China | Europe | Monetary Policy & Inflation | US
Key Events: The Fed May Surprise… Hawkish
- By Dominique Dwor-Frecaut, Henry Occleston, Mirza Baig and Caroline Grady
- 6 min read
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
US – Europe – CEEMEA + Asia
US
Summary
- Fed doves more concerned by strong growth
- Core mom CPI to remain stable around 20bp
Fed
Key issues facing the Fed include the ongoing growth acceleration that is inconsistent with slowing inflation as well as the ongoing rally in energy prices.
I expect the outcome of the meeting to be:
No hike
SEP to show:
- One more 2023 hike.
- Two 2024 cuts instead of four in the June SEP.
- Unchanged inflation trajectory.
- Higher growth trajectory.
For full details please see FOMC Preview – Emerging Inflation Risks.
Data
This week’s data continued to point at strong growth and limited disinflation. The CPI surprised on the positive side. The Atlanta Fed nowcast of Q3 GDP fell to 4.9% from 5.8% from 5.6% a week ago and compared with trend of 2%. The Citi economic surprise index rose to 64.8 from 61.4 a week ago. WTIC spot rose to $90.3/barrel from $87.5/barrel a week ago.
Key data by order of importance includes:
S&P Manufacturing and services PMI (Friday), Philly Fed manufacturing survey: I agree with the consensus that sees the surveys moving sideways
Residential real estate – NAHB Index (Monday), building permits and housing starts (Tuesday), existing home sales (Thursday): there is scope for small positive surprises as the residential market is recovering and the consensus sees the data moving sideways or down.
Jobless claims (Thursday): I agree with the consensus that is consistent with a tight labor market.
Balance of payments data – current account balance (Thursday), TIC (Monday): I agree with the consensus.
Leading Index (Thursday): since 2022 the leading index has decoupled from GDP, which reflects its composition tilted towards the manufacturing sector.
Events/Political Developments
House Republicans have announced formal impeachment proceedings against President Biden.
House Speaker McCarthy has laid out plans to keep the government funding past September 30th but is facing opposition from spending hawks. My base case scenario continues to be that, as in most episodes of budget brinkmanship, a last minute agreement involving a CR (continuing Resolution ie an agreement extending current funding levels) will be struck.
Auto workers have started a strike that could be a new headache for the administration as it could add to price pressures if it lowers the supply of cars. On the other hand, ahead of next year’s election, the administration cannot side with employers without weakening President Biden claim to be “the most pro-union president in history”.
Europe: A Final BoE Hike?
Key Points
- The BoE will announce policy on Thursday. This will not only see rate policy, but also provide guidance for the next 12 months of QT. We err towards a final hike of 25bp (to 5.5%).
- We have been of the opinion that the BoE could (read: should) have paused hiking some time ago given the economic fundamentals, but have been prevented from doing so by idiosyncratic data surprises.
- Wednesday’s UK inflation will be an important release. Headline CPI is expected to tick up on the back of fuel costs and alcohol duty, but Bailey has already warned they can look through such a rise. Core inflation is expected to drop back, which would constitute a decent fall in MoM core momentum.
A Final BoE Hike?
We err on the side of the BoE hiking 25bp again, although there is a risk of a pause, if inflation surprises on the downside. The BoE outlook has become much more dovish recently, in line with our longstanding expectations. The loosening labour market has been a driving force behind this (since February we have warned that BoE forecasts looked overly optimistic on unemployment). Given UK household weakness, compounded by the rise in unemployment, our base case is that the BoE could have done a lot less hiking. The issue has been one of credibility (or lack thereof), which kept them hiking on the back of repeat one-off surprises in inflation.
However, the need to react strongly to headline inflation misses appeared to change at the last meeting, with the adoption of a more detail-oriented data focus. This week’s inflation print will be important (more information below), but as Governor Bailey has already warned, they will look through the headline – it will be the detail that matters.
For now, we continue to see good value in 2s10s GBP steepening outright and vs EUR, and by being short 1Yx1Y US OIS vs 1Yx1Y SONIA. These trades have performed very well since inception, and are close to our targets. There is room for them to go further in the near-term, but we are watching closely for signs of the momentum fading.
Meanwhile, in QT our expectation is for active sales to remain strong, with a strong risk of an acceleration vs the previous £80bn pa rate seen over the last 12 months. That itself could allow some more dovishness in rate hikes. Our lean is that given the composition on the APF portfolio, they will ultimately need to sell more in the 5-7Y space, as such we also like 2s5s gilt steepeners.
UK Inflation – Headline Up, Core Down
On the back of fuel and alcohol price rises, headline UK CPI is expected to rise to +7.0% YoY or more (from +6.8%). However, Bailey has already noted they would look through this. Expectations for core are much more dovish, with a decline to +6.8% (from +6.9%) expected. While this is only a modest decline in YoY, it would constitute a confirmation that MoM momentum is close to trend (Chart 1).
When adjusting for seasonality, it would mean just a +0.14pp beat vs typical August, close to the level seen in June (recall: July’s outturn was supported by rent – a reflection of policy transmission). We expect that the detail will show that wage-intensive services inflation continues to return towards normal (Chart 2).
