Asia | Emerging Markets | Europe | Global | Monetary Policy & Inflation | US
US and Europe Inflation to Cement Continued Hawkishness
- By Dominique Dwor-Frecaut, Ben Ford and Henry Occleston
- 12 min read
US – Europe – $-Bloc and Scandies – China/Japan
US
Summary
- CPI to show that inflation is not slowing down.
- Fed minutes unlikely to shed light on when the Fed could pivot.
Monday 10 October 2022 is Columbus Day, a federal holiday.
Fed
Fed speakers last week remained hawkish. Waller explicitly ruled out the Fed pausing out of concerns over financial stability which he thinks are overblown.
This week we will get the minutes of the September meeting. I doubt we will get more insights on the issue du jour, namely what would cause the Fed to pause to assess the damage so far (i.e., monetary policy famously long and variable transmission lags).
FOMC members have been very candidly stating that ‘we are going through a period of exceptional uncertainty’, in plain English they have no clue on when inflation will head down. They have also made it clear that they would react to an actual rather than expected inflation slowdown.
This is prudent on their part since their previous inflation forecasts have turned out so disastrously wrong. The rest of us are left to figure out on our own when the turning point for inflation might be. In my humble opinion, not until 2023 H2, once the labor market is much less stretched than currently.
This week Evans, Brainard, Mester, Kashkari, Barr, Bowman, Cook, and Bullard are speaking. I expect more of the same, that is complete and utter focus on inflation and policy tightening to continue until inflation has been slain. I was struck last week by how even Governor Cook, likely the most liberal FOMC member, echoed these themes.
This week the more interesting speech could be from Barr, vice chair for supervision, who might give us hints on regulatory relief for banks (see Regulatory Relief for US Banks to Support the Bond Market?).
Data
The NFP did not support a Fed pivot anytime soon, as I expected.
The most important data of the week is Thursday’s CPI. I don’t have a strong view to offer against the consensus of 0.4% MoM for core. In any event even if the CPI came out lower than expected, in view of the September NFP the Fed would still go for 75bp in 3 weeks.
What I am looking for is a continuation of the upward trend, namely a further acceleration in the Cleveland Fed median and trimmed mean CPI that will get published within a few hours of the BLS release (the BIS has a great discussion of why trimmed and median price CPI are better indicators of trend when inflation is high).
Other key inflation data:
- The Atlanta Fed median wage increase, not in the BBG calendar but key to the inflation outlook. Because it is not biased by changes in the distribution of employment, it is a better indicator of wage inflation than the average hourly earnings included in the NFP release. It has no set publication date but should be out by Friday.
- PPI (Wednesday): I will be looking for an increase in the price of chips. For all the doom and gloom of manufacturers, chip prices have been rising since Q4 2021, though more slowly since January 2022. Since chips are included in just about any consumption goods, especially durables, a further increase in the price of chips could support continued stabilization of core goods inflation.
Key demand data:
- Retail sales (Friday): I agree with the consensus of 0.2% MoM for headline. Since retail sales track goods and restaurant spending, they tend to be closely correlated with goods consumption that is released with the personal spending and income later in the month. No decrease in real terms would be a strong outcome in view of the ongoing decline in non-durable goods consumption.
- U Mich consumer confidence (Friday): the consensus expects a small improvement and I disagree. The survey is sensitive to inflation, especially gas prices, that have been rising since mid-September. Interviews start at the end of the previous month which suggest the survey results will capture some of the negative impact of the recent increase in gas prices on consumer confidence. Watch out for an increase in inflation expectations. How long will the Fed keep telling us that inflation expectations are stable?
- NFIB small business optimism (Tuesday): the consensus sees no change in the index, and I don’t have a strong view. Since the pandemic, the small business index has underperformed the PMIs, that represents large listed corporates. There was an improvement in the small business index in August and I would look at a continued improvement in September as a sign of the economy picking up momentum.
Other data:
- September budget balance (Tuesday): I expect a surplus of about $80bn, which would bring the deficit for FY2022 to about 3 ½% of GDP, lower than under the Trump administration.
