With Fed Chair Powell's term expiring in February, debate is starting to swirl about his fate: will Biden keep him, grateful for monetizing all the trillions in stimmies the president has unleashed to
purchase votes kickstart hyperinflation, or will more progressive elements in the Democratic party hold out for an even more librrrral Fed chair.
According to WSJ's new Fed-whisperer, Nick Timiraos, Powell "who enjoys broad support in markets and among lawmakers from both parties" is viewed by some inside and many outside the administration as the front-runner for the job, but if Biden decides he would prefer his own pick, rather than the Republican chosen by President Trump, Fed governor Lael Brainard is the most likely candidate to succeed him. More:
Some Democrats want Mr. Biden to replace Mr. Powell. They prefer the White House name a woman or member of a minority to lead the central bank as part of a broader push for diversity at the top ranks of the U.S. government. “Leaving aside my policy differences with the current leadership of the Fed, it would be a huge missed opportunity to reappoint a conservative white male as Fed chair,” Graham Steele, a former Democratic Senate aide, wrote in a tweet last year. Mr. Biden announced his intent Monday to nominate Mr. Steele to a top Treasury Department post.
But while the WSJ's conclusion was ambiguous and did not hint at either outcome as more likely, JPMorgan's chief economist, Michael Feroli, was more definitive warning that "Fed chair Powell faces an uphill challenge in securing a second term as Fed chair" adding what we already know namely that "if Biden opts for change, Governor Brainard is positioned as the leading contender."
Feroli starts off by praising Powell’s response to the COVID-19 financial crisis and recession which "was aggressive, creative, and determined; his leadership during that period has justly received applause from economists and legislators across the political spectrum." Praise notwithstanding, Powell "is now at risk of losing his job."
As he further notes, even though the framework review that he led moved monetary policy in a direction favored by progressives, the Fed has responsibility for more than just monetary policy (see "The Central Banks New Mandate: Social Justice, Race, Gender Issues, Climate Change And Inequality"). Given the central bank’s significant regulatory and supervisory powers, Feroli thinks that left-leaning voices in the administration likely will not want a Republican like Powell to remain chair, and thus JPMorgan sees "a significant chance that Powell is not nominated to serve another four-year term as chair after his current term expires in January. (Moreover, even though Powell’s term as governor goes to 2028, we suspect he would resign if not re-nominated as chair)."
If Powell isn’t nominated, Feroli thinks governor Brainard is the most likely replacement. Brainard has been a governor since 2014 and generally has been viewed as one of the more dovish members of the FOMC. Equally important for her chances of being nominated, "she has favored a more activist use of the Fed’s regulatory powers. Given her stated views on the economy and monetary policy, it is reasonable to conclude that a Chair Brainard would continue to tilt monetary policy in a dovish direction."
Other names that have been mentioned as possible Fed chairs include Michigan State professor Lisa Cook and Howard University professor and AFL-CIO chief economist William Spriggs. While less is known about their views on monetary policy, it’s clear from their public comments and research that they would also place strong emphasis on the Fed’s full employment mandate. Any of these candidates—Brainard, Cook, or Spriggs—would almost certainly reinforce the Fed’s current dovish stance. However, the Fed’s current policy stance is already laser-focused on providing accommodation. This raises the bar for how much more dovish any of these candidates can push the Committee.
In addition to a new chair, next year the Fed could see a few other changes in key positions.
- First, there’s still a vacancy on the presidentially-appointed Board.
- Second, it’s pretty clear that Quarles will not be nominated for another term as vice chair of supervision when his term in that role ends this October. However, he has indicated that he may stay on as governor even if he loses his leadership role (his term as governor ends in 2032).
- Third, Vice Chair Clarida’s term as governor and vice chair ends next January. Even though he spear-headed the framework review that should further the administration’s economic priorities, the same political dynamics that may put Powell’s job at risk could also affect Clarida.
As Feroli concludes, these decisions could interact; if Quarles and Clarida departed the administration could be assured of a Democratically-controlled Board even with Powell as chair.
* * *
That said, no matter how the DC politics play out, JPMorgan believes that the Board is almost certain to remain focused on the Fed’s employment mandate next year, which was recently reinterpreted by the Fed’s framework review. The Fed will now no longer seek to minimize deviations from full employment, but rather shortfalls from full employment. To be sure, even Feroli is unsure how this will materially change how the Fed conducts policy as "it’s hard to find instances where the Fed tightened policy only because unemployment was too low (though it has hiked when low unemployment was forecasted to lead to inflation)."