EZ PMIs – Likely to Remain Bearish
EZ PMIs have been a hard read on most accounts, and the deterioration in services will support calls for a pause within the ECB. Further signs that companies are raising prices slower than input prices are rising will be important to watch out for.
We ultimately think that EZ inflation will overshoot ECB forecasts in September, which will drive a return to hawkish commentary, but until then we like to play into the benign rates environment by being long BTPs vs Bunds post-ECB.
CEEMEA + Asia
Asia
Rate decisions dominate the calendar in Asia’s week ahead.
BoJ is likely to keep policy on hold on Friday, but after the drama this week there will be a strong focus on the messaging. Front-end swaps surged this week on Governor Ueda’s remarks hinting at an early end to NIRP. Curiously, the BoJ waited several days before walking those comments back. We suspect BoJ is deliberately creating ambiguity on the subject to limit downward pressure on the yen, and the official narratives will shift often. A CPI report ahead of Friday’s decision won’t affect the vote but will shed light on underlying price pressures.
We expect Bank Indonesia to hold rates at 5.75%, in line with consensus. Thanks to falling inflation, real policy rate is becoming more restrictive. Real policy rate (ex-post) is at 2.5%, highest in the region. However, BI remains very focused on FX stability, and with narrowing rate differentials with US, especially in long-end bond yields, and USDIDR close to this year’s highs, we suspect BI to remain prudent and keep policy rates unchanged for a while. BI continues to use DNDF intervention and did its first auction of SRBIs to attract short-term capital.
BSP (Philippines) on 21st is likely to stay unchanged at 6.25%, in our view. While headline CPI accelerated again in August, BSP continues to forecast inflation to decline to 2-4% target band. Fuel and food prices are a concern, and PHP is also on the cusp of making new lows. We think further hikes may be necessary, but it seems BSP prefers to watch and wait for now.
CBC (Taiwan) is also likely to be unchanged at 1.875% on 21st. While electronics exports are starting to recover, domestic demand remains soft. However, we would not rule out further tightening in this cycle. Inflation picked up to 2.5% in August, above the central bank’s 0-2% target range, and M2 growth for July at 7.2%YoY is still above CBC’s reference range of 2.5-6.5%.
Apart from MPC meetings, we would also closely watch Korea’s 20-day exports data on 21st. We do not forecast this number but use it as a high frequency indicator for global manufacturing. The previous YoY print was -16.5% but this could narrow significantly due to different timing of chusok holidays.
CEEMEA
Key Points
- Thursday’s interest rate meetings in Turkey and South Africa are the highlight of the week.
- Given strong political support another large rate hike of 500bps is expected from the CBRT. For the SARB, despite ZAR weakness and an expected near-term stalling in disinflation, we expect the policy rate to remain on hold.
- Real economy data in Poland (Wednesday and Thursday) and August CPI in South Africa (Wednesday) are also key for forthcoming monetary policy decisions.
SARB Very Likely Done on Hikes
This week’s SARB decision should be easier than the July meeting. The policy rate was left on hold last time at 8.25%, but a shift up in inflation expectations had made this a finely balanced vote (three MPC members voted to leave rates on hold and two voted for another 25bps hike). Two very favourable inflation prints over June (5.4% YoY) and July (4.7%), plus the recent shift down in inflation expectations, all points to rates firmly on hold at 8.25%.
The wildcard is Wednesday’s CPI release where a much less helpful base effect is in play. The disinflation process is expected to stall with YoY inflation rising to 4.8% with higher energy prices a key driver. But given the rate is now close to the 4.5% midpoint of the SARB’s target we do not think this will trigger another rate hike.
ZAR performance is the other important consideration. Unlike for the July meeting where the rand had appreciated materially, ZAR has lost around 5.5% since the last policy meeting. Bond yields have also moved higher reflecting rising fiscal risks and higher US rates.
Overall, we expect the SARB will maintain its hawkish tone and refrain from ruling out further hikes.
Another Bumper Hike Expected from the CBRT
Erdogan’s recent U-turn in favour of ‘tight monetary policy’ signals that another large rate hike is ahead. After starting with a gradual tightening, hiking by just 250bps in July and 650bps in June the CBRT surprised with a 750bps hike in August, taking the policy rate to 25%. This was the first meeting with three new deputy governors joining governor Erkan and saw forecasts for the year-end policy rate revised sharply higher.
August inflation at 59% and surprisingly strong political support for higher rates leaves another 500bps hike to 30% expected this week.
Weak Real Economy Data Could Trigger Another Near-term Cut in Poland
The August releases for IP, retail sales, wages and employment could provide clues for the 4 October MPC meeting. Governor Glapinski justified the shock 75bps rate cut earlier this month partly on much weaker economic growth. Any significant miss on this week’s data, alongside the September CPI later this month, would likely provide enough ammunition for another rate cut. Poland’s 15 October general election is undoubtedly the main driver which also leaves significant scope for another rate cut next month.