China | Europe | Monetary Policy & Inflation | US
Key Events: We Breakdown What Is the Target for Real Rates and When Will They Start to Bite?
- By Dominique Dwor-Frecaut, Ben Ford and Henry Occleston
- 6 min read
US
Summary
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- Consensus is likely to yet again underestimate NFPs.
- Construction spending to show continued non-residential strength and residential recovery.
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US – Europe – $-Bloc and Scandies – China/Japan
US
Summary
- Consensus is likely to yet again underestimate NFPs.
- Construction spending to show continued non-residential strength and residential recovery.
Fed
There was only limited new news conveyed by Powell and Bostic, the only Fed speakers this week. Powell was asked repeatedly about the Fed’s June ‘hawkish pause’ and justified it by arguing that monetary policy had been restrictive only for six to nine months (likely based on TIPs rates), that he was waiting for the full impact to be felt and that he did not know at what speed this impact would come.
He further specified that, while he had not seen credit tightening beyond what tends to be associated with Fed tightening, academic studies suggested the banking crisis would reduce credit availability. The Fed therefore needed to give more time for this dynamic to play out.
This week, the Fed is publishing its minutes, where it will discuss the economic and policy outlook. I will be very focused on the Fed’s assessment of the economic outlook, in part because Powell’s view that we are two hikes away from the terminal FFR rests on his expectations that growth is slowing.
In my view, that is not what the data is showing. To the contrary, the data suggests growing risks of an acceleration in growth, though this is not my base case scenario yet. FOMC communication will eventually catch up with the data, which could lead to the Fed scrapping its plans to cut the FFR 100bp in 2024. This could take a while though.
As of this writing speakers next week include Williams and Logan.
Data
This week’s data continued to point at sticky inflation and strong growth. The Atlanta Fed Q2 GDP nowcast rose to 2.2% from 1.9% QoQ SAAR a week ago. The Citi economic surprise index jumped to 54.4 from 22.5 last week. PCE was in line with consensus, personal income was higher than consensus, and the series of positive surprises in residential real estate data continued.
Key data this week includes:
NFP (Friday): I disagree with the consensus that, at 200,000, is too low in view of other data showing strong economic momentum.
ISM PMIs: Manufacturing (Monday) and Services (Thursday): I agree with the consensus. Manufacturing is likely to be weak but represents only about 10% of the economy. Services is likely to remain in expansionary territory.
Construction spending (Monday): I agree with the consensus and expect the strong uptrend in non-residential construction and the bottoming out of residential construction to continue.
JOLTS (Thursday) and jobless claims (Thursday): These data are likely to show continued labour market strength. As always, I will be focusing more on layoff and quit rates than on job openings in the JOLTS data.
Trade balance (Thursday), Ward vehicles sales (Monday), Factory orders (Wednesday): I agree with the consensus.
Events/Political Developments
The administration is in damage limitation mode, after the Supreme Court struck down its student debt forgiveness plan. It is likely to push forward new, income-linked repayment plans, that could cut debt service in half. In any event, the debt forgiveness would have cut only $0.4tn out of household debts of $19.6tn and compared with household net worth of $149tn.
The administration has announced it is considering additional restrictions on the exports of AI chips to China. The new measures would be implemented after Treasury Secretary Janet Yellen’s trip to China in early July.
Links to New York Fed POMOs/TOMOs: Repos, Treasury, MBS, CMBS
Europe: Up, Up, and Survey(s)
Key Points
- There are a lot of surveys released this week in the UK and Europe.
- ECB Consumer Expectations and UK Decision Maker’s Panel Surveys: EZ inflation expectations have de-anchored, while UK ones are re-anchoring. We see value in positioning for a drop in the 10Y UK inflation swap rate.
- Final PMIs surveys: (Monday and Wednesday) will be informative in the details after the very bearish preliminary outturn (particularly in France).
- Manufacturing activity data: The weakest part of the Eurozone economy will be watched closely for signs that weakness is persisting or broadening.
