China | Europe | Global | Monetary Policy & Inflation | US
Key Events: SVB Is a Reality Check for Tech
- By Dominique Dwor-Frecaut, Ben Ford and Henry Occleston
- 12 min read
US – Europe – $-Bloc and Scandies – China/Japan
US
Summary
- Markets to digest SVB bankruptcy that is unlikely to turn out systemic.
- Used car price inflation could turn positive and end disinflation.
Fed
I do not believe the bankruptcy of Silicon Valley Bank (SVB) is a systemic market event:
- The issue of unrealized losses on bond holdings across all banks was well known.
- SVB had unique exposure to tech startups as was its recently fast asset growth.
- SVB represents less than 1% of total US banking assets.
- The banking system is highly concentrated and big banks’ large and stable deposit base suggest contagion risks are limited.
In addition, the Fed will be keen to show that the risk management framework it put in place after the GFC is not constraining monetary policy. Furthermore, the Fed is more likely to address the LT issues revealed by SVB (exposure to non-banks, unrealized losses on bond holdings) through asking weaker banks to raise more capital rather than through letting go of its inflation mandate.
I therefore see the SVB bankruptcy as lowering the risk of a 50bp hike at the March 22 meeting, rather than changing the LT FFR trajectory. It balances the increased risk of a 50bp hike cause by the large positive NFP surprise.
If I am wrong and the SVB bankruptcy turns out systemic, then markets should be pricing the FFR going back to 0 rather than to 4.8%!
The pre-meeting blackout started on the weekend.
Data
The Atlanta Fed GDP nowcast for Q1 rose to 2.6% from 2.3% a week ago. The Citi economic surprise index rose to 44.7 from 38.9 a week ago.
Key data this week by order of importance:
- CPI (Tuesday): I agree with the consensus 40 bp for core MoM. I will be looking for signs that used car prices are troughing, following the Q4 trough in Manheim auction prices (Used Car Rises to End Disinflation).
- PPI (Wednesday) and Import prices (Thursday): I agree with the consensus.
- Retail sales (Wednesday): In view of strong employment growth, and therefore household income, I see scope for a positive surprise relative to the consensus -0.4% for headline.
- NAHB Housing Market Index (Wednesday), housing starts and building permits (Thursday): I see scope for a small positive surprise to the consensus that expects roughly no change, as the real estate market seems to be stabilizing (though residential investment is still deeply negative).
- Industrial production (Friday): I agree with the consensus that sees a small MoM increase.
- TIC (Wednesday): I agree with the consensus.
- Jobless claims (Thursday): I agree with the consensus showing low initial claims.
- Small business survey (Tuesday): I agree with the consensus that sees no change.
- New York Fed (Wednesday) and Philly Fed (Thursday) manufacturing surveys: I agree with the consensus.
- University of Michigan consumer confidence index (Friday): The recent recovery in gas prices and inflation suggest a negative surprise is possible relative to the consensus that assumes no change.
Events/Political Developments
President Biden’s FY2024 budget proposes to expend social and military spending while reducing the deficit through higher taxes on higher income households and large corporates. While the budget is unlikely to get voted by a split Congress, it could prove popular with voters and make it more difficult for the Republicans to refuse to raise the debt ceiling without expenditure cuts.
Links to New York Fed POMOs/TOMOs: Repos, Treasury, MBS, CMBS
Europe: ECB to Hike 50bp With Hawkish Forecasts
Key Points
- The ECB (Thursday) is likely to hike 50bp, guide for more hikes ahead (another 50bp in May is my base case), and provide hawkish forecasts with a significant upward revision to 2023 core CPI.
- UK labour market data (Tuesday) is expected to see unemployment rise but wage growth remain stubbornly high. The balance of these factors will be key. Data has tended to surprise to the upside on wage growth, and this is a risk again this week.
- The UK’s Spring Budget (Wednesday) could see some additional support to households in the near-term given positive recent deficit numbers, but I expect fiscal prudence will remain the aim.
- I continue to see value fading pricing for BoE hikes, and this week could provide another boost to EUR/GBP.
ECB to Hike 50bp With Hawkish Forecasts
Thursday will see the ECB update its policy and its forecasts. It will almost certainly mean a 50bp hike and guidance that there is more to come. I have expected 50bp in March and May since the last meeting.
The updated projections should support the hawkishness. While headline inflation will need to be revised lower, the GDP profile will need to be raised. The shift down in headline inflation should come with heavy caveats and be largely offset in tone by a significantly higher path for near-term core inflation (Chart 1).
