Key Events: Even the Doves Are Starting to Fly Away

US – Europe – $-Bloc and Rest of G10 Europe – China/Japan

US

Summary

• Fed doves are more concerned by strong growth.
• Core MoM CPI to remain stable at around 20bp.

Fed

Waller gave the clearest signal yet that the Fed will be on hold this month.

Overall, the doves (Williams, Goolsbee, Bostic) came across as more nuanced this week. A common theme was the strength of the US economy.

The Beige book conveyed its usual highly shaded picture of the economy but did not provide much of the data not already shown, namely stronger growth and slower inflation than at the time of the June FOMC and cooling labour markets.

The pre-meeting blackout started on the weekend.

Data 

This week’s data continued to point at strong growth and limited disinflation. The services PMI surprised on the positive side. The Atlanta Fed nowcast of Q3 GDP rose to 5.8% from 5.6% a week ago and compared with trend of 2%. The Citi economic surprise index rose to 61.4 from 52.1 a week ago. WTIC spot rose to $87.28/barrel from $85.55/barrel a week ago.

Key data by order of importance includes:

CPI (Wednesday): I agree with the consensus but as always it is the details that will provide the underlying story. I expect OER inflation to remain around 50bp, core services excluding housing above 20bp, and core goods inflation negative.   

PPI (Thursday) and import prices (Friday): I agree with the consensus showing slower MoM increases, though it is not consistent with market reaction to the prices paid sub-indices in the manufacturing and non-manufacturing PMIs. Those have been rising and there are market concerns it could lead an increase in the PPI, but I do not find the data convincing.

Small business optimism (Tuesday): I agree with the consensus and will be looking for continued signs of no credit crunch.

U Mich consumer confidence (Friday): I agree with the consensus, though the headline number is no longer a predictor of durable purchases. To me the more interesting part of the survey will be inflation expectations. Gasoline prices were about 10% higher in August than in July and I will be looking for higher 1yr inflation expectations as a result.

Manufacturing: Fed Board and NY Fed Empire survey (Friday): I agree with the consensus. In any event, manufacturing is only about 10% of the economy.

Jobless claims (Thursday): I agree with the consensus that is consistent with a tight labour market.

Events/Political Developments 

Recent polls still show former-president Donald Trump as the front runner in the Republican primaries, by a very large margin. They also show that a Biden/Trump re-match is within the margin of error.

Europe: ECB Needs to Keep Hiking

Key Points

• The ECB will announce its policy decision and release new forecasts on Thursday. We expect the forecasts will remain hawkish and err on the side that the ECB will hike to 4.0%.
• If the ECB was to pause it does not mean they will not hike in October. We see best value positioning for higher terminal rate and fewer cuts in 2024 via paying 6m fwd 1Y EUR OIS.
• UK labour market data (Tuesday) is likely to show that the labour market continues to loosen faster than the BoE has baked into its forecasts. Wage growth is highly uncertain, but we expect there will be headwinds ahead.
• We see positioning for BoE dovishness via paying 1Yx1Y US OIS vs (rec) 1Yx1Y SONIA, and also via 2s10s GBP steepeners (outright and boxed vs EUR).

ECB Needs to Tighten More – We Lean Towards a Hike This Week

Given the fundamental picture, despite the slowing in Eurozone growth, our lean is that the ECB needs to tighten further to get inflation onto a trajectory consistent with their medium-term inflation forecast.

We stand by our longstanding expectation for terminal rate at 4.0%, with upside risk. Our lean at this stage is that the ECB will hike 25bp at their meeting on Thursday. If they do not, we would see value fading dovish pricing thereafter, as October will be a live meeting, and September inflation could provide an upside surprise before then (given that more firm repricing tends to be seen then).

Negative recent survey sentiment has dampened the mood, but the survey data has become less useful as a forecast for hard data since COVID. The ECB are aware of this.

A cautious hike makes sense given the ECB’s metrics and the recent data we have had. In such an instance we would expect that they stress that they are near to being done. There is, however, a strong risk that they choose not to hike on the back of the slight slowdown in August core inflation momentum and the recent negative survey data. Regardless of the decision, we expect they will stress the data dependence of future decisions and push back on pricing for 2024 cuts.

If the ECB does choose to pause, October remains a live meeting. There is upside risk to September inflation given firm repricing tendencies. If we get a strong read there in core inflation, then the hawks will push strongly for the hike they missed in September.

While our lean is for a hike in September, our stronger view is that there is value positioning for a higher terminal rate more generally, and to fade the cuts priced in 2024. We like paying 6m fwd 1Y EUR OIS.

UK Labour Market Could Add to Dovishness

Tuesday will see the UK labour market data released. It is the most important UK data of the week in our view. The labour market has loosened faster than the BoE had assumed (as we had long warned it would). Market expectations are for another rise in unemployment up to 4.3%. There could be upside risk here, although we warn that single outturns can be shifted greatly by MoM changes in participation. More tellingly will be whether full time employment continues to shrink, and if part-time employment is also weakening (it has provided much of the growth in employment since the start of the year). If this continues to be the case, then wage growth should see headwinds ahead. We have previously highlighted the risk ahead that employment composition (which has previously been supporting ONS wage growth figures) will switch to negatively impacting it (Chart 1).

A further rise in unemployment driven by a decline in employment would be strongly dovish and add to our conviction that there is good value in fading BoE hikes currently priced. We like this via paying 1Yx1Y US OIS vs (rec) 1Yx1Y SONIA, and also via 2s10s GBP steepeners (outright and boxed vs EUR).

$-Bloc and Rest of G10 Europe

China/Japan

Chinese data and policy actions stay in the spotlight next week.

• The market will be watching for an uptick in property transactions and property price data, which should offer the first decent read on how activity has responded to the recent easing of property measures.

• Credit and activity data will also be watched closely, but we think market’s estimate of RMB 2.7trn, translating to 9.1% YoY growth, might be a touch optimistic. We think further support measures will be necessary to turn China’s credit impulse meaningfully higher, and that measures already taken will take some time to come through the data.

• We expect PBoC to make another calibrated 10bps cut to the 1Y MLF rate, though we cannot rule out a pause given the ongoing pressure on the currency and broad resurgence in the US dollar.

• There should be relatively less focus on FAI, IP, and retail sales figures as these would be slower to respond to recent policy actions. We expect IP and FAI to remain at their depressed levels, but retail sales may surprise to the upside, capturing the recent strength in high frequency indicators like auto retail sales, daily cinema visits and domestic travel.

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.

Ben Ford is Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

Mirza Baig is a macro strategist, specialising in Asian FX and fixed income markets. Mirza is currently working as a desk analyst at Morgan Stanley, prior to which he worked in macro strategy roles at BNP Paribas and Deutsche Bank.

Photo Credit: depositphotos.com

(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.)