Fed Support
As expected, the Federal Reserve delivered no policy changes and kept the federal funds rate target range at 0.25% to 0.50%. However, it left the door open for a potential September move, citing a reduction in global risks and continued improvement in the labor market. Fed funds futures currently imply an 18% probability of a September hike.
Markets are increasingly pricing out, rather than pricing in, further tightening. This has supported precious metals, with gold rebounding successfully from levels above USD 1,300 per ounce. Many investors have grown skeptical of the Fed’s guidance, which has contributed to renewed demand for gold.
Toward the end of the week, markets also turned to the Bank of Japan, which disappointed. Investors had expected more, and the increase in ETF purchases by JPY 3 trillion fell short of what had been priced in. The BoJ acknowledged that its policy is not currently delivering the desired results.
Late on Friday evening, the results of stress tests for selected European banks were released. As expected, Italian banks posted the weakest outcomes.
FX markets
The main EUR/USD pair once again pushed higher, moving above 1.10 and finishing the week above 1.11. The broad range that has persisted for more than a year remains intact. The U.S. dollar was weakened primarily by the further postponement of Fed rate hikes. In December 2015, Fed officials had projected four increases in 2016; we are now in the second half of the year and rates remain unchanged.
Dollar weakness and the BoJ’s under-delivery boosted the Japanese yen, which strengthened from 106 to 102.07 USD/JPY. Notably, the yen has been gaining despite relatively constructive performance in risk assets. With low and in many cases negative rates globally, investors continue to search for the most attractive alternatives.
The delayed pace of U.S. tightening also supported the Chinese yuan, which recorded its strongest appreciation in the past four months. Analysts broadly agree that China’s central bank is seeking to avoid unwanted volatility ahead of the September G20 meeting.
Most emerging market currencies weakened against the euro, largely reflecting stretched, overbought conditions. Exceptions included Central European currencies, the Turkish lira, and the South African rand. The rand in particular continues to surprise on the upside, strengthening beyond 15.51 EUR/ZAR, supported in large part by a fiscal surplus in July. Unemployment and the political backdrop, however, remain key uncertainties.
The Turkish lira recovered part of the losses it had accumulated two weeks earlier. The ongoing crisis poses a major challenge for Turkish economic performance in the period ahead, while the decline in tourism is another hit to external revenues.
The Russian rouble weakened for a third consecutive week, driven mainly by a more than 20% drop in oil since June 2016. With crude prices around USD 40 per barrel, the Russian budget remains under pressure. The Russian central bank refrained from cutting rates, as doing so could have further weakened the rouble.
The Brazilian real proved more resilient to the decline in oil, showing a smaller pullback. Political changes have helped keep the currency near year-to-date highs, with additional support potentially coming from the upcoming Olympic Games.
The Indonesian rupiah gave back some of the gains recorded since the UK referendum, but remains below 15,000 EUR/IDR. Stable inflation leaves room for further rate cuts in the period ahead. The Indian rupee showed a similar pattern.
Bond markets
Indian bonds delivered their best monthly performance in July in the past three years, supported by an attractive risk premium relative to yields in developed markets.
Equity markets
Emerging market equities posted a fifth consecutive week of positive returns and have held onto the breakout achieved two weeks ago. Short-term overbought conditions are evident, although the timing of any correction remains difficult to call. August tends to be a relatively quiet month, though exceptions do occur, as in August 2015.