Key Events: It’s PCE Week, Will This Lead Us Down a Path to a 50 Point Cut?

Jump to: US | Europe | $-Bloc | Emerging Markets

US

Summary

• Core PCE to fall further away from the Fed’s 2% target.
• Q4 GDP could surprise on the upside but is likely to remain close to 2% trend.

Market Implications

• I am still expecting, on balance, a 50bp cut at the March FOMC meeting, but only with a 50% probability.

Fed

Fed speakers continued to jawbone markets away from pricing too many cuts to preserve policy optionality. Waller’s speech was very data focused, likely to contain market expectations of ‘too many’ cuts. At the same time, he explicitly discussed the risk of overtightening for the first time, which data developments and his model of the labour market show as significant and growing. He also indicated that the forthcoming revisions to the CPI, to be released on 9 February, would be a key driver of his rates view, which to me points to a March cut.

The pre-meeting black out starts this weekend.

Data

Retail sales surprised positively, as I expected and in line with strong growth. The Atlanta Fed nowcast Q4 GDP rose to 2.4% from 2.2% a week ago. The Citi economic surprise index rose to 13.5 from 7.5 a week ago. WTIC spot rose to $74.2 /barrel from $72.7/barrel a week ago.

Key data by order of importance includes:

December core PCE (Friday): based on CPI and PPI, the unrounded MoM core print should be about 15bp, roughly in line with the consensus estimate of 0.2%. If so, the six-month average core PCE would fall further away from the Fed’s 2% target.

December personal income and spending (Friday): at 0.4% and 0.3%, the consensus seems reasonable. It would leave the savings close to current levels – historically low because households have absorbed higher inflation and the decline in their real income through lower, but still positive, savings.

Q4 GDP (Thursday): the consensus estimate at 2% QoQ SAAR is below the Atlanta Fed’s 2.4% and on the low side of my expectations for a bit above trend print.

December new home sales (Thursday): the consensus expects an increase, in line with lagged housing starts, and I agree.

January PMIs: Richmond Fed manuf. (Tuesday), S&P manuf. and serv. (Tuesday), KC Fed manuf. (Thursday): the consensus sees the PMIs moving sideways, and I agree.

Jobless claims (Thursday): I agree with the consensus that sees continued low claims.

December Leading Index (Monday), December Chicago Fed National Activity Index (Thursday), December durable goods orders (Thursday), December goods trade balance (Thursday): I agree with the consensus. 

Events/Political Developments

Former President Trump’s victory in the Iowa caucus confirmed his frontrunner status.  The next primary, in New Hampshire, is on 23 January.

Congress has agreed on a new CR extending government funding until 1 or 8 March, depending on agencies. I expect a series of CRs through 2024.

Europe

Summary

• Expect the ECB to leave rates unchanged. We stand by our long-standing expectation that they can cut in June.
• European PMIs are expected to generally trend upwards – the detail is more important than the headline.
• UK public finance data will provide insights to the headroom the chancellor will have at the March statement.

Market Implications

• We continue to see value in paying April ECB-dated ESTR and in being long SONIA September 2024 futures.

ECB to Stand Pat – Push Back on Priced Cuts

The ECB has been pushing back on market pricing. The Davos conference provided an excellent stage to do so, and the tone has been unequivocal: the market is being optimistic on cuts.

I expect this tone will remain at the ECB’s meeting this week, and for them to leave policy unchanged.

Our central case for some time has been that the ECB can afford to wait until they have a full picture of Q1 data before cutting – which places the June meeting as the earliest candidate for such a move.

The minutes from the ECB’s meeting in December provided a good reason as to why they are coming out more forcefully recently: ‘…sharp market repricing threatened to loosen financial conditions excessively, which could derail the disinflationary process…’

They hence agreed ‘not to accommodate market expectations in the post-meeting communication.’

Much of the financial condition loosening they fear can be attributed to two factors:

• The miss in November EZ inflation
• The Fed’s December dovish pivot (Chart 1).

December’s CPI showed that November was something of a one-off, and that the ECB’s forecasts are actually more accurate than had been expected (Chart 2). We expect they will want to plug this little win.

