US CPI to Support Fifth 75bp Fed Hike

US – Europe – $-Bloc and Scandies – China/Japan

US

Summary

• Fed Williams, a dove, to give his take on an increase in the terminal FFR
• Consensus CPI still far too high for the Fed

Fed

The FOMC was hawkish as I expected:

• The Fed hiked 75bp.
• The Fed mentioned policy lags in the statement. But during the presser, Powell made clear he did not know what these were and therefore would remain driven by data developments.
• Powell announced a higher terminal rate in the December SEP and left open the possibility of another 75bp hike in December.

Please see my full review. Chair Powell did a better job than I expected of introducing slower hikes without engineering an easing of financial conditions.  In fact financial conditions tightened after the FOMC. 

Chair Powell analysis of the US economy is getting closer to mine, which adds to my conviction of a close to 8% terminal FFR.  I am also expecting a 75bp hike at the December FOMC meeting, and my conviction increased after the October NFP. 

As of this writing (Friday), speakers include Collins, Barkin, Williams, Logan, Waller, Mester, and George.  Of those Williams could be the more interesting one because he is the more dovish and therefore could set a ceiling under the December SEP increase in the terminal FFR.

Data

The large October NFP surprise, which I expected, is consistent with a Q4 growth rebound, though there is not enough data yet to make it my base case scenario and at the moment I see it mainly as a risk.

The most important data this week is the CPI. I agree with the consensus of 0.5% for core mom which, if realized and together with the October NFP, supports a 75bp hike in December.  As always, I will be looking for higher trimmed mean and median price CPI, stabilization of goods price inflation and acceleration of services price inflation.

Other key data are:

• Small Business survey (Tuesday): a continued recovery ie a positive surprise would add to the risks of a Q4 growth rebound
• U Mich Consumer confidence (Friday): I agree with the consensus of a roughly unchanged number in line with roughly unchanged inflation, including gas prices
• Consumer credit (Monday): I will be looking for a continued growth acceleration outside of student loans.
• Inventories (Wednesday), Initial claims (Thursday) and monthly budget statement (Thursday).

Events/Political Developments

Odds of a GOP takeover of the Senate continued to increase over the past week while the GOP remains comfortably on track for a House takeover.

The fate of the administration  student debt forgiveness plan remains in limbo as the courts have yet to issue their ruling.

The Democrats are said to be considering raising the debt ceiling through reconciliation during the lame duck session of Congress (i.e., after the mid-term elections).  If this further reduces the risk of fiscal consolidation in 2023.

Links to New York Fed POMOs/TOMOs:  Repos, Treasury, MBS, CMBS

Europe: Taking Stock of the Central Banks

Key Points

• BoE speakers to show the hawkish arguments fade as the doves begin to look for a pause.
• ECB speakers to show the hawks talking up the need for more hikes and QT.
• UK GDP to show continued slowdown through September, exacerbated by the Queen’s funeral.

The BoE: Hearing from the Extremes

As we had expected, last week’s BoE saw a 75bp hike, alongside a pushback against market terminal rate. The effectiveness of the latter communication was tempered by the fact that the MPC took ‘market pricing’ to be the 5.25% the market was pricing at end-October rather than the 4.8% it was pricing on Thursday. Nevertheless, the decision to talk down terminal rate, project incredibly dovish forecasts, and imply that mortgage rates are too high all while being unable to refer to the fiscal tightening set to come at the Autumn Statement (17 November) suggests a pivot is underway.

We continue to expect that dovishness will build into the year-end, and a pause of hiking by February is a strong possibility.

The week ahead will provide new insights in the form of Haskel (hawk, speaking Wednesday) and Tenreyro (dove, speaking Friday). The doves have been almost totally silent since the September meeting. Tenreyro’s inclination towards 25bp at last week’s meeting was a surprise. It suggests she would now favour a pause. Meanwhile, on the hawkish side, Haskel should provide some insight into why he (and Mann) did not look for 100bp. We have previously highlighted the three rationales for hawkishness that Mann, Haskel and Ramsden have cited, all of which are in the process of fading.

UK GDP Data to Show Slowdown Underway

UK GDP data for September and Q3 (Friday) is likely to show a further monthly contraction, exacerbated by the Queen’s funeral. The BoE base case is for a prolonged recession, and the data should confirm that the process of economic slowdown is already well underway.

ECB Hawks Likely to Push Back on Pivot Pricing

The recent ECB meeting saw the market incorrectly start to price a December deceleration. This was quickly reversed by ECB clarification and the inflation data. Looking ahead we expect the ECB will need to lean strongly on more hawkish rhetoric and play up the path to QT. This week will provide ample opportunity for that, with hawks such as Schnabel, Wunsch, Holzmann and Nagel all speaking.

Speaking last week, Lagarde highlighted the likelihood of higher ECB rates ahead, the risk of second round effects in wages, and that a recession alone would not be sufficient to tame prices. The more hawkish speakers (Kazaks, Nagel) doubled-down on the need for continued large hikes, while the comments from the doves came off relatively weak (see: Centeno: ‘we have definitely front-loaded rate hikes’, Visco: ‘peak rate of 3% a possibility’). I expect the week ahead will see more of the same, with the hawks winning ground after recent inflation overshoots.

$-Bloc and Scandies

Central Bank Watch

Reserve Bank of Australia

The RBA hiked the cash rate to 2.85% (+25bp), as we had expected.

One should note, 25bp was not a foregone conclusion. Inflation had come out hotter than expected, subdued by electricity subsidies in WA and Queensland which will ADD to Q4 CPI. As a result, the market had assigned a 20% chance of a 50bp hike while one of the big four Australian banks had changed their base case to a 50bp move! Instead, the RBA stuck with a 25bp move repeating the point that there is a lag in the effect of monetary policy from when it is delivered.