The review also changed the employment mandate to be “broad-based and inclusive.” Conceptually, there is no simple way for the Fed to use one tool, the interest rate, to target differing objectives. In fact, many have argued that using such a simple, blunt tool, will only lead to even more labor market distortions while blowing the already biggest asset bubble in history even bigger.
As a practical matter, the FOMC may get "bailed out" by economic developments. One prominent dimension of a more inclusive labor market is the narrowing of black-white employment outcomes (Figure 1). Some of this narrowing has come from a deterioration in white prime-age labor force participation. In any event, the broad-based and inclusive clause may be a check the Fed doesn’t have to cash.
If this understanding is correct, then FAIT should at the least seek to move inflation expectations (here proxied by the Fed’s Index of Common Inflation Expectations) back to where they were before the Fed began its most recent hiking cycle.
Beyond that, the practical implication of the new framework will be policy that maximizes employment subject to the constraint that inflation expectations do not break out of the historical range, which when it comes to consumers, we already know they have through the 1-year point. Should inflation not revert to baseline fast, the Fed will be in deep trouble.
Finally, Feroli also cautions that there is "a modest risk that if a leadership transition is viewed as too extremely dovish by the market, this may ironically induce a more hawkish policy response to insure the Fed hasn’t completely lost inflation-fighting credibility." He goes on:
When President Reagan surprised the market on June 2, 1987, by nominating the perceived dove Alan Greenspan for Fed chair the dollar weakened and the 10-year Treasury note sold off 27 basis points on the day. From his first day as chair on August 11, 1987, until Black Monday on October 19, 1987, the Fed hawkishly surprised the markets, and the minutes indicate it was motivated by concerns that the markets were losing faith in the Fed’s inflation credibility.
This risk would only become a consideration if market-based inflation expectations—and inflation expectations more generally—moved into a range that was materially and persistently above the Fed’s 2 percent average inflation goal. Given that the market - if not consumers - has taken FAIT in stride, this is probably a pretty low risk, particularly if the next chair is already known to market participants.
Old Ideas and the New New Deal
Over the past decade and a half, virtually every branch of the federal government has taken steps to weaken the patent system. As reflected in President Joe Biden’s July 2021 executive order, these restraints on patent enforcement are now being coupled…
Over the past decade and a half, virtually every branch of the federal government has taken steps to weaken the patent system. As reflected in President Joe Biden’s July 2021 executive order, these restraints on patent enforcement are now being coupled with antitrust policies that, in large part, adopt a “big is bad” approach in place of decades of economically grounded case law and agency guidelines.
This policy bundle is nothing new. It largely replicates the innovation policies pursued during the late New Deal and the postwar decades. That historical experience suggests that a “weak-patent/strong-antitrust” approach is likely to encourage neither innovation nor competition.
The Overlooked Shortfalls of New Deal Innovation Policy
Starting in the early 1930s, the U.S. Supreme Court issued a sequence of decisions that raised obstacles to patent enforcement. The Franklin Roosevelt administration sought to take this policy a step further, advocating compulsory licensing for all patents. While Congress did not adopt this proposal, it was partially implemented as a de facto matter through antitrust enforcement. Starting in the early 1940s and continuing throughout the postwar decades, the antitrust agencies secured judicial precedents that treated a broad range of licensing practices as per se illegal. Perhaps most dramatically, the U.S. Justice Department (DOJ) secured more than 100 compulsory licensing orders against some of the nation’s largest companies.
The rationale behind these policies was straightforward. By compelling access to incumbents’ patented technologies, courts and regulators would lower barriers to entry and competition would intensify. The postwar economy declined to comply with policymakers’ expectations. Implementation of a weak-IP/strong-antitrust innovation policy over the course of four decades yielded the opposite of its intended outcome.
Market concentration did not diminish, turnover in market leadership was slow, and private research and development (R&D) was confined mostly to the research labs of the largest corporations (who often relied on generous infusions of federal defense funding). These tendencies are illustrated by the dramatically unequal allocation of innovation capital in the postwar economy. As of the late 1950s, small firms represented approximately 7% of all private U.S. R&D expenditures. Two decades later, that figure had fallen even further. By the late 1970s, patenting rates had plunged, and entrepreneurship and innovation were in a state of widely lamented decline.
Why Weak IP Raises Entry Costs and Promotes Concentration
The decline in entrepreneurial innovation under a weak-IP regime was not accidental. Rather, this outcome can be derived logically from the economics of information markets.
Without secure IP rights to establish exclusivity, engage securely with business partners, and deter imitators, potential innovator-entrepreneurs had little hope to obtain funding from investors. In contrast, incumbents could fund R&D internally (or with federal funds that flowed mostly to the largest computing, communications, and aerospace firms) and, even under a weak-IP regime, were protected by difficult-to-match production and distribution efficiencies. As a result, R&D mostly took place inside the closed ecosystems maintained by incumbents such as AT&T, IBM, and GE.