The ECB has been clear that they will not just be driven by the Fed (in fact, if financial conditions ease due to the Fed, it will leave them needing to push back stronger).

My expectation for some time has been that unless the ECB’s hand is forced, it can afford to be patient, and wait for the Q1 labour market data it has been expecting to come.

It is on this basis that we entered an April ECB-dated ESTR payer in our model portfolio.

 Any noise around PEPP’s winddown being able to accelerate would help our bearish EGB view, but I hold little expectation of this.

European PMIs – Watch Employment and Price Setting Details

The market will make a lot of noise around whether the headline manufacturing and services PMIs have beaten or missed expectations. But to the ECB, the details are more important.

I will be watching the manufacturing PMIs for signs that the passthrough of input cost deflation continues to slow, and whether employment decline is slowing.

I will be watching services for similar impacts – but more specifically whether the passthrough of wage costs continues to build (ECB will be watching this closely), and if employment growth was maintained.

$-Bloc and Rest of G10 Europe

Summary

• Australia: NAB Business Survey is likely to show weakening demand.
• Canada: BoC to prove cautious, with price progress disappointing.
• New Zealand: non-tradables inflation will help RBNZ pivot to a neutral stance.
• Norway: Norges Bank to prove stubbornly boring.
• Sweden: labour market update fundamentals to show loosening.

Market Implications

• We remain short AUD/CAD. We expect the NAB Business Survey and caution from the BoC will help the trade.

NAB Business Survey Likely to Deliver Dose of Reality

Markets remain bullish on the Australian dollar, with clients suggesting that the economy is in a good place. However, as was part of our thesis to turn short AUD/CAD, we are less convinced.

Key signs of this come from the NAB Business Survey (Tuesday). There, we expect a continued indication that demand is waning, price expectations to reverse the momentary increase from last month, and confidence and conditions to continue to decline (Charts 3 and 4). This lines up with our view that the mortgage refix story will play out through 2024, which should bring forward pricing for RBA cuts.

A Cautious Step Incoming from The BoC

The BoC (Wednesday) are widely expected to keep the policy rate at 5.0%. We agree. However, it will be the guidance and digestion of recent data the market analyses. After all, in the December meeting, they had their focus kept on core inflation, inflation expectations, wage growth, and corporate pricing behaviour. Looking through the four, we find:

• Core inflation: progress has been slower than hoped for. The BoC had wanted a decline out of the range in which core inflation momentum had spent most of 2023. And, while it looked like we had that in the November report, the December report gave us little further encouragement (Chart 5). Core goods inflation is struggling to return to target, while services inflation momentum continues to trend higher. As a result, the BoC will tread cautiously on taking positives from the most recent inflation outturn.
• Inflation expectations and corporate pricing expectations: both, too, stalled. And while great progress has already been made, the final hurdle is proving tricky to defeat.
• Wage growth: while the labour market is undoubtedly loosening (Chart 6), wage growth is proving stubborn. This, on the back of yet again declining productivity, has kept ULCs at record highs.

Non-Tradables Inflation Will Help RBNZ Turn More Neutral

The December manufacturing PMI outturn delivered only negativity. However, manufacturing is a small portion of the economy (8%). It means the services outturn (Monday) matters more. There, the November number showed an expanding services economy (Table A). We will be watching for a continuation of trend in new orders, which should help it closer to 50.

CPI (Tuesday) will be the most important release of the week – even more so now the RBNZ are working on a single, rather than a dual, mandate. Of all the numbers to pay attention to, non-tradables inflation should be the focus – it measures NZ domestic inflation – and it will be the RBNZ’s focus, too. As it stands, consensus has non-tradables inflation increasing by +0.8% QoQ. This is below the RBNZ’s forecast (+5.7% YoY, which implies +0.9% QoQ; Chart 7).

As a result, this week should prove bearish for NZD. However, trading the view is likely to prove difficult if you are not already positioned. We missed the bounce on the long-term trend line in AUD/NZD, while NZD/CAD has declined 1% from its range already.

