Last night, Fed official, Lael Brainard, detailed the new Fed framework of flexible average inflation targeting. Brainard acknowledged that lax monetary policy may induce excessive risk taking and inflate bubbles but, it’s not the task of monetary policy to curb or deflate them. According to Brainard this is the task of macroprudential policy. It works primarily by imposing restrictions, rules, regulations creating counterbalances etc. An example is increased capital adequacy ratios for systemically important banks. Monetary policy on the contrary, works by creating conditions, environment or incentives.
Monetary policy is more about adding/removing incentives, while Macroprudential is more about creating/lifting restrictions.
A shift towards macroprudential policy in controlling market bubbles can mean that critique of monetary policy regarding fuelling market bubbles may not be as appropriate as altering the inflation targeting framework. The Fed is likely to rethink how it should control or prevent market bubbles.
So, while the Fed is thinking about how to convince stock markets not to grow so high and fast, already revealed bias towards higher tolerance of inflation creates relatively safe opportunity for risk taking. This is definitely a macro theme which suggests that USD decline is far from complete unless other central banks won’t come up with dovish comments. For example, ECB chief economist Lane said on Tuesday that EURUSD rate is important for monetary policy. This is probably the faintest hint that excessive Euro appreciation won’t be tolerated. In this light, the 1.20 level ahead of the ECB meeting in September looks like a sound resistance level. But, the EURUSD sell-off is capped as well since the cyclical nature of the euro + ultra-dovish Fed should maintain surplus of buyers after the pullback. The range of 1.18-1.1850 appears have to good entry points for long positions.
EU Inflation in August was also a big disappointment for Euro. The slowdown in the Core CPI from 1.2% to 0.4% is a serious challenge for the ECB, which is unlikely to be ignored. Market participants are well aware of this, pricing in dovish expectations in the common currency. Lackluster retail sales in Germany added concerns declining by 0.9% MoM.
USD gains were fueled by rising factory activity in the US in August thanks to broad-based rise of new orders, showed the ISM index. The US construction sector grew at a slower pace than expected, but amid the surprise in EU inflation this added to bullish USD momentum.
The aggregated activity index rose to 56 points (vs. 54 pts forecast). The index rose in line with regional surveys such as Philly Fed, NY Fed mfg. surveys etc. Production basically stalled in August, but the share of firms reporting an increase in new orders was the highest since 2004. Nevertheless, the hiring sub-index remained in contraction zone, showing modest rise from 44.3 to 46.4. So far, this suggests that the rate of layoffs has slowed down somewhat.
PMI activity indices show what was the proportion of firms (out of the total number of respondents) that reported an improvement/deterioration in a certain parameter of activity (or activity in general) compared to the previous month. The low base effect, which occurred due to lockdowns, creates a situation where in the first months after lockdowns, activity will certainly increase compared to previous periods which tells us to execute caution when interpreting PMI reports.