The near-term profile for core inflation will likely need to be revised significantly higher. I view it as likely that 2023 core HICP will be revised up above 5%. This would be a similar upward revision to that seen in December, which would likely mean a further upward revision to 2024 and possibly 2025 core HICP. If this turns out to be the case, I would expect a strong hawkish market reaction.
The fact that February’s meeting minutes pointed towards a future 2025 CPI forecast closer to 2% is worth noting. Such an outturn would probably drag down medium-term core inflation too, which does not seem too credible.
The real risk to the dovish-side is that Lagarde fails to deliver the hawkish tone the market is gunning for. On the face of it they are still in ‘data dependent’, ‘no forward guidance’ mode. Higher core HICP, GDP and wage growth forecasts should give them reason to sound more hawkish, but Lagarde in particular has a good record of underdelivering.
The ECB Can Hike Well Beyond 4% – Bullish EUR/GBP
Into the future, I think the Eurozone is looking into a fundamentally higher rates environment. Even before I turned hawkish the ECB I wrote a report last year on how high ECB rates could feasibly go. The rationales I cited then remain true now.
The market is pricing c.4% terminal rate right now, around the middle of my ‘range of reasonableness’ that I have held since February (Chart 2). A significant upward revision in core inflation in the ECB projections could be enough to push this profile significantly higher. Meanwhile, if the ECB were to revise medium-term core inflation lower, I would see value in fading any dovish reaction to this.
Meanwhile, with the UK set to see labour market data and the Spring Budget this week (more information below), there is room for a rise in the 2Y EUR/GBP swap spread and with it a rise in the currency pair (Chart 3).
UK Budget and Labour Market Data to Confirm BoE Pause?
The UK will release labour market data on Tuesday. The release, along with Wednesday’s Spring Budget, and the week after’s inflation release, will decide whether the BoE pauses hiking.
The market right now is looking for the unemployment rate to rise to 3.8%. Even a miss on that number would be roughly consistent with the BoE’s very flat February MPR expectation (Chart 4). The risk at this stage is that surveys suggest hiring difficulties have ticked back up – but this may not hit the hard data for a few months. Further out, I expect to see activity rates rise given that UK consumer savings rates remain under significant pressure.
Probably the more important release will be wage growth. Private wage growth will be the most important part from the BoE’s perspective. Right now, the market is looking for regular wage growth to dip to 6.6%, while total pay growth drops to 5.7% YoY. While those would constitute YoY declines, they would still be relatively strong outturns, consistent with c.6.9% private wage growth. Add to this the fact that wage growth has consistently beaten analyst forecasts in recent months and there could be substantial upside risks.
If there is a significant beat in wage growth it may lead the BoE to lean towards another hike. Nevertheless, with 25bp in March fully priced and more thereafter, I continue to see value fading pricing for BoE hikes (currently priced at c.4.70%) via being long short-end UK bonds or receiving short-end GBP swaps.
The UK Chancellor will set out the Spring Statement on Wednesday. Expectation is for updated forecasts to show a smaller deficit than previously guided, likely with a positive revision to near-term growth. Further-out, however, the picture may be bleak – that may be enough to put off the Chancellor from providing too much additional support. Productivity and getting people back into the labour force will be a high priority. There is also a strong possibility of the UK’s Energy Price Guarantee (EPG) being kept at £2,500 post April (currently scheduled to rise to £3,500). That would constitute a boost to the consumer and reduce inflation in the near-term. How this spend is offset elsewhere will determine whether such a boost would lead the BoE to see more hiking as required. I do not imagine it will lead them to significantly alter their growing desire to pause soon.
$-Bloc and Scandies
Reserve Bank of Australia
The RBA hiked the policy rate by 25bp to 3.6% and dovishly revised forward guidance, as we had expected. We continue to expect a 25bp hike in April with a terminal rate of 3.85-4.00%. We will break the past week into two components: 1) the statement; 2) the presser.
In the statement, there were several key takeaways:
- ‘Inflation has peaked in Australia.’
- Medium-term inflation expectations are anchored and MUST remain that way.
- Growth has slowed in line with weaker household consumption. Recall, this is one of the conditions Governor Lowe had placed on the RBA pausing. Any drastic worsening of the picture will only bring forward the end of the hiking cycle.
- The labour market remains very tight, despite a marginal easing driven by seasonal effects.
- ‘Wages growth is still consistent with the inflation target.’ Additional data the RBA trackers (outside of the ABS WPI Index) suggests the peak in wage pressures has passed.
- The RBA remain uncertain on mortgage payments. We have long held the view that damage will show through Q2.