- Jobless claims (Thursday): I expect a continuation of continuing claims increasing by less than initial claims. That is, workers are getting laid off but finding jobs quickly.
- Import prices (Friday): a continued decline would be a sign of improving supply.
Events/Political Developments
The IMF meetings start on Monday. Inflation, commodities prices, recession are likely to be prominent discussion themes but I am not seeing market moving events. I expect more of the US’ ‘the dollar is our currency but your problem’ and I am not seeing much scope for mutually beneficial cooperation between the US and other countries.
Links to New York Fed POMOs/TOMOs: Repos, Treasury, MBS, CMBS
Europe
Key Points
- Another heavy week for ECB and BoE speakers.
- The UK Chancellor will also take questions in the House of Commons (Tuesday). The Treasury was begun to walk back its previous fiscal imprudence. We will be watching for further signs of this.
- The ECB minutes largely confirmed our expectation that the ECB will hike through 2% by year-end. However, Italian yields are looking concerning. We watch for signs that anxiety around that is growing.
- UK data will likely show that the labour market remains very tight on account of the reduced activity rates since COVID. We watch for signs of flagging vacancies, or that the cost-of-living crisis is forcing people back into the labour force.
Hawkish Signs in the BoE
As the BoE’s Ramsden pointed out last week, the BoE had already taken into account the government’s energy support at its previous meeting. It had not incorporated the range of tax cuts the calamitous fiscal event unveiled. However, to do so is now something of a moving target. Chancellor Kwarteng has already walked back the planned top rate tax cut, and the suggestions have been that there may be spending cuts to come.
Could this then be that we are seeing peak hawkishness? It is something we’ve been looking for a while, and unfortunately the answer seems to be ‘it remains to be seen’. Arch-hawk Mann (speaking on Thursday) is likely to be able to take last week’s DMP survey’s rise in medium term CPI expectations as hawkish (Chart 1). However, there is some nuance in reading the result. The ‘expectations for CPI’ (a relatively recent series) appears to far reflect a guesstimation of economic events rather than anything more specific (which would be where the survey draws its strength). That much can be seen from the spread over price setting expectations a year ahead (Chart 2).
The Chancellor’s Back-Pedal Continues
Meanwhile, we expect to see the Chancellor continue to walk back the prospect of fiscal deficit into the medium term. This is something we cited as a highly likely outcome early on in the saga. His questions before parliament (Tuesday) will probably provide further room for him to lay the groundworks for cuts to spending further out. Expect to hear questions on the triple lock of pensions, and the prospect for benefits to fall in real terms.
Waiting on the UK Labour Market to Change
The UK labour market is a conundrum that the BoE are still in the process of wrapping their heads around. Employment has barely grown since the COVID crash, yet unemployment has dropped like a brick. Instead, it has all been a case of a declining labour force (people choosing not to work).
Updated data for August (Tuesday) may provide signs that the worrying cost of living situation, and the slowly (then) rising mortgage rates are pushing people back into work, and that the number of vacancies is dropping. Those would be dovish outcomes, albeit the most likely result is a continuation of labour market tightness which will support continued need to hike.
UK GDP to Drop In August
UK GDP, which grew in July, and was revised positive last week for Q2 (avoiding an otherwise likely technical recession) is expected to fall back in August, in part due to strike activity. This would put Q3 GDP on a strongly negative path (given that September will likely see weakness from the extra bank holiday for the Queen’s Funeral).
ECB Remains Hawkish – Watch Italian Bonds
Despite the UK panic selling seen post-fiscal event, the ECB seem remarkably placid about the risks that something similar might occur there. While European Pension Fund LDI exposure is far smaller as a % GDP than UK ones, that is not to say the risk there is zero. Any sharp rise in swap rates could yet trigger difficulty. Meanwhile, Italy remains the problem child. 10Y BTP yield is at 4.7%, and there is almost no sign that Germany and French deficit spending (and hence bond supply) is about to slow. This would be cause for concern even if the country had not just changed leaders, and was in the process of rushing a budget plan through. A lot can go wrong – careless politician comments can cause a lot of damage even with more sustainable debt levels. 10Y BTP Bund spread is fast re-approaching 240bp, and the pressure will not fall away without a drop in core yields. I continue to see a return to net asset purchases as a risk.