UK Inflation Expectations Re-Anchoring
Inflation expectation anchoring remains an important factor for central bankers. On this front, we will get two important surveys: in the EZ, the ECB’s consumer expectations survey (CES, Wednesday) will provide a view of consumer inflation expectations, while in the UK, the decision maker’s panel survey (DMP, Thursday) will provide an updated view on business outlook.
The UK is currently seeing what appears to be a strong re-anchoring tendency recently, with business and consumer outlooks both having come down sharply from previous highs (Chart 1). With the BoE’s most recent action, we see a strong possibility for market pricing of future inflation, too, to fall back further.
By contrast, inflation expectations in the Eurozone look comparatively unanchored from pre-2020 levels (Chart 2). There has been some retracement more recently, but the ECB will need to see stronger progress there before they can breathe easily.
Final PMIs – Watching the Details
This week will provide an opportunity for more insights into the state of manufacturing and services outlooks via the PMI surveys. Of particular interest will be any further indications of slowing hiring.
The preliminary PMIs (released two weeks ago) provided a bearish surprise for the Eurozone. Manufacturing missed, dropping to 43.6; as did Services (it dropped to 52.4). This left a 2.5ppt drop in Composite, the largest drop for a year. While May had seen near stagnation in new orders, June saw them drop for the first time since January.
The weakness remained focused in manufacturing (factory output fell for a third straight month, its fastest decline since October), but Services also slowed sharply.
Payrolls numbers were important takeaways. After having previously sustained positivity despite the worsening outlook, Manufacturing headcount was cut for first time since January 2021. Services employment meanwhile slowed but remains strong.
Looking ahead, while weakening surveys will not be enough to offset the ECB’s hawkishness, the labour market weakening does highlight one of the issues I have been warning of re: the ECB’s forecasts – their complete 180 on unemployment since December (from an upward slope to a continued decline).
Within the countries, the French outturn will be important. The preliminary reading was particularly brutal, with services now in contraction at 48.0, the big drivers of weakness being: inflation, challenging financial conditions, and some business shutdowns. If we were to see more widespread signs of the effects of credit conditions tightening, the market may take that as signs that the ECB needs to do less than priced.
The offset to this will be the strong wage pressures, which continue to build.
In the UK, manufacturing remained weak (46.2), while services slipped more than expected (53.7) but remained expansionary.
Within services, the loss of momentum for consumer spending was noted, with weak demand in construction and RE. Financial services remained resilient.
Manufacturing saw an unchanged rate of contraction, suffering from falling new orders and customer destocking. Input costs declined at the fastest rate since February 2016.
Manufacturing Weakness to Continue
Given the weakness in manufacturing PMIs, it is no surprise that the market is looking for continued weakness in this week’s May manufacturing and industrial production numbers (unchanged MoM German IP, -0.2% MoM French, and +0.1% MoM Spanish IP). Important to watch will be signs of the breadth of weakness. German data will be under close scrutiny.
The continued downturn in the sector will be of some concern to the ECB, but it could also drive further fiscal loosening. So far this has been somewhat piecemeal; Germany is already spending to support its industry, and France is seeking measures to block competitive Chinese imports. The EU has announced limited bloc-wide support, relying on relaxed state aid rules, but ahead it is likely that more will need to be done on the spending side. This could ultimately provide a headache to the ECB too.
$-Bloc and Scandies
Australia
The RBA are out on Tuesday (our RBA preview); Bloomberg consensus is leaning toward a hike while the market is pushing for a pause. There are merits for both; core and services inflation remain strong, as does the labour market, yet Deputy Governor Bullock appeared dovish when commenting on the labour market. Meanwhile, survey data confirmed softer demand, but hiccups have continued in services inflation progression.
Turning to markets, and focusing on the event, we find that positioning for a hike is best done by being long AUD/NZD. Further afield, we continue to await opportunity to receive front-end Aussie yields.