Paradoxically, the antitrust campaign against patent “monopolies” most likely raised entry barriers and promoted industry concentration by removing a critical tool that smaller firms might have used to challenge incumbents that could outperform on every competitive parameter except innovation. While the large corporate labs of the postwar era are rightly credited with technological breakthroughs, incumbents such as AT&T were often slow in transforming breakthroughs in basic research into commercially viable products and services for consumers. Without an immediate competitive threat, there was no rush to do so.
Back to the Future: Innovation Policy in the New New Deal
Policymakers are now at work reassembling almost the exact same policy bundle that ended in the innovation malaise of the 1970s, accompanied by a similar reliance on public R&D funding disbursed through administrative processes. However well-intentioned, these processes are inherently exposed to political distortions that are absent in an innovation environment that relies mostly on private R&D funding governed by price signals.
This policy bundle has emerged incrementally since approximately the mid-2000s, through a sequence of complementary actions by every branch of the federal government.
- Starting with its 2006 decision in eBay, Inc. v. MercExchange LLC and through its 2017 decision in Oil States Energy Services LLC v. Greene’s Energy Group LLC, the Supreme Court has repeatedly weakened patent protections. The court adopted a similar policy perspective in its April 2021 decision in favor of a broad understanding of copyright’s “fair use” exemption in Google LLC v. Oracle America Inc.
- In 2011, Congress enacted the America Invents Act, which enables any party to challenge the validity of an issued patent through the U.S. Patent and Trademark Office’s (USPTO) Patent Trial and Appeals Board (PTAB). Since PTAB’s establishment, large information-technology companies that advocated for the act have been among the leading challengers.
- In May 2021, the Office of the U.S. Trade Representative (USTR) declared its support for a worldwide suspension of IP protections over Covid-19-related innovations (rather than adopting the more nuanced approach of preserving patent protections and expanding funding to accelerate vaccine distribution).
- President Biden’s July 2021 executive order states that “the Attorney General and the Secretary of Commerce are encouraged to consider whether to revise their position on the intersection of the intellectual property and antitrust laws, including by considering whether to revise the Policy Statement on Remedies for Standard-Essential Patents Subject to Voluntary F/RAND Commitments.” This suggests that the administration has already determined to retract or significantly modify the 2019 joint policy statement in which the DOJ, USPTO, and the National Institutes of Standards and Technology (NIST) had rejected the view that standard-essential patent owners posed a high risk of patent holdup, which would therefore justify special limitations on enforcement and licensing activities.
The history of U.S. technology markets and policies casts great doubt on the wisdom of this weak-IP policy trajectory. The repeated devaluation of IP rights is likely to be a “lose-lose” approach that does little to promote competition, while endangering the incentive and transactional structures that sustain robust innovation ecosystems. A weak-IP regime is particularly likely to disadvantage smaller firms in biotech, medical devices, and certain information-technology segments that rely on patents to secure funding from venture capital and to partner with larger firms that can accelerate progress toward market release. The BioNTech/Pfizer alliance in the production and distribution of a Covid-19 vaccine illustrates how patents can enable such partnerships to accelerate market release.
The innovative contribution of BioNTech is hardly a one-off occurrence. The restoration of robust patent protection in the early 1980s was followed by a sharp increase in the percentage of private R&D expenditures attributable to small firms, which jumped from about 5% as of 1980 to 21% by 1992. This contrasts sharply with the unequal allocation of R&D activities during the postwar period.
Remarkably, the resurgence of small-firm innovation following the strong-IP policy shift, starting in the late 20th century, mimics tendencies observed during the late 19th and early-20th centuries, when U.S. courts provided a hospitable venue for patent enforcement; there were few antitrust constraints on licensing activities; and innovation was often led by small firms in partnership with outside investors. This historical pattern, encompassing more than a century of U.S. technology markets, strongly suggests that strengthening IP rights tends to yield a policy “win-win” that bolsters both innovative and competitive intensity.
An Alternate Path: ‘Bottom-Up’ Innovation Policy
To be clear, the alternative to the policy bundle of weak-IP/strong antitrust does not consist of a simple reversion to blind enforcement of patents and lax administration of the antitrust laws. A nuanced innovation policy would couple modern antitrust’s commitment to evidence-based enforcement—which, in particular cases, supports vigorous intervention—with a renewed commitment to protecting IP rights for innovator-entrepreneurs. That would promote competition from the “bottom up” by bolstering maverick innovators who are well-positioned to challenge (or sometimes partner with) incumbents and maintaining the self-starting engine of creative disruption that has repeatedly driven entrepreneurial innovation environments. Tellingly, technology incumbents have often been among the leading advocates for limiting patent and copyright protections.