Norges Bank to Prove Stubborn

The Norges outturn (Thursday) should prove relatively straightforward. In December they were hawkish and pushed their worries about core inflation. Core inflation has since disappointed forecasts, but with still elevated core inflation momentum. As a result, Norges Bank are likely to repeat much of the December message: positive signs in core inflation but risks remain.

Ignore Prospera, Unemployment to Show Loosening Labour Market

Only one release is worth noting this week: the labour market report (Friday). While Bloomberg only reports the unemployment number – expected to come in at 8.1%, which would be in line with Riksbank forecasts – the underlying details are more important and show the decline can pick up pace. That is because full-time hires have slowed – they have been holding up the strength in the labour market (Chart 8); part-time hires slowed a long time ago – they have been part of the bankruptcy stories that dominate headlines.

Emerging Markets

Summary 

• MAS (Singapore) and BNM (Malaysia) to both stay on hold. 
• We expect a 10-15bps 1Y LPR cut in China. 
• South African disinflation to continue.  
• SARB to remain firmly on hold.  
• Brazil and Mexico CPI in spotlight. 

Market Implications 

• You can find an overview of our open EM trades in our Model Portfolio. 
• Most recently, we entered a short CNH vs an EM basket and went long EUR/PLN. 

MAS to Keep Slope/Band Unchanged  

MAS’s quarterly MPC meeting is due next week, though there is no announced date for this yet, and there is a chance the date could spill over to next week.  

We expect the MAS to keep all basket parameters unchanged, similar to market consensus. Any downward revisions to CPI forecast for 2024, however, will indicate a higher chance of easing at the April meeting, which is against our current expectation.  

BNM to Hold Rates at 3% 

Malaysia’s central bank meets on Wednesday and is expected to keep rates on hold at 3%. BNM is waiting for clarity from the government on a rollback of subsidies and price controls, as these would pose upside risks to inflation. Thus, even with data softening and current inflation falling, we think the bar for BNM to cut is high until there is clarity on the fiscal front.  

China LPR Cut  

After PBoC unexpectedly kept the MLF rate unchanged this week, the market expects Chinese banks to keep the Loan Prime Rate (LPR) unchanged on Monday. However, we think there is a reasonable chance that the LPR is reduced by 10-15bps. This is because banks’ net interest margins have increased due to cuts in their deposit rates last year, and cheaper term funding being provided by the PBoC through its Pledged Supplementary Lending (PSL) facility. As such, the central bank may want the banks to pass on this easing via lower lending rate benchmark.  

Brazil and Mexico biweekly CPI 

As we approach the first MPC meeting of BCB (31 January), the January IPCA-15 will be an important release on Friday. While the headline number is expected to be around 0.4-0.5% MoM on the back of food price volatility on El Nino effects, we think services inflation will continue to soften. BCB has indicated a steady path of 50bps for the next two meetings, and the path beyond will be a function of CPI trends.  

Mexico does not print much data next week, but the biweekly CPI will be notable. We do not forecast this number, but will be watching the core-services component closely, given Banxico is focusing on this measure of inflation.  

South African Inflation to Decline  

Another decline in fuel prices in December should mean YoY disinflation continues for another month. We see some upside risks from food prices but not enough to change the recent trend of modest disinflation. Core inflation is, however, expected to move higher in YoY terms given the weight of fuel prices in the headline CPI improvement.    

SARB to Remain Firmly on Hold 

CPI still well above the SARB’s preferred 4.5% will mean the SARB remains firmly on hold at 8.25% on Thursday. And with January’s ZAR weakness, we expect the hawkish tone from 2023 will continue. Rate cuts will not be discussed with the SARB, which is likely to repeat that the fight against inflation is not yet over. 

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 a Researcher at Macro Hive. Benjamin 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.

Caroline Grady is Head of Emerging Markets Research at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.

Mirza Baig is a Senior Macro Strategist at Macro Hive, specializing in EM research. He has been researching and trading global FX & rates products for over 19 years, boasting affiliations with Morgan Stanley, BNP Paribas, Deutsche Bank, and Point 72.

(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.)