04/09/2023
Reserve Bank of Australia
The Reserve Bank of Australia
paused for a second consecutive month in August and may well choose to stand pat again this
week. Australia’s inflation rate
eased to 4.9% in July
,
down from 5.4% in June to its lowest level in 17 months. Although this is still too high,
the RBA is likely to choose to wait and see if it comes down further before committing to
what would likely be a final 25bps to 4.35% some time later in the year.
Bank of Canada
Signs of a slowdown in Canada’s economy are likely to ensure the country’s central bank
stays on the sidelines at its September meeting, which takes place on Wednesday.
The economy contracted by 0.2% (annualised) in the second
quarter
. The Bank of Canada paused rate hikes in March
and April, resuming with two further 25bps hikes in June and July as inflation remained too
high. Having raised rates to 5%, it’s now likely the BoC will stay on hold until it gets
more data on the economy and prices, leaving the door open to further hikes if necessary –
but a surprise contraction in GDP is ample cover to pause this month.
Federal Reserve
For the Fed a pause is almost baked in (7% chance of a hike, 93% a pause,
according to the CME’s FedWatch Tool
), but the key will be the dots – do policymakers think they need to do another 25bps
later in the year, or is the top indeed in? Markets currently see a roughly one in three
chance the Fed hikes in November before starting to price in cuts. The
June dots indicated
members
thought they would go for one more hike from where rates are now, and
minutes from the July meeting indicated a leaning towards
tighter policy.
But the
policymakers will follow through and that they will instead prefer to take a bit more time
to assess the long and variable lagged effects. To maintain the hawkish bias and reassure
markets that no cuts are coming, this could be wrapped up as a ‘skip’ – one more to come but
not yet, allowing optionality to come to a full stop a bit more slowly.
Friday’s labour market report from the US
coupled
with the miss on JOLTS and lighter-than-forecast GDP growth was painted as some kind of
perfect setup for the Fed: slowing jobs and growth, higher unemployment creating looser
conditions with the market as new workers raised the participation rate…but the market
reaction was I believe a tad more confused. Yields initially tumbled before kicking up
higher again…the 10yr rising to its highest in a week, whilst the 2yr was a little more
subdued so the inversion between the 2yr and 10yr Treasuries narrowed – the re-steepening
tell before a recession. What else was there to consider? Firstly, the nonfarm payroll
revisions were quite big – about 110k fewer jobs the previous two months. And the 7-8 months
of downward revisions we have seen is kind of what happens when the market is kind of maxed
out. The good news for the Fed is that there are lots more workers and the economy couldn’t
absorb them quick enough – which makes it lots looser and can suppress wages + the inflation
impulse. Indeed, the labour force increased by 736k, but the economy could only absorb a net
77k, suppressing wage growth – this is the key. Can these find jobs and keep the economy
moving along nicely whilst simultaneously pushing down inflation and wages…? That would be
the ultimate win for the Fed. The market now sees the Fed already at the peak in rates, and
has brought forward cut expectations to May from June. Meanwhile inflation has cooled and
core PCE at +0.2% month-on-month is kind of at the level the Fed can live with as it will
see the year-on-year figure come down towards 2%.
European Central Bank
It’s a much
finer call for the ECB this month – expectations for one more hike is pretty split depending
on who you talk to. The inflation and economic picture is kind of muddy.
Core inflation edged down to 5.3% in August from 5.5% in
July
, whilst headline remained
steady at 5.3%. The day before this data some sticky Spanish and German inflation figures
had seen markets shorten the odds on a hike by the ECB, only for the broader Eurozone data
to see yields dip back down. Meanwhile the PMI data is painting a woeful picture for the EZ
economy. Eurozone business activity contracted faster in August,
according to the latest flash PMI survey data from
S&P Global
, as the downturn spread
further from manufacturing to services. Both sectors of the economy reported falling output
and new orders. Chart: inflation cooler but services inflation is stickier
The ECB left another hike in September on the table at
its last meeting in July. How much have things changed? The economic outlook has hardly
improved, but inflation is a shade cooler. Does that mean it’s time to pause?
Minutes from the July meeting
released
a few days ago illustrate a bias towards tightening, but that policymakers are probably a
bit more mindful of being too hawkish. For instance, policymakers agreed that “in view of
the prevailing uncertainties and the large costs of bringing inflation down once it had
become entrenched, it was argued that it was preferable to tighten monetary policy further
than to not tighten it enough. Before deciding to stop the tightening cycle, the Governing
Council needed clearer signs of whether inflation would converge to target once the effects
of recent shocks had faded”. In July the ECB was more worried about inflation being too high
than anything else – just. But that calculation may have become more balanced and a pause
could be the easier course of action for the central bank.
Bank of England
The
economy is cracking but inflation and wages are still probably too high for the BoE to be
comfortable. Private sector wages are +11% and services inflation ticked higher in July.
Markets have scaled back where they think Bank of England interest rates will peak, pushing
down short-end gilt yields with the 2yr note under 4.90% from highs around 5.50% in July.
Markets had been pricing the MPC to hike rates to 6.50%, a full 125bps above where they are
now. But this has changed a lot in the last couple of months for a number of reasons –
cooling inflation pressures from energy, cracks in the economy and moves across the
sovereign debt market as traders eye the Fed endings its rate hike cycle. Chart:
Inflation cooling, but still too high
Cracks: The last composite PMI registered the first sub-50
contraction reading since January, and the softest figure in 31 months.
It noted that firms signalled a renewed downturn in
business activity in August, ending a six-month period of expansion
.
Mostly this was down to a faster fall in new orders due to softer domestic economic
conditions and higher borrowing costs. Input costs moderated, with costs rising at the
slowest in two-and-a-half years, but reports of persistently strong wage pressures
underlines the problems facing businesses and the Bank of England in taming inflation.
Meanwhile, Sage reported on August 23rd that sales at Britain’s small businesses have
collapsed by a fifths. It’s not a good look for the BoE as it faces the September meeting –
as I said last time the Bank has thrown in the towel and already committed to a recession.
And when the global recession hits it won’t matter much anyways…Maybe one more hike this
September and done? It would seem to be unlikely the BoE would want to still be hiking as
the Fed and ECB hit the peak. A worsening economic backdrop – albeit the economy is bigger
than everyone realised because of ONS revisions – might however see the BoE prefer to play
to play the waiting game –maybe one in five chance it pauses. Huw Pill, the chief economist
the Bank, indicated he prefers to pause and stay restrictive for longer rather than hike
more and cut. Remember that for all central banks we are an inflection point where holding
rates steady will produce ever-more restrictive policy as inflation cools off – that is
until we hit the bottom in core inflation, which is below where we are now but is not 2%.
And for each of them the battle is not really about how high they go and when they stop but
reiterating to the markets that they will not be cutting any time soon. 
Neil
Wilson
Chief Market Analyst at Finalto
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