Advocates of a weak-patent/strong-antitrust policy believe it will enhance competitive and innovative intensity in technology markets. History suggests that this combination is likely to produce the opposite outcome.
Jonathan M. Barnett is the Torrey H. Webb Professor of Law at the University of Southern California, Gould School of Law. This post is based on the author’s recent publications, Innovators, Firms, and Markets: The Organizational Logic of Intellectual Property (Oxford University Press 2021) and “The Great Patent Grab,” in Battles Over Patents: History and the Politics of Innovation (eds. Stephen H. Haber and Naomi R. Lamoreaux, Oxford University Press 2021).congress covid-19 vaccine oil
Mandatory COVID-19 vaccines on university campuses: An obvious solution or a problem?
Mandating vaccines risks turning a highly effective public health intervention into a contentious battleground — but it also may save lives.
The University of Toronto has announced that in addition to requiring vaccination for students living in residence, it will “require students, faculty, staff and librarians who participate in activities that carry a higher risk of COVID-19 transmission to be vaccinated — and require all community members to self-declare their vaccination status” on an online platform. The university will use “anonymous, aggregate data on vaccination status, by campus,” to inform health and safety measures.
As September approaches, more post-secondary institutions will announce how they are managing COVID-19-related decisions.
We are two researchers with an interest in social and structural determinants of health who have been discussing and writing about the pandemic for the last 16 months.
We are involved in research about increasing COVID-19 knowledge and protective behaviours, and reducing pandemic stress among diverse LGBTQ+ and racialized people, and how harm-reduction programs for people who use drugs, and other addiction services and HIV prevention have changed in response to COVID-19.
While one of us is more supportive of mandatory vaccination on campuses — given voluminous evidence for COVID-19 vaccine safety and effectiveness — we are both nevertheless concerned about mandatory vaccination.
Avoid ‘battleground’ scenario
Our shared experience in social work, public health and ethics, including sexual health and HIV research, leads us to believe that mandating vaccination can risk turning a highly effective and routine public health intervention into a contentious battleground.
What otherwise might be an everyday health behaviour becomes increasingly loaded with stereotypes and assumptions about political motivations that can divide communities and marginalize individuals and their lived experiences.
Our research has shown us that reasons for engaging in practices often not condoned by health researchers and public health officials — such as sharing drug-using equipment — are often complex. And they often make sense in the context of people’s daily realities.
In the case of people living with HIV and people who use drugs, they often have sophisticated understandings and complex interactions with the health-care system. These communities often have innovative ideas about how to better meet the needs of their peers.
Mandatory in public sectors?
We have personally followed public health requirements and have been vaccinated. We also recognize that vaccines have been the most impactful public health intervention of the last century. Vaccines save millions of lives every year.
But we also understand that while everyone who lacks antibodies to new coronavirus strains is at risk, the risks of infection, morbidity and mortality are influenced by broader socio-political and economic systems. In this way, COVID-19, like many other infectious diseases that concern public health experts, is rooted in inequity.
Social contexts, inequities
The COVID-19 pandemic has exacerbated pre-existing inequalities among racialized (“visible minority”) communities because of systemic racism in the health-care system, workplaces and living conditions.
Communities that experience the brunt of systemic racism and ongoing colonization, including in the health-care system, may be understandably reluctant or hesitant to get vaccinated. Black and Indigenous communities are navigating especially painful histories with harmful state-sponsored medical interventions.
Engaging these communities about vaccination requires cultural humility and respect.
Then there are those considered “anti-vaxxers,” who reject vaccinations despite the evidence for their safety and efficacy.
In Canada, 70 per cent of the population has received at least one vaccine dose. Fifty-six per cent are fully vaccinated.
Risk of infection on campus
We share concerns about the risk of infection on campus and the importance of students getting vaccinated.
We also see rates of vaccination among young people ages 19 to 29 (69 per cent at least one dose, and 46 per cent fully vaccinated) in a positive light, considering they only became eligible recently, and with challenges in vaccine availability across Canada. Assuming single doses translate into fully vaccinated, we are left with questions about the remaining 31 per cent.
We consider two possible stances: mandatory vaccination and vaccine promotion.
In scenario one, post-secondary institutions view the nearly one-third unvaccinated as a threat — to the health and safety of themselves, other students, faculty and staff on campuses.
Putting aside the small subset unable to be vaccinated for medical or religious reasons, we are left with young persons who may be vaccine-hesitant. Or possibly anti-vaccination.
