26/09/2023
No Quarter: CBs’ higher for longer
HODL
After a raft of central bank decisions, we look at the
key outcomes for the market. The Fed and Bank of England both paused but stressed, as
expected, that rates would stay higher for longer. The ECB hiked but signalled it is at the
top of the cycle, implying it has stopped. The BoJ remains a sizeable outlier – but for how
long?
Bond yields have moved decisively, with the US 10yr breaching
4.5% for the first time since 2007 and the 2yr note yield above 5.2%, its highest since
2006. With major central banks seemingly on pause, the initial bear flattening in the curve
may give way to steepening driven by the back of the curve rather than the front, with the
front end looking quite well priced for the higher for longer message. Steepening may be
delayed as policymakers stick to their ‘higher for longer’ stance, although there are
increasing headwinds to further tightening which may suppress further flattening. If data
holds then we can see the back end moving up and front steadying in line with expectations
for CBs to do no more. Real rates have exploded higher as a result with the 10yr TIPS above
2.1%, its highest since 2008. This is indicative of policy and market rates becoming more
restrictive as inflation cools.
The question now is how long the central banks maintain this hawkish
stance.
Federal Reserve: Stairway to Heaven
The Fed was hawkish – it left the door open for another hike
in November and signalled it will maintain higher rates for longer. Policymakers left one
more hike on the table with the dot plot for 2023 steady at 5.6%. Even if the Fed doesn’t
really think it will follow through with another hike it’s useful for it to leave it there.
This is about optionality rather than desire. Rates are already plenty restrictive and it
would require a change in the outlook for inflation’s stickiness before November to really
go for another hike.
The big change was for 2024, with real rates seen much higher
– core CPI forecast unchanged at 2.5% but median Fed funds rate revised up to 5.1% from
4.6%. So, Fed keeping rates more restrictive for longer and forecasting just 50bps in cuts
next year. The revision higher in the 2024 dots is unambiguously a hawkish signal that it
plans to keep rates higher for longer – with the emphasis now very much on the longer bit.
Though we should note that it’s not just longer – real rates will be more restrictive next
year (longer = higher as inflation cools) and this is because of the labour market strength.
The unemployment rate has been revised down significantly (to 4.1% in 2024 from the June
forecast of 4.5%) and is projected to stay there through the forecast period. Further ahead,
rates are seen 50bps higher through 2025 as well with the median at 3.9% from 3.4% in June,
falling to 2.9% in
2026
.
Fed officials are predicting higher growth and inflation and rates, for
longer. Does this add up? The Fed seems to be saying they’ve ascended the (rate hiking)
stairway to (economic) heaven. And who can argue? Unemployment remains near decades-lows,
growth is good and the Fed revised up its GDP forecast for this year and next; all whilst
carrying out the most aggressive hiking cycle in decades and intending to maintain more
restrictive policy for longer. Call that American exceptionalism or something.
In the press conference, chairman Powell sounded like a guy
who wasn’t sure whether he should be pleased or not. Notably he said the soft landing was
not the FOMC’s baseline scenario even when it was clear from the statement and dots that it
very much is. “The worst thing we can do is to fail to restore price stability, because the
record is clear on that,” he said, hammering home the Volcker credentials. We know that the
Fed generally doesn’t stick to its dots so why are we putting so much faith in them? The
market is broadly buying the what the Fed is selling – the data needs to hold from here:
focus on the jobs market now more than inflation.
Bank of England: Dazed and Confused
I don’t know if we categorise this as a hawkish hold – what
appears clear is that the BoE saw the CPI print coupled with soft growth figures and thought
it’s enough to warrant holding fire for the time being, even if wage growth is troublingly
high. The vote was split 5-4, a tight call that was reflected in the market pricing ahead of
the event.
Given the market – and possibly the MPC as well – was fairly well minded
that they would hike right up until the CPI print the day before, it seems the BoE is a
little confused right now about if they have done enough and what they do next. The
statement was quite vague, saying only that policy rates are restrictive. Officials were
keen not to offer clear guidance on the next move for rates.