The ECB’s minutes have added to our conviction that they will break through neutral range by the year-end. The week ahead will see a vast number of speakers, including Lagarde. While thus far there has been little sign that the CB is moving towards purchases, it would be surprising if it was not at least being discussed, particularly in the wake of the gilt sell-off.
$-Bloc and Scandies
Central Bank Watch
Reserve Bank of Australia
The Reserve Bank of Australia (RBA) hiked the cash rate to 2.6% (+25bp). This was the sixth hike from the central bank but fell short of our expectation of a fifth 50bp hike. The Board remains resolute in returning inflation to target. They may well hike slower for longer.
Further afield, we see a low likelihood of a wage-price spiral in Australia, which should limit the terminal rate. The market is now pricing in the higher end of our expectations for the terminal rate (3.25%-3.5%).
Bank of Canada
We continue to expect the Bank of Canada to hike to 3.75% (+50bp) in October and then to 4.00% (+25bp) in December, while another hike further afield may be needed. However, this is not set in stone. We await the release of the consumer (16 October) and business surveys (17 October) as well as inflation data (19 October) before cementing our view.
AUD/CAD could fall to 0.85, or lower.
Reserve Bank of New Zealand
The Reserve Bank of New Zealand (RBNZ) hiked the Overnight Cash Rate (OCR) by 50bp (to 3.5%) for the fifth time in this cycle. 75bps was also up for discussion. Some members were concerned about persistent inflation, which could be pushed higher by a potential wage-price spiral and NZD weakness. Others wanted to wait to see the effects of their 325bps of hikes.
We continue to expect another 50bp in November, taking the OCR to 4.0%, and for work to continue in 2023.
Norges Bank
At this juncture, we expect a further 25bp of hiked over November and December, meaning the policy rate will end the year at 2.75%. A further 20-50bps will follow in 2023.
Riksbank
The monthly GDP indicator fell 1.3% MoM through August, the fastest in a year and far quicker than markets had expected (-0.7% MoM). It came on the back of slowing industrial orders (-4.2% MoM) which were plagued by collapsing domestic orders (-9.5%) and easing exports (-3.7% MoM).
Pair this with dwindling consumption (retail sales: -0.4% MoM August), and the case for the dovish board members has become even stronger. Add on First Dep Gov Anna Breman becoming more neutral/dovish (see minutes update), it is becoming harder for the hawks to force through a 75bp hike in November. Markets are pricing in a 70bp move. Pricing is likely volatile given there is still CPI, GDP, and unemployment to come ahead of 24 November.
We expect that the Riksbank is likely to follow with (at least) 50bp in November and 25bp in February. This would take it to the forecasted 2.5%.
EUR/NOK is overvalued, but not overdone (yet).
Calendar Preview
Here are the key events to watch:
Australia
- Two surveys are released this week: Westpac-Melbourne Institute Consumer Sentiment report (Tuesday, 00:30 BST); NAB Business Survey (Tuesday, 01:30 BST). They will headline the week ahead of inflation expectations (Consumer Inflation Expectations (Thursday, 01:00 BST).
Canada
- A quiet week ahead here.
New Zealand
- Other than an update to spending (Card Spending (Monday, 22:45 BST)), it is a quiet week ahead here.
Norway
- Inflation (CPI (Monday, 07:00 BST)) kicks off the week; Norges Bank has just updated its forecasts. They are looking for headline inflation to reach 5.0% YoY.
Sweden
- Speeches from Ingves (Monday, 13:30 BST) and Ohlsson (Monday, 16:30) will prelude an update on Sweden inflation (CPI (Thursday, 07:00 BST)). Riksbank is looking for CPIF to reach 9.7%, 0.4pp higher than consensus.
China/Japan
Key data releases this week include China’s CPI, PPI and trade balance.
Links to BOJ Rinban , BOE OMO
Due to the administration declaring the end of the pandemic I am ending my Covid monitoring for now.