With the rapidly spreading Delta variant, the unvaccinated are at considerable risk for infection, and transmission to others. Clusters of infection increase risks of further mutations. Mandatory vaccinations might be necessary in this case. But is anything owed to the unvaccinated?
As many people return to workplaces, they want flexibility. Many universities adopted online learning platforms. If the unvaccinated are not permitted to attend in-person classes, they should be offered online alternatives.
Concerns that this will breach students’ privacy and open them up to shaming from instructors and classmates need to be addressed. Shaming people for health choices often backfires, sometimes intensifying their beliefs. We imagine online options being extended to all students during this transition period.
Scenario two, vaccine promotion, considers the role our respective universities have played during the pandemic.
Both the University of Toronto and the University of Windsor host vaccine clinics and offer expert advice.
The University of Windsor (UW) does not require students to be vaccinated to return to campus at this time. It is partnering with UW Students’ Alliance and WE-Spark Health Institute to promote vaccination through peer-engagement and accessible information.
The approach means vaccination is made readily available, including on-campus clinics, and students are given time to make the decision about vaccination.
Incentive-based approaches are another option; they may lead some students “on the fence” to be vaccinated, but are unlikely to sway the truly hesitant.
Scenario two creates options for diverse students from across Canada, with different levels of vaccine access, to return to campus. This approach may be in keeping with the role of universities as bastions of critical debate. As COVID-19 continues to evolve, it will require ongoing vigilance.
In considering a highly consequential policy, we both support dialogue and community engagement, for which our research in Canada and globally has afforded ample evidence. An important way forward is for higher education leaders to consult with students, faculty and staff.
Universities have a short window to be proactive about the fall and winter semesters. They need to consider what a gentler return home for students might look like this time compared to 2020.
Significantly, they should also be considering how they can meaningfully support students, faculty and staff to return and recover from this exceptionally challenging period — one that is not yet over.
Peter A. Newman receives funding from the Canadian Instututes of Health Research, the Social Sciences and Humanities Research Council, the International Development Research Centre, and the Canada Foundation for Innovation.
Adrian Guta receives funding from the Canadian Institutes of Health Research, the Social Sciences and Humanities Research Council, and the University of Windsor Humanities Research Group.vaccine antibodies pandemic coronavirus covid-19 mortality transmission canada ontario
Fear that the spread of the Delta mutation of the covid would disrupt the global economy spurred the unwinding of risk-on positions. Interest rates fell, and the traditional funding currencies: the US dollar, Swiss franc, and Japanese yen, strengthened..
Fear that the spread of the Delta mutation of the covid would disrupt the global economy spurred the unwinding of risk-on positions. Interest rates fell, and the traditional funding currencies: the US dollar, Swiss franc, and Japanese yen, strengthened most in July. While major US indices set new record highs, as did Europe's Dow Jones Stoxx 600, the MSCI Emerging Markets Equity Index fell 7%.
The preliminary July PMI reports were below expectations in the US, UK, and France. Japan's composite PMI has been contracting since February 2020. There has been some re-introduction of social restrictions in parts of Europe. The UK's "Freedom Day" (July 19), when mask requirements and social restrictions were supposed to be dropped, turned into a caricature as the Prime Minister and Health Minister were in self-quarantine due to exposure, and the number of cases reached the highest level in 5-6 months.
Given the large number of people in the world that remain unvaccinated, the challenge is that the virus will continue to mutate. Moreover, even in high-income countries, where vaccines are readily available, and stockpiles exist, a substantial minority refuse to be inoculated. This is encouraging the use of more forceful incentives that deny the non-vaccinated access to some social activity in parts of the US and Europe. In the US, the vaccines have been approved for emergency use only, and broader approval by the FDA could help ease some of the vaccine hesitancy. Yet, rushing the process would be self-defeating. An announcement still seems to be at least a couple of months away.
In some countries, the surge in the virus even where not leading to hospitalizations and fatalities, maybe tempering activity and postponing more "normalization" like returning to offices. The increase in the contagion has also prompted several companies to postpone plans to have employees return to offices. In other countries, like Australia, the virus and social restrictions are having a more dramatic economic impact. Its preliminary July PMI crashed to 45.2 from 56.7, the lowest since last May. Although many countries in East Asia seemed to do well with the initial wave, they have been hard hit by the new mutations. For some, the recovery already had appeared to be in advanced stages.
Floods in China, India, Germany, and Belgium add to the economic angst. A freeze in Brazil sent coffee prices percolating higher. Wildfires in Canada stopped the downside correction in lumber prices. While rebuilding is stimulative, in the first instance, the natural disasters could be inflationary as transportation and distribution networks are impacted.
