedmann, said that inflation might overshoot the ECB’s expectations faster than expected.

Therefore, there is s significant number of voices in the Governing Council that are becoming more hawkish and concerned about the looseness of financial conditions. However, given our views of peak growth and inflation, alongside clearly deteriorating economic momentum, our view is that hawkish concerns are likely to be transitory in the EU. Further, we think the hawkish contingent is likely to be in the minority in the Governing Council. Therefore, we expect the commentary to be marginally more hawkish, but not policy. This should keep global liquidity flowing and support our preferred exposure (US stocks ) over the intermediate-term.