Fed to Hike 75bp / Is Eurozone CPI Peaking?

US Key Points

• Fed to hike 75bp and push back against market pricing of cuts in 2023.
• Employment Cost Index to show acceleration in wage growth.

Europe Key Points

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• Italy gears up for September elections – focus on fiscal and reform agendas of the parties.
• Preliminary Eurozone July CPI readings are expected to be mixed, with aggregate bloc MoM CPI expected to drop – that would be a dynamic change from the last 12 months. Likely upside risk from the recent gas price spike.
• GDP and unemployment data to provide more background to the ECB’s rate trajectory. Expectations are for a broadly stronger Q2 than Q1.

US

Fed

My expectations for the FOMC meeting are:

• A 75bp hike.
• Chair Powell is likely to push back against market pricing of cuts in 2023, likely with limited success because strong hawkishness could undermine further the credibility of the Fed forward guidance.
• Chair Powell is likely to provide hints of next steps in QE; I expect the bond cap to be lifted to $90bn in December as well as outright MBS sales to start in Q4.

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Data

I am not attaching a strong weight to the large negative surprise in the S&P services PMI; as the survey’s employment component showed strong expansion, if slowing and other recent indicators point at robust but slowing growth. 

Covid hospitalizations continue to gather pace though hospital capacity remains ample (Charts 1, 3 and 4). 

This is a data heavy week. Key data include:

• Employment Cost Index: based on the Atlanta Fed median wage and on services inflation, I expect a positive surprise relative to a 1.1% QoQ sa consensus. This print will give us a sense of the tightness of the labor market and therefore of inflationary pressures.
• Core PCE: I agree with the consensus of 0.5% MoM for core. In addition, I will be looking for a further increase in the trimmed mean PCE, a decline/increase in core goods/services inflation, a marked acceleration in core services inflation, and continued convergence of core goods PCE with the CPI.
• Personal income and spending: I agree with the consensus that expects consumption to have kept up with inflation and implies a further decline in the savings rate.
• GDP: I agree with the consensus. I will also be looking for an acceleration of the growth in the average of GDP and GDI,  as well as for a slowdown in the growth of final sales to private domestic producers to about 2% QoQ saar from 3% in Q1 (see Growth pessimism partly reflect measurement issues).
• Durable goods orders: I agree with the consensus.  I will be focusing on capital goods orders that correlate well with equipment capex in the GDP data. Consensus expectations imply continued strength.
• Conference Board consumer confidence: I agree with the consensus and will be looking for a further decline in the jobs plentiful minus hard to find indices, though I expect it to remain above pre-pandemic levels. This would be in line with a slowing but still strong labor market.
• FHFA and Case Shiller House price indices: despite the declines in existing and new home sales, these indices are still growing by more than 1.5% a month!
• Activity surveys (Chicago National activity index, Dallas and Richmond Fed manufacturing surveys, MNI Chicago) are generally expected to slow, and I agree.  This is consistent with the ongoing slowdown in the US economy.
• Retail and wholesale inventories: I will be looking for a further recovery in the retail and wholesale inventories to sale ratios, especially for cars.
• Trade balance (goods):  I agree with the consensus that expects a small improvement relative to May.  Even with this improvement the trade balance would remain close to a historical worst, which is consistent with the US growing faster than its trade partners.

Other key data includes new home and pending sales, jobless claims and mortgage applications.

Events/Political Developments

The announcemetn this week by House Speaker Pelosi that she was planning a trip to Taiwan ellicited strong reactions by Chinese officials when the administration is trying to steady its relationship with the mainland.

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

Europe

Risk-Off Outcomes in Europe

Last week saw the resolution of a series of high-risk events across Europe in an aggregate risk-off manner. Russian gas flow via Nord Stream resumed at continued low capacity, but EU efforts to create a framework for gas demand management show a growing political consensus to remove dependency on Russian regardless. That could yet mean capping economic output in the future. Meanwhile, Italian elections are now set for 25 September, after PM Mario Draghi failed to gain the support he needs to continue in a negative outcome for Italian assets in general. Finally, the ECB surprised with a 50bp hike, taking them out of negative interest rates. President Christine Lagarde announced the end of forward guidance, while simultaneously guiding the market that interest rates were headed to the same trajectory as prior (only faster), to end in a ‘broadly neutral’ region. The ECB’s announced transmission protection instrument (TPI) has so far been pretty poorly received by markets, with BTP/Bund spreads widening out after the press conference.

The week ahead sees the release of preliminary July CPI, economic confidence readings, unemployment numbers and Q2 GDP releases across Europe.

September Elections For Italy

Campaigning will begin imminently ahead of the Italian elections on 25 September. Right now a centre-right coalition of FdI, Lega and FI are polling to gain majorities in both houses. Whichever group wins will face a tight deadline to quickly draft their 2023 budget plan for EU assessment, and then pass the law before the end of the year. Meanwhile, the need to retain Draghi’s trajectory of reform legislation will be a major consideration as it will be needed to retain access to EU post-Covid reconstruction funds. Any information gleaned on party intentions around budgets and reform will be front-and-center.

Eurozone Preliminary July CPI

While medium term inflation is the main priority of the ECB right now, the consistent high and rising trajectory of current inflation sets much of the pressure on their policy decisions. Following the ECB policy announcement last week, the market has been satisfied to price in the same terminal rate of interest rates as it did before, despite the acceleration in hiking speed. Expectations for July CPI outturns are nuanced and will be affected by price cap policies as well as underlying dynamics.

The market is generally looking for a continued YoY rise across the countries, but the MoM effects are somewhat mixed. Consensus is split on the MoM EZ number move, with a slight favouring amongst economists for a modest decline in July. That would be the first decline in the reading in 12 months and would no doubt gain strong headlines. Meanwhile, Eurozone YoY core inflation is expected to tick back up again after its slide in June. Given the gas price rise in July, the risks may be to the upside, albeit with some offset from the price of oil and of national policy intervention on prices. A beat in the EZ MoM reading would likely lead the market to price in more ECB hiking.

Eurozone Q2 GDP and Unemployment

The week will also see the release of Q2 GDP numbers, Spanish and German unemployment readings, and various confidence surveys. Expectations are for a positive Q2 GDP outturn across the major countries, with an acceleration in QoQ growth in France, Italy and Spain, and a slight slowdown in Germany. Meanwhile, in unemployment, the expectations are for the German rate to tick up once again after the bounce last month, reportedly from Ukrainian refugees being counted. In Spain, the expectation is for the post-2020 unemployment decline to continue. In surveys, the trajectory remains very negative, particularly after last week’s <50 PMI readings.

Other G20 Countries

This week the BOJ is publishing its minutes and summary of opinions.

Key data releases this week include Australia’s CPI and China’s and Australia’s PMIs.    

Links to BOJ Rinban , BOE OMO

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. He holds a BA in Economics from Durham University, and an MSc in Economics & Social History from the University of Oxford.

(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.)