The market reacted by pushing down nominal and real interest rates. In late July, the US 10-year inflation-protected note yield (real rate) fell to a record low near minus 1.13% Ten-year benchmark yields in the US, Europe, Australia, and China were at 4-5 month lows. Expectations for rate hikes by high-income countries eased, and Beijing surprised investors by cutting reserve requirements by 50 bp (freed up ~$150 bln of liquidity).
Still, other central banks, like Russia who hiked rates by 100 bp in late July, are pushing forward. In Latin America, Brazil, Mexico, and Chile are likely candidates for rate hikes in August. The market anticipates additional rates hikes from the Czech Republic and Hungary. On the other hand, Turkey's central bank meets under much political pressure to cut rates. Inflation is not cooperating, and it reached 17.5% in June, a new two-year high. Yet, the Turkish lira downside momentum eased, and this alone, in the face of a stronger dollar, meant it was the best performing emerging market currency last month, up about 3.0%. Its 12% loss year-to-date still makes it the second-worst performing emerging market currency so far this year, behind the Argentine peso's nearly 13% decline.
The Federal Reserve does not meet in August, but the Jackson Hole symposium (August 26-28) may offer a window into official thinking about the pace and composition of its bond purchases. Under that scenario, a more formal statement would be provided at the end of the September FOMC meeting (September 21-22). Chair Powell has pledged to give ample notice about its plans to taper. This means that the initial timing of the beginning of the tapering may be vague by necessity. Many expect the Fed to begin reducing its bond purchases either later this year or early next year.
The debt ceiling debate may add another wrinkle. The debt ceiling waiver expired at the end of July. There are several different ways that Treasury can buy time. There are many moving parts, and it is hard to know exactly when Secretary Yellen would run out of maneuvers, but she probably has around two months. In the past, the uncertainty was reflected in some T-bill sales. Recall it was the debate over the debt ceiling (the government has already made the commitments or spent the funds and now has to pay for them) that prompted S&P to remove its AAA rating for the US in 2011.
Meanwhile, Beijing is waging an internal battle to retain control in the technology and payments space. It has also stepped up its antitrust actions and moved to make it more difficult for internet companies to have IPOs abroad. At the same time, the US threatens to de-list foreign (Chinese) companies if they refuse to allow US regulators to review their financial audits. This is more than quitting before getting fired, though at the end of July the US announced that concerns over risk disclosures have prompt it to freeze applications for Chinese IPOs and the sale of other securities. Its efforts to turn the private schools into non-for-profits are driven by Beijing's domestic considerations, but foreign investors--hedge funds, a couple US state pension funds, and provincial pensions in Canada appear to have been collateral damage. Even the Monetary Authority of Singapore had exposure.
The jump in Chinese yields and the drop in equities that pushed the CSI 300 (an index of large companies listed on the Shanghai and Shenzhen exchanges) 21% below the February peak prompted some remedial measures by officials. They succeeded in steadying the bonds and stock markets, and the yuan recovered from three-month lows as July wound down. However, both the disruption and the salve, the selling of industrial metals, coal, and oil from its strategic reserves, demonstrate the activist state that gives foreign investors reservations about increasing allocations to China. To draw foreign capital, officials may be tempted to engineer or facility a strong recovery in shares and the yuan.
Beijing is also meeting resistance from abroad. Its aggressiveness in the region, including the aerial harassment of Taiwan and rejection of the Arbitration Tribunal at the Hague regarding the United Nations Convention on the Law of the Sea (that pushed back against Chinese claims in the South and East China Seas). Over the past few weeks, the situation has escalated. The UK announced it will station two naval vessels in the area. Japan has promised to defend Taiwan should it be attacked by China. The US has not been that unequivocal. The EU has been emboldened. Latvia became the first EU member to open a representative office of "Taiwan" instead of Taipei.
Many wargame scenarios are premised on China attacking Taiwan, but this does not seem to be the most likely scenario. Top US military officials have testified before Congress that Beijing wants to have the ability to invade and hold Taiwan within six years based on comments from President Xi to the People's Liberation Army. Yet, if China senses that the status of Taiwan is truly changing, it could move against the Pratas Island, which is off the east coast of China and the south tip of Taiwan. It is closer to Hong Kong than Taiwan. It is an uninhabited atoll with a garrison. Taking this island would send a signal about its determination, with the costs and risks of invading Taiwan. It is true to the ancient Chinese idiom about killing a chicken scares the monkeys.