Elsewhere in the statement, they reiterated much of the same: soft landing is their aim, and unemployment is to remain around record lows for 2022 and increase gradually to 4% by 2024. They also updated their inflation forecast to peak at 8% later this year.

Within the speech, there were a few interesting points. Notably, The Board discussed NOT raising interest rates. I think this was more to tame market pricing than anything which saw a terminal rate >4%. Governor Lowe also noted that they are prepared to hike by 50bp, if needed. We see this as unlikely – it would have to come after a strong Q4 print (recall, they ‘officially’ care about quarterly inflation, not their new monthly figure) which would mean a 50bp hike in February. This would be with a 3.1% cash rate.

Further afield, we see a low likelihood of a wage-price spiral in Australia, which should limit the terminal rate. We expect the RBA terminal rate between 3.25%-3.60%.

Trade idea: AUD/USD could fall to 0.60.

Bank of Canada

Canadian employment shot 108k higher, the largest increase since February, as the labour force tightened. Meanwhile, wage growth picked back up to 5.6% YoY. This certainly adds to the case for a larger move in December (recall, the Bank were debating between 25bp or 50bp), after all, a weakening labour market encouraged the BoC to hike by 50bp at their last meeting. However, it is likely that the October CPI print (16 November) casts the final say.

Trade idea: We continue to like being long Canada 2Y vs US 2Y, long USD/CAD, and short AUD/CAD.

Reserve Bank of New Zealand

On the front of it, a forecasted unemployment rate (3.3%) helps make the debate between a 50bp and 75bp hike on 23 November more balanced (Chart 3). But, peeking behind the curtains, both employment and participation grew faster than the RBNZ had forecasted. Meanwhile, hourly earnings outstripped the Bank’s expectations (Chart 5).

We continue to expect the RBNZ to hike the Overnight Cash Rate (OCR) to 4.25% (+75bp) on 23 November, with work to continue in 2023.

Trade idea: The parity trade you forgot about: AUD/NZD.

Norges Bank

Norges Bank has raised the policy rate to 2.5% (+25bp), as we had expected.

They signaled that the policy rate will most likely be raised further in December, though within the Monetary Policy Assessment they weighed uncertainties in their outlook. That is, while they expect that lower freight rates and electricity prices could help curb underlying inflation ahead, assisted by tighter financial conditions, they noted that inflation has increased more than projected, and the labour market appears to be a little tighter than previously anticipated. We think it means they likely hike by 25bp in December – our base case.

EUR/NOK has jumped +0.6% higher, pushing through 10.30, as NO 2Y yields dropped just shy of 10bps – they had been as low as 3.10/3.15% indicating further room for NOK weakness.

Trade idea: EUR/NOK to re-test year highs.

Riksbank

There were three important takeaways from the Riksbank Business Survey: 1) Costs are accelerating; 2) The economy is slowing; 3) A wage-price spiral is unlikely.

1. Costs are accelerating, but there is a limit
   
   The survey showed that two-thirds of price setters are raising prices more than normal. Moreover, of those planning to raise prices within the next year, 90% said they would raise them at a faster pace than normal. Incredibly, one issue retail has had is to raise prices in keeping with a depreciating SEK!
   
   Not everything was bad news, however. Notably, respondents were uncertain if services could continue to pass on costs at the same pace as they had been. Like many central banks of late, Riksbank doves – the board is split – may push to look at the outlook on inflation. This is certainly a plus for those who could push for a 50bp hike, instead of a 75bp hike.
   
2. The economy is slowing
   
   Another point to the doves. The economy is slowing, and the respondents are becoming more concerned with future expectations (Chart 6). This is despite disruptions in output, and/or problems in delivering products, easing (Chart 7).
   
3. A wage-price spiral is unlikely
   
   ‘The Swedish [wage formulation] model will be preserved. This is in everyone’s interests.’
   
   Inside the Riksbank Business Survey, they added an article on wage formation. Swedish wages are (mostly: 88%) formed using central wage agreements, which are due to be reviewed at the turn of the year – typically completed in Spring.
   
   In short, confidence remains in the Swedish wage formation model. 60% say wages are moving normally. The risk comes around ‘specialists’ who, from the survey, appear to be pushing any potential wage drift (Chart 8).

At this stage, we expect 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%.

Calendar Preview

Here are the key events to watch:

Australia

• NAB Business Survey (Tuesday, 00:30 GMT): The last survey saw demand remain resilient (as costs turned lower, prices stalled) while employment found have found a top. The update will be key data for the RBA.
• Bullock Speech (Wednesday, 09:05 GMT): You can find details here, she will be taking questions.

Canada

• A quiet week here.

New Zealand

• Inflation Expectations (Tuesday, 02:00 GMT): Perceptions of inflation have appeared to have topped. However, the most recent inflation print was far from forecast. Failing for expectations to moderate further will likely push markets to cementing a 75bp hike later this month.
• RBNZ Review of Monetary Policy (Wednesday): A report that will cover the last five years.

Norway

• CPI (Thursday, 07:00 GMT): Attention must be paid to CPI-ATE. It overshot, and, importantly, did not top as Norges Bank had forecasted. Failing to top could re-spark conversation surrounding a 50bp hike.

Sweden

• Production and Consumption (Wednesday, 07:00 GMT):

China/Japan

The BoJ is releasing its summary of opinions this week.

Key data releases this week include China’s CPI, PPI, domestic credit, external trade and FX reserves.

Links to BOJ Rinban , BOE OMO

Due to the administration declaring the end of the pandemic I am ending my Covid monitoring for now.

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 Researcher at Macro Hive. Ben 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.

(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.)