- Forward guidance was dovishly revised, as we had expected.
In the presser, we gained additional insights:
- The RBA are watching four areas: 1) global core inflation; 2) monthly inflation readings (will want better update on state of services and further evidence of a deceleration in goods price inflation); 3) spending data to show a clear slow down, not just a moderation; 4) slowing of the labour market.
- They will need data to COLLECTIVELY suggest for the RBA to pause. This is the ‘clear cut’ reasoning we have been pushing for a while on the RBA – i.e., they do not want to pause prematurely and get caught red faced (again).
Looking forward, there will be several important data points to watch:
- This week
- CBA household spending (13 March) – while we do not get many great details, the YoY number relates well to the YoY retail sales number.
- NAB Business Survey (14 March) – look for any deterioration in demand.
- Labour Force Survey (16 March) – the RBA are looking for a rebound in employment following the weaker January number. Another weak reading would be worrying for our April expectations.
- Further afield
- Retail sales (28 March).
- CPI (29 March) – pay particular attention to services CPI.
- Job vacancies (30 March) – we track SEEK Job Ads which fell 11.4% through Q4. The official number would have to be seriously negative to shock the market. Main takeaway here: job ads remain above pre-Covid levels.
We took profit on receiving AUD vs USD 2Y OIS following the decision, having returned a touch over 40bps in two weeks, and we are happy following Friday’s NFP. Now, risk reward looks favourable in paying the front-end. More investigation is needed here for best entry, however.
Turning to FX, with the US labour update falling short of driving the Fed to another 50bp hike, we think there is the possibility of disinflation and China’s return to driving AUD. We will be watching correlations closely. We stop short of turning long AUD/USD as it stands with our short-term AUD model suggesting AUD/USD is 4.5% overvalued. It has tended to sell off at a 5% short-term overvaluation.
Bank of Canada
In reality, the BoC decision update was relatively tame. They kept the policy rate at 4.5% and downplayed tightness in the labour market in the statement. Deputy Governor Carolyne Roger’s speech gave us a better insight into where the BoC stands. To summarise, concentration remains on inflation (notably, services and core inflation), an eye has been fixed on productivity growth (as we had previously noted) and the tightness in the labour market. Overall, data has proved ‘mixed’ versus forecast. The risk remains that productivity fails to return to trend, wage growth remains elevated, and the labour market remains tight. Going forward, we continue to expect that the BoC are done hiking and place a 30% risk on another hike.
Norges Bank
Friday’s CPI proved a pleasant surprise, printing largely in line with forecast, reducing the possibility of a 50bp move later this month. We continue to expect a 25bp hike.
Digging a bit deeper, headline CPI (6.3% YoY) finished half a percentage point below forecast for February. Meanwhile, CPI-ATE (5.9%), Norges’ preferred measure of core, returned in line with forecast as imported consumer inflation moved to a marginal 0.2pp above forecast. Elsewhere, the regional outlook survey (to be updated 16 March) is providing a poor reading on every inch of the economy, excluding oil which has found investment intentions at their largest to start a year (for 2024) since 2015. The details suggest a faster weakening of the economy than forecasted by Norges. Unemployment has returned above forecast, too.
While we continue to expect a 25bp hike later this month, we expect others will kick up a fuss and note the possibility of a 50bp move. The above should hopefully make it seem unlikely. However, here are the arguments for a larger sized move: wage growth was higher-than-forecasted through 2022 while NOK has been weaker-than-forecasted – we remain bullish EUR/NOK. Additionally, near by central banks are likely to keep up the pace (ECB & Riksbank) while Norges considered hiking last time out, against their forward guidance.
Riksbank
The past week gave us plenty to digest from Riksbank board members. In short, they appear to have come to some consensus at the 1 March meeting, all now becoming somewhat more data dependent, with Bunge presenting the clearest shift in stance.
In the speeches, Thedeen focused his data dependence on core inflation, his change in tone once the peak arrives will be most interesting. Meanwhile, Breman continued her role in saying that the policy rate needs to be higher for longer (the fewer hikes, but fewer cuts narrative) but is sensitive to core inflation. Bunge opened the floor to a 25bp or 50bp April hike. Even if she wants to go for 25bp, she is likely outweighed by the more hawkish side of the board. We continue to expect a 50bp hike in April.
Looking forward, next week’s inflation print will be closely watched. Markets expect CPIF excluding energy to remain at 8.7% YoY, some 0.7pp above forecast! Further afield, hawkishness should fade as falling core inflation momentum rubs off on the YoY number.
China/Japan