If they really
think that the disinflation seen in the Aug CPI is enough to declare victory then they are
wrong. CPI inflation fell from 7.9% in June to 6.7% in August, which is ‘good news’, but the
core stickiness is not really budging fast enough – core goods CPI inflation fell from 6.4%
in June to 5.2% in August, which the BoE notes was much weaker than expected in the August
Report. Services CPI inflation rose from 7.2% in June to 7.4% in July but declined to 6.8%
in August, again below the Bank’s own forecasts. It’s interesting to note that members felt
that the decline in the August services inflation was down to one-off factors…so why pause
now? If they think they want to await more incoming data then maybe they are right. Maybe
more than the CPI they are looking at the weak growth data and starting to fret they have
already done too much? Again like the Fed we come back to the data – further weakness in the
economy and more disinflation would see the BoE pivot to a more dovish outlook and possibly
tee up rate cuts for next year – what they say now is not necessarily what is going to
happen. But for the moment, as per the Fed and ECB, it’s
very much less of a case of how high as how long – the decision to pause confirms that the
BoE is falling in line with peers – the emphasis now is on duration not the absolute level.
Bank of Japan: Communication Breakdown
The Bank of Japan was unchanged with no major changes to the
statement, disappointing some who’d thought the central bank might have a few more crumbs on
normalisation. Governor Ueda said the BoJ could consider ending yield curve control and
modify negative interest rate policy … but only when it sees 2% inflation in sight. And he
stressed the BoJ would consider additional easing if necessary. He kept mum on FX moves and
interventions, but USDJPY weakened to 148 and this must be a worry with 150 a line in the
sand. And all this despite signals the BoJ should be moving more swiftly to normalise policy
with core inflation at 3.1%, and core-core accelerating to 4.3% in August. That marks 17
straight months with inflation above target – yet Ueda is still saying they won’t move until
it returns sustainably to target. Go figure – there will be no “quiet exit” as Ueda hopes
for – it will be messy and they know it. Communication seems muddled.
Beyond the G4
Norges Bank: How Many More Times
Norway’s central bank hiked by 25bps to 4.25%, which was
widely predicted. But in a surprise move it said it could raise again in December. “There
will likely be one additional policy rate hike, most probably in December,” Governor Ida
Wolden Bache said in a statement.
Beyond December is there scope for more?
Swiss National Bank: Misty Mountain Hop
The SNB hit pause, ending five consecutive increases since it
started lifting rates out of negative territory in June 2022. Again, there is the option to
do more – a hop or a skip rather than a full stop. “The significant tightening of monetary
policy over recent quarters is countering remaining inflationary pressure,” the SNB said in
a statement. “From today’s perspective, it cannot be ruled out that a further tightening of
monetary policy may become necessary to ensure price stability over the medium term.” CHF
has been the best performing G10 currency this year.
Riksbank: The Song Remains The Same
Sweden’s central bank hiked for an eighth straight meeting,
taking the policy rate to 4%. Inflation ex-energy had cooled to 7.2% from 8% – not down
enough and the Riksbank says it may need to tighten further. Meanwhile the Riksbank is
planning to sell a quarter of its currency reserves in order to protect against an
anticipated appreciation in the krona, which governor Thedeen believes is undervalued for no
particular reason. Speaking last week at a panel event at the Stockholm School of Economics,
the governor stressed that the krona will rise in the long term, noting that “it is
genuinely difficult to say exactly when it will strengthen and how much. But it can happen
quickly once the trend is broken and the krona strengthens again.”
Central Bank of Turkey: When the Levee Breaks
The Central Bank of Turkey opted for another bumper 500bps
hike in the one-week repo rate, taking it to 30%. It’s the fourth jumbo hike since June,
underscoring the shift in the central bank’s approach to inflation since the appointment of
Hafize Gaye Erkan. Since her appointment in June the CBT has moved decisively away from the
unorthodox policies previously pursued. More tightening is to be expected to bring inflation
under control though.
Neil
Wilson
Chief Market Analyst at Finalto
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