Canada
CPI Presents No Reason to Be Dovish
CPI down to 3.4% YoY from 4.4%. However, the BoC will struggle to be dovish following the release. First, the slowdown was largely driven by lower fuel prices due to base effects. Second, annualised momentum of the core measures (what they have been constantly turning to) have, at best, moved sideways at 3.7% (one went lower, two went higher; Chart XX). And third, while services inflation has slipped to 4.6% YoY from 4.8%, the MoM outturn remained above 0.5% MoM, with momentum extending above historical levels. Overall, the outturn fails to take a July hike off the table following a strong retail sales update last week, too.
Monthly GDP followed and disappointed expectations; GDP flatlined through April vs expectations for a +0.2% MoM increase. If you take out the impact of strikes (-0.08pp) it increased +0.1% MoM. The advance April estimate sits at +0.4% MoM. The BoC survey ended the week showing less pessimism while inflation expectations made some progress – I shall review the full details next week.
All eyes turn to the June labour force update. And while the BoC are concentrating on productivity numbers, we are watching for continued signs of weakness in the labour market – part-time workers have been responsible for gains through April and May and near matched the full-time employment gain in March. It means that although the YoY employment rate has stabilised, it has done it on a loose footing, meaning further weakness could prevail.
New Zealand
Cautious Optimism to Be Taken from ANZ Business Survey
The ANZ Business Survey proved hugely positive, versus what it has been. The headline number jumped 13 points in June to -18. Here are the key points from the report:
- RBNZ peak likely fed into the improved confidence.
- Activity outlook returned above 0 for the first time in 14 months, led by a less pessimistic outlook in retail and now positive outlook in services.
- Costs sunk to 76.0 from 84.1 while services pricing intentions (which we have pointed to for their strong relationships to services CPI through Covid) continued to slide lower.
- In contrast, consumer inflation expectations ticked higher. Recall, however, the RBNZ are likely to pay attention to RBNZ 1Y inflation expectations (sent to the chat the other day with a new paper).
- Wages continue to slide lower, an important point for the RBNZ’s focus on non-tradable inflation.
- The reading for exports returned negative, and to its lowest over the past three months. It likely reflects some disappointment around China.
- Labour capacity constraints eased but remained elevated. Continued foreign labour flow will further ease the restraint.
However, all this positivity sits on the idea that the RBNZ has come to the end of its hiking cycle. However, this rests on inflation continuing its path lower and realised demand remaining poor. We remain of the idea that the Kiwi economy will look poor into yearend.
Norway
The past week saw retail sales jump +1.2% MoM, NOK sales fall below our forecast, and unemployment fall below Norges’. First, on retail sales, the outturn has disrupted what looked like a guaranteed downwards trend. Instead, the decline has stalled. Second, on NOK sales, we had not expected 1bn to be reached for another two months. Now that it is there, history shows it is no longer weighing on the currency. Third, given Norges are more worried about the labour market versus Riksbank (the latter has an advantageous set up in wages), the reading can push to a comparatively more hawkish Norges.
Sweden
The Riksbank did pretty much what we said they would do this week; the Riksbank raised the policy rate by 25bp to 3.75% (this time, no reservation) and revised the peak terminal rate above 4%. They also upped the pace of bonds sales. Read our review here.
In the background was the decision that the Riksbank will likely begin to hedge FX reserves later this year. Running the numbers shows it will do little to SEK. Here are the key points:
- Riksbank reserves are SEK410bn/$41.1bn and they are likely to hedge using forwards or swaps.
- Starting size is subject to inquiry but have been hinted at one quarter of reserves ($10.275bn; 6-7bn of USD/SEK and 2-3bn of EUR/SEK). The enquiry could be complete by early autumn.
- Say it lasts the quarter following, then they are selling $0.16n SEK a day. Given that BIS has a daily SEK turnover at $154bn, it should do little to the currency.
China/Japan
Key data releases this week include China’s and Japan’s PMIs, China’s CPI, PPI, foreign reserves, and domestic credit.