Williams Airs Alternative Policies
Days on from sharing Hawkish comments which leant some support to USD, Fed’s Williams has now done an about-turn and is sounding decidedly Dovish opining that “monetary policy frameworks should be critically re-evaluated” and “alternative monetary policies” should be considered including a higher inflation target and/or nominal GDP targeting. Williams noted that he believes these approaches “have a number of potential advantages over standard inflation targeting”.
Williams emphasised however that he is “not advocating an abrupt reversal of course”. However, by raising these policy alternatives, he is clearly moving hikes off the table. What is particularly interesting about these comments is their proximity to the Jackson Hole event, especially given Williams’ close ties with Janet Yellen. Adopting nominal GDP targeting and or a higher inflation target would both lean heavily on the USD.
LIBOR Rate Adding Pressure
Rising US LIBOR rate is adding extra downside pressure to USD with further catalysts coming from China, not just from the deflationary risks of RMB weakness, but where agents there are scaling back their USD loan exposure. 3m USD LIBOR rates have shifted significantly higher from 62bps to 82bps fuelled by regulatory changes taking effect on October 14th. In 2013 when China tightened monetary policy conditions, trying to curtail soaring domestic lending growth, the country’s corporate sector substituted RMB loans for USD loans with USD loans consequently accounting for more than 10% of Chinese GDP. The historic rise in China’s FX reserve in q1 2014 and the accompanying RMB appreciation has been tied to USD denominated borrowings and the swap of USD proceeds into RMB. Now, with US LIBOR rate rising, the consequent increase in corporate credit costs might push some foreign corporates to scale back their USD borrowings.
Typically, this move would lead to increased USD demand and push USD higher, however, two other factors come into play here which darken the USD outlook. Firstly, the Japanese MoF as recently reported increasing overseas demand for short-term Government paper, which is linked to Chinese entities whilst the Fed’s custody holdings (treasuries held on behalf of foreign FX managers at the Fed) have reportedly fallen. The drop in custody holdings continues to fall despite a pause in the decline of global currency reserves which suggests a re-allocation by reserve managers from USD into holdings in other currencies, such as JPY, keeping the pressure on USD.
Secondly, the increase in US LIBOR rates, which has led to Chinese corporates reducing their USD denominated debt, also has the potential to further weaken RMB from here. Supporting this idea are expectations of accelerated capital outflow from China in July. Whilst the amount of the outflow is still comparatively moderate to those seen earlier in the year, a sizeable increase is visible. A weaker RMB weighs on import prices for China’s trading partners, and the more developed the trading relationship is, the costlier the impact of weakening import prices is on local inflation rates. Japan is particularly vulnerable here with falling inflation rates forcing real rates up and this increasing the attractiveness of JPY denominated holdings.
US Inflation data yesterday added further pressure to USD with headline CPI in July printing 0.8% YoY vs. an expected 0.9% and the core reading printing 2.2% YoY vs. an expected 2.3%. The core reading rose just 0.1% in July vs. 0.2% in June and compounds fears of benign economic activity in the US. Given the weak Q2 GDP print and the Fed’s non-committal attitude at the July meeting, traders are scaling back expectations of a Fed rate hike in September. Attention now turns to the July FOMC minutes this evening though in the light of this recent data perhaps some relevance will be lost.