Bannockburn's World Currency Index, a GDP-weighted basket of the top dozen economies, rose fractionally after falling 1% in June. The two largest components after the dollar are the euro and yuan. The former slipped by was virtually flat near $1.1860 and the latter softened by less than 0.1 %. The yen, with about a 7.3% weighting in the basket, was the strongest, gaining about 1.25% against the US dollar. Sterling was almost eked a 0.5% gain. The Indian rupee slipped 0.1%, while Brazil's real was the weakest currency in the index, falling by about 4.6% in July.
Dollar: The greenback's two-month uptrend stalled in the second half of July, sending the momentum traders and late longs to the sidelines. The dollar's pullback had already begun before the FOMC meeting at which the Fed lent support to priors about a tapering announcement in the coming months. The next opportunity is in late August. The weaker dollar tone that we expect to carry into August could create the conditions that make a short-covering bounce ahead of the Jackson Hole symposium more likely. Some assistance, like the moratorium on evictions, ended on July 31, and others, like the federal emergency unemployment compensation (where states continue to participate), are finishing in early September. Meanwhile, the Biden administration appears to see some of its infrastructure initiative approved in a bipartisan way and the other part through a reconciliation mechanism that it can do if there is unanimous support from the Senate Democrats. Inflation remains elevated, and Treasury Secretary Yellen and Federal Reserve Chair Powell warned it may remain so for several more months but still expect the pressure to subside. The price components of the PMI have eased in the last two reports. There appears to have been some normalization in used car inventories that also reduce the pressure emanating from the one item alone that has accounted for about a third of the monthly increase of late.
Euro: The leg lower that began in late May from around $1.2265 extended more than we had expected and did not find support until it approached $1.1750 in the second half of July. A trough appears to have been forged, and the euro finished near the month's highs. Technical indicators favor a further recovery in August. Overcoming the band of resistance in the $1.1950-$1.2000 shift the focus back to the highs. The low for longer stance by the ECB may be bullish for European stocks and bonds. The Dow Jones Stoxx 600 reached new record highs in late July. Bond prices are near their highest levels since February-March. The IMF raised its 2021 growth forecast for the euro area to 4.6%from the 4.3% projection in April and 4.3% next year from 3.8%. The economy seemed to be accelerating in Q3, but the contagion and new social restrictions may slow the momentum. Inflation is elevated about the ECB's new symmetrical 2% inflation target, but it pre-emptively indicated it would resist the temptation of prematurely tightening financial conditions. The debate at the ECB does not seem about near-term policy as much as the commitment and thresholds for future action.
(July 30, indicative closing prices, previous in parentheses)
Spot: $1.1870 ($1.1860)
Median Bloomberg One-month Forecast $1.1885 ($1.1950)
One-month forward $1.1880 ($1.1865) One-month implied vol 5.3% (5.6%)
Japanese Yen: The correlation of the exchange rate with the 10-year US yield is at its highest level in a little more than a year (~0.65, 60-day rolling correlation at the level of differences). The correlation of equities (S&P 500) and the exchange rate is in the unusual situation of being inverse since early this year. In early July, it was the most inverse (~-0.34) in nine years but recovered to finish the month almost flat. The yen rose by about 1.4% in July, offsetting the June decline of the same magnitude. Its 5.7% loss year-to-date is the most among the major currencies and the second weakest in the region after the Thai Baht's nearly 9% loss. The JPY110.60-JPY110.70 represents a near-term cap. The JPY109.00 area should offer support, and a break would target JPY108.25-JPY108.50. The extension of social restrictions in the face of rising covid cases is delaying the anticipated second-half recovery. The preliminary composite PMI fell to a six-month low in July of 47.7.
Spot: JPY109.85 (JPY111.10)
Median Bloomberg One-month Forecast JPY109.85 (JPY110.70)
One-month forward JPY109.80 (JPY111.05) One-month implied vol 5.4% (5.4%)
British Pound: Sterling reversed lower after recording a three-year high on June 1 near $1.4250 and did not look back. It dipped briefly below $1.38 for the first time since mid-April on the back of the hawkish Fed on June 16 to finish July at new highs for the month and above the downtrend line off the early June highs. A convincing move back above $1.40 would confirm a low is in place and a resumption of the bull move, for which we target $1.4350-$1.4375 in Q4. The postponement of the economy-wide re-opening until the middle of July, and a central bank looking past the uptick in CPI above the 2% medium-term target, weighed on sentiment. The central bank will update its economic forecasts in August, and both growth and inflation projections likely will be raised. The furlough program ends in September, and it may take a few months for a clear picture of the labor market to emerge. Nevertheless, the market has begun pricing in a rate hike for H1 22.
