Markets to Watch This Week: Will the BoE Confirm Market Hawkishness?

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Last Week’s Highlights

Land of the rising equity market! Japanese equity markets continue to perform after rising 4.5% in local currency terms last week (Chart 1). Warren Buffett added to his holdings in Japanese trading companies as his conviction grows, increasing his stake to almost 9.9% in some of his companies.

Japan continues to implement shareholder-friendly reforms and carry on the work done during President Abe’s tenure. These reforms have increased the attractiveness of Japanese equities as the Bank of Japan (BoJ) stays on hold while global central banks hike interest rates. A weaker yen also helps!

The BoJ stays dovish. The BoJ kept its easy monetary policy on Friday despite stronger-than-expected inflation. It maintains inflation will slow later this year and signalled its intention to stimulate until it is clear whether a more demand-driven, durable price rise will take hold. As expected, the yen continued to depreciate, falling the most against an already weak dollar (Chart 2).

The Fed paused while hawkishly revising its forecasts. Despite the 50bp increase in the SEP 2023 FFR, Dominique believes the Fed is dovish. The SEP projections raised the Fed forecast of Q4 2023 inflation to nearly twice as much as the Fed’s target! By contrast, the Fed projections see unemployment remaining near cycle lows.

Dominque now expects a hike in July and another one in November. She bases this on Chair Jerome Powell’s explanation that, since the Fed has already hiked 500bp, it will decelerate.

The ECB hiked by 25bps… but just as importantly, we saw it (finally) capitulate on its overly dovish inflation forecasts. Henry has been expecting that since March, but the turn was undeniably dramatic. The shift in unemployment expectations over its horizon is notable as it reflects the labour market strength despite higher rates and weak survey data.

Aussie economic activity slowed, but the labour market stayed strong. The NAB Business Survey showed a weaker economic backdrop; business conditions fell while business confidence returned negative – the spread between the two is now converging and trending weaker, forward orders have turned negative (they correlate well with retail sales), and employment expectations slipped lower though remained positive.

Meanwhile, the labour market tightened. Employment jumped +75.9k through May (FT: +61.7k; PT: +14.3k) after a contraction in April (-4.0k), unemployment slipped to 3.6% from 3.7%, while participation crept 0.2pp higher to 66.9%. As has been usual, weak employment changes preceded strong ones.

What to Watch

Will higher interest rates impact US housing? Dominque will be watching US housing data this week. We get the NAHB index today, building permits and housing starts on Tuesday, and existing home sales data on Thursday. Dominique agrees with the consensus on building permits but disagrees with housing starts and existing home sales, where she expects small increases in line with the recovery in the residential real estate market. This mix adds further evidence that demand for housing remains strong even if construction activity has stalled.

Following the Fed and ECB, the BoE is up this week… Henry expects a 25bp hike, but he believes they are in a tricky situation given recent data. He thinks it could be attractive to fade the BoE soon, but the timing is likely to be better after CPI and the policy meeting. We have already seen both a stronger sterling and higher UK rates in anticipation of a more hawkish, BoE with markets now pricing in a terminal rate of almost 6% (Charts 2 and 3).

Speaking of inflation, UK May CPI is expected to stay high across headline and core on Wednesday. Henry thinks the details will indicate whether some of the ‘one-off’ jumps in April have faded.

Is manufacturing still flashing red? Flash PMIs are released on Thursday for much of Europe and the US. Consensus expects the weakness in manufacturing to continue while services signal expansion. Curiously, one of the key drivers of the strength in the services PMI has been the financial services sector – and that is despite higher interest rates and a potential bank crisis. One driver of this has been easier financial conditions, so let us see if this endures.

The Week Ahead: Watch Dominique and Henry as they reflect on the recent FOMC and ECB  meetings. Dominique wonders if the Fed is losing credibility given the market reaction to their recent pause. Henry discusses his research on ECB and BoE and who must bear the cost of inflation.

Viresh Kanabar has worked in the UK financial services industry for over 8 years including in Consulting and Investment Risk. Most recently he launched The Macro Journal Substack where he puts out regular in-depth reports covering all areas of global macro.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

Photo Credit: depositphotos.com

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