Fed Minutes to Stress Further Hikes Likely in 2023 / The Rhine Runs Dry

US Key Points

• Fed minutes to show further rate hikes in 2023.
• Retail sales to surprise on upside.

Europe Key Points

• Another quiet week in Europe. Central bank speakers largely absent.
• A heavy slew of UK data released.
• UK inflation continues to surge higher, and consumers continue to feel the pressure.
• Elsewhere, the heatwave across Europe is having critical implications for German and European supply chains. We will be watching out for any opportunistic action from Russia.

US

Fed

Following lower than expected CPI and PPI, Barkin, Daly, Kahskari and Evans stressed that they expected further hikes through 2023.  By the end of the week, the market pricing of the end-2022 FFR was down 4bp on the week and pricing of the end-2023 FRR was up 12bp on the week. At 3.2%, the end-2023 FFR remains well below the June SEP at 3.8%, while the end-2022 FFR at 3.5% is roughly in line with the June SEP.

The minutes are out this week and I expect them to reinforce the message that rate hikes will continue into 2023.

As of this writing, there are 3 speakers scheduled, Barkin, George and Kashkari and I expect them to stay on message on 2023 rate hikes.    

Data

The inflation data was better this week with both the CPI and the PPI printing below expectations (please see July 2022 CPI: A Transitory Respite for the Fed).

Covid related hospitalizations have plateaued (Charts 4 and 6).

The most important data will be the retail sales (Wednesday). I am expecting a positive surprise, relative to the consensus 0.2%, as the recent stronger than expected labor market, PMI and consumer confidence data suggest economic growth could be picking up.

Other key data include:

• NY Fed ‘Empire’ survey (Monday) and Philly Fed survey (Thursday): I am expecting a positive surprise in the NY Fed survey, in line with improving output data, and I agree with the consensus on the Philly Fed that sees the survey improving.
• Industrial production (Wednesday): I agree with the consensus that sees an improvement. 
• NAHB Housing market index (Monday): I am expecting a negative surprise as the consensus expects no change, which seems unlikely since the market is cooling.
• Building permits and housing starts (Tuesday) and existing home sales (Thursday): I agree with the consensus that sees weaker numbers.
• Initial claims (Thursday): I expect the current pattern of initial claims being larger than the increase in continuing claims, roughly the consensus, to continue. This pattern shows that workers are getting laid off but finding new jobs quickly. This reflects the current combination of strong growth with economy wide post pandemic restructuring.
• TIC (Monday): I agree with consensus.

Events/Political Developments

The Inflation Reduction Act, a whittled down version of the administration Build Back Better Bill, that funds a combination of climate, health care and budget deficit reduction initiatives is poised to become law this week after it was voted by House and Senate. 

Links to New York Fed POMOs/TOMOs:  Repos, Treasury, MBS, CMBS

Europe

A Quiet Week on the Continent, but Busy in the UK

In a week, with little by way of European data or central bank speakers, it will be UK releases that dominate. Markets may have been able to find comfort from the recent miss in CPI in the US, but there is unlikely to be the same kind of reprieve for the BoE.

UK CPI (released Wednesday) is expected to come in at 0.4% MoM, leaving the YoY continuing on the upward trajectory. The reading itself is probably not that important, given that for now it is the expected outturns in Q4 (after Ofgem’s new price cap rise comes into effect, announced 26 August) that will ultimately dominate. The story seems clear, that prices are continuing to surge in the near-term on energy costs, and there is nothing that the Bank of England (BoE) can do about it.

Meanwhile, UK labour market data (released Tuesday) will continue to show that hiring difficulties remain strong, and wages continue to rise wages significantly above pre-COVID rates (Chart 1).  The market is looking for headline wage growth of 4.5% YoY, but there could be upside based on more timely PAYE data (Chart 2). Even if they do overshoot, it still means a rapid decline in purchasing power for UK consumers. This should be shown in continued deterioration in August GfK consumer confidence and July retail sales data.

Against this backdrop, the BoE has a difficult balancing act on its hands. It needs to be perceived to be doing something about inflation, while being conscious that continuing to just hike rates until inflation drops will put increased pressure on the consumer.

European Risks Remain High

A drought has been declared in the UK. For Europe, it is a largely similar story. The lack of rain and the intense heats seen through July, and now August are having serious implications. This will heighten the issues European manufacturing is already facing with regards to energy supply. Low and hot rivers restrict the amount of water nuclear power plants can discharge, and consequently the amount of power they can produce. France has recently tweaked the rules to allow five plants to continue discharging, but it remains an issue.

Meanwhile, the water level on the Rhine, down which barges need to travel to fuel the German industrial heartland are at dangerously low levels (Chart 3). This weekend is expected to see the level at the key river point at Kaub drop below 40cm, effectively stopping many barges from passing that point. That last happened in 2018, but it happened then much later in the year, suggesting that worse may be ahead.

At the same time, recent setbacks suffered by Russia in its invasion of Ukraine (including costly destruction at a naval airbase in Crimea) may encourage them to further tighten their stranglehold on Europe’s energy supply. We will be watching closely for signs of escalation, or how it may come about. By our calculations, if Russian gas to Germany is restricted further, the 15% EU suggested reduction in gas usage will not be sufficient to avoid a shortage.

China/Japan

Data releases this week include Japan’s CPI and China’s SWIFT data on CNY transactions.

COVID-19 Monitoring

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)