Spot: $1.3905 ($1.3830)
Median Bloomberg One-month Forecast $1.3930 ($1.3930)
One-month forward $1.3910 ($1.3835) One-month implied vol 6.6% (6.5%)
Canadian Dollar: The Canadian dollar reached its best level in six years in early June (~$0.8333 or CAD1.20) but has trended lower amid profit-taking and the broad gains in the US dollar. The usual drivers of the exchange rate: risk appetites, commodities, and rate differentials were not helpful guides recently. Canada has become among the most vaccinated countries, and the central bank was sufficiently confident in the economic outlook to continue to slow its bond purchases at the July meeting despite losing full-time positions each month in Q2. Speculators in the futures market have slashed the net long position from nearly 50k contracts (each CAD100k) to less than 13k contracts in late July. The downside correction in the Canadian dollar appears to have largely run its course, and we anticipate a better August after the heavier performance in July. Our initial target is around CAD1.2250-CAD1.2300.
Spot: CAD1.2475 (CAD 1.2400)
Median Bloomberg One-month Forecast CAD1.2435 (CAD1.2325)
One-month forward CAD1.2480 (CAD1.2405) One-month implied vol 6.8% (6.5%)
Australian Dollar: Since peaking in late February slightly above $0.8000, the Australian dollar has trended lower and by in late July briefly dipped below $0.7300, posting a nearly 9% loss over the past five months. The 50-day moving average ~$0.7570) fell below the 200-day moving average (~$0.7600) for the first time since June 2020, illustrating the downtrend after the strong recovery from the low near $0.5500 when the pandemic first stuck. The combination of a low vaccination rate and the highly contagious Delta variant forced new extended lockdowns for Sydney and social restrictions that have sapped the economy's strength. It will likely slow the central bank's exit from the extraordinary emergency measures. Indeed, the Reserve Bank of Australia is likely to boost its weekly bond-buying from A$5 bln to at least A$6 bln. A convincing break of $0.7300 could open the door for a return toward $0.7000, but we suspect the five-month downtrend is over and anticipate a recovery toward $0.7550 over the next several weeks.
Spot: $0.7345 ($0.7495)
Median Bloomberg One-Month Forecast $0.7425 ($0.7610)
One-month forward $0.7350 ($0.7500) One-month implied vol 8.9 (8.5%)
Mexican Peso: The dollar chopped higher against the peso in July and reached a high near MXN20.25 on July 21. It trended lower and, in late July, fell below the seven-week trendline support near MXN19.90. After finishing June less than 0.1% weaker, the greenback lost about 0.4% against the peso in July, which was the fifth consecutive month without a gain. The other notable LATAM currencies were the weakest three emerging market currencies (Chilean peso ~-4.1%, Colombian peso ~-4%, and the Brazilian real ~-3.8%). If the upper end of the dollar's range has held, a break of MXN19.80 may warn a test on the lower end of the range (~MXN19.50-MXN19.60). The 5.75% year-over-year CPI for the first half of July and the highest core inflation for early July in more than 20-years keep expectations for another rate hike intact when Banxico meets on August 12. The market has another hike priced in for the September 30 meeting as well. The dispute with the US over measuring domestic content for auto production under USMCA could undermine Mexico's role in the continental division of labor, but instead, producers in Mexico may choose to pay the WTO auto tariff standard of 2.5%. The IMF's latest economic forecasts revised the projection for Mexican growth this year to 6.3% from the April projection of 5%.
Spot: MXN19.87 (MXN19.95)
Median Bloomberg One-Month Forecast MXN19.94 (MXN19.97)
One-month forward MXN19.95 (MXN20.02) One-month implied vol 10.5% (10.7%)
Chinese Yuan: The dollar spent most of July within the trading range that had emerged in late June found roughly between CNY6.45 and CNY6.4950. The range was maintained even after the PBOC unexpectedly cut reserve requirements by 50 bp (announced July 9). However, Beijing's more aggressive enforcement of antitrust, discouragement IPOs abroad, making private education non-for-profit without foreign investment triggered sales of Chinese shares. It helped lift the dollar in late July to around CNY6.5150, its highest level in three months and just shy of the 200-day moving average. The pursuit of domestic policy objectives appears to be putting at risk strategic goals. A drying up of capital inflows from spooked foreign investors may have slow efforts to liberalize capital outflows that could eventually lead to making the yuan convertible. At the same time, China's actions give a timely example of what holds the yuan back from a significant role in the world economy and why a technology solution (e.g., digital yuan) will not suffice. As the dollar briefly traded above the upper end of its recent range in July, the risk is that it slips through the lower-end range, which could spur a move toward CNY6.40.
Spot: CNY6.4615 (CNY6.4570)
Median Bloomberg One-month Forecast CNY6.4555 (CNY6.4360)
One-month forward CNY6.4780 (CNY6.4815) One-month implied vol 4.0% (4.7%)
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