by Marc Chandler
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This year was supposed to be about the easing of the pandemic and the normalization of policy. Instead, Russia's invasion of Ukraine threw a wrench in the macroeconomic forecasts as St. Peter’s victories broke the brackets of the NCAA basketball championship pools. The war has pushed up the price of energy, metals, and foodstuffs, which seemed to be advancing prior to the conflict.
High-frequency economic data are important because of the insight generated about the economy and the possible impact on policy. However, in the current context, Fed, ECB, and BOJ policy seems to be looking past the upcoming reports. Fed Chair Powell's recent comments underscore the risk of a 50 bp hike as early as the next FOMC meeting (May 4). A consensus appears to be forming, and the market recognizes this. The Fed funds futures have nearly an 80% chance of a 50 bp move discounted. The market appears to be heavily favoring a 50 bp hike in June as well. The ECB is on hold until at least later this year. The BOJ's efforts are likely to become more complicated as inflation is going to surge soon, but the economy is weak. It may be forced to defend its Yield-Curve control cap of 0.25% on its 10-year bond.
US: Before we get to the March jobs report on April 1, the US has a full slate of economic releases. They include a preliminary estimate of the February goods trade balance, likely to remain near a record shortfall set in January ($107.6 bln). Investors may be more sensitive to the February personal income and consumption reports and the associated deflator. The Fed targets the headline PCE deflator, and it is expected (median forecast in Bloomberg's survey) to rise to 6.4% from 6.1%. The core measure, which officials talk about but do not formally target, is expected to rise to 5.5% from 5.2%.
Another strong US employment report is expected. The labor market has met the Fed's objectives and, if anything, is too strong for the central bank as wage growth is running ahead of estimates of productivity gains (but not keeping pace with CPI or the PCE deflator). For example, average hourly earnings rose 5.1% year-over-year in February. The pace is likely to accelerate 5.4%-5.5%. However, the base effect will make for difficult comparisons in the second quarter, and earnings growth may stabilize.
US jobs growth is expected to be robust, but the median (Bloomberg survey) forecast of 485k would be only the second report below 500k since last May. In 2021, nonfarm payrolls grew by an average of 562k a month. As the public health crisis subsides, the service sector growth is accelerating. In February, of the 678k increase of jobs estimated, nearly 550k were in the private service sector. Manufacturing added 36k jobs in February as some supply chain disruptions appear to be easing. Momentum in the sector is consistent with another increase of 30k-40k.
The unemployment rate is derived from the household survey, while the nonfarm payrolls are determined by a survey of businesses. The median Fed forecast saw the unemployment rate, which was 3.8% in February, finishing this year and next at 3.5%. What is striking is that the median Fed forecast cut this year's growth projection (2.8% vs. 4.0%) and boosted the Fed funds target by 100 bp, but the median forecast for unemployment did not change in 2022 or 2023. The Fed's slight concession was that the median projection for 2024 edged up to 3.6% from 3.5%. Recall too that pre-pandemic, the unemployment rate troughed at 3.5%. However, that was achieved with a 63.3%-63.4% participation rate. It stood at 62.3% in February.
The capital markets are typically sensitive to the jobs report, but perhaps due to how they trickle in, the auto sales tend to get short shrift. Yet they tell us something about US consumers, purchases of durable goods, retail sales, and personal consumption expenditures. The auto sector accounts for around 3% of the US GDP. They were softer than expected in February (14.07 mln seasonally adjusted annual rate vs. 14.4 mln expected by the median forecast in the Bloomberg survey). That is also about 10% below February 2021 sales. The median forecast is for a 13.95 mln unit pace in March, which, if accurate, would represent around a 21.5% decline from last March.
Europe: A few hours before the US jobs data, the preliminary estimate of the eurozone's March CPI will be reported. The market expects a surge of 1.9% in March alone, which would loft the year-over-year pace to 6.7% (from 5.8%). This is mostly due to food and energy. The core rate is expected to increase to 3.1% from 2.7%.
Nevertheless, there is little doubt that the ECB will not change rates in Q2 nearly regardless of the actual report. The head of the Dutch Central Bank Knot continues to press with the idea that a rate hike can be delivered before the bond-buying is complete. Even if it made sense to tighten via the interest rate channel while easing via the bond purchase channel, ECB President Lagarde has laid out a more orthodox, if it can be called that, sequencing. Knot and his allies may be better served to argue for an earlier end of bond purchases, which presently extended through Q3. The swaps market has about 45 bp of tightening priced in before the end of the year. To put that in context, consider that on the day before the US warned that a Russian attack could happen at any moment (February 11), the swaps market was discounting about 50 bp in hikes, similarly backloaded toward the end of the year.
Also, on April 1, the EU and Chinese officials held a summit. What a bad year for the chess players in Beijing. In retaliation for the EU's first sanctions since the Tiananmen Square attack in 1989, China sanctioned several EU officials, including members of the EU parliament: a blunder of huge proportions. It effectively killed the investment agreement that had been painstakingly negotiated over several years. In addition, the consequences of Russia's invasion of Ukraine are also against Beijing's strategic interests. The railroad conduit of trade from China to Europe has been disrupted, and Europe is pulling closer to the US in energy and defense. NATO is reinvigorated and may grow. Countries like Australia, Japan, and South Korea that want to check Chinese aggressiveness in the Pacific are inspired by the bravery in Ukraine. Meanwhile, some Republicans in the US Congress are calling for further decoupling from China. The US-centric flawed international order is stronger, we have argued, when a bad actor is punished.
China: In the middle of March, Vice Premier Liu He seemed to signal a dramatic switch of Beijing's policy thrust. There had been a sense in the markets that it was becoming more supportive for growth, but Liu seemed to confirm the multiprong adjustment. The crackdown on the tech platforms would ease, the real estate market would not be abandoned, the economic impact of the Covid lockdowns would be addressed, and more economic support measures would be announced. Even without any clear action to back up the assurances, the Golden Dragon Index that tracks Chinese companies that trade in the US rallied nearly 45% since Liu spoke.
In the bond market, the Chinese 10-year premium has collapsed. It last finished above 100 bp on March 7. Last week fell to nearly 30 bp. It narrowed by 22 bp in the last two sessions. At the same time, the yuan has been falling against the dollar, and the four-week decline is the longest since last July. The dollar's high so far this year is around CNY6.3860. We suspect it can head toward the CNY6.40 area, which marks previous congestion and houses the 200-day moving average.
With the Covid-related lockdowns still being experienced in several key production areas, we fear the risk is on the downside. The "official" and Caixin manufacturing PMI was already near the 50 boom/bust level (50.2 and 50.4, respectively) in February. The non-manufacturing PMI is also vulnerable as Covid is battled. It stood at 51.6 in February. Caixin's service PMI was at 50.2 in February, so it would not take much for it to fall below 50 into contraction territory.
Japan: Bedeviled by Covid and natural disasters, the Japanese economy may be contracting in Q1. Consumer spending jumped 10% in Q4 21 as earlier Covid restrictions were eased before being re-imposed. Japan's composite PMI fell to near last year's lows in February and recovered a bit in March. Yet, its remains below 50 for the third consecutive month. Rising energy and food prices, coupled with last year's cut in mobile charges last year, are expected to see what will appear as a surge in Japanese inflation. The BOJ's quarterly Tankan Survey is likely to show sentiment deteriorated. Small businesses have been particularly hard hit and did not benefit as much as the large businesses in Q4 22.
The ink from the budget for the new fiscal year has not even dried, and there is much talk about the supplemental budget in the April-June period. Some in Tokyo may think there is a political advantage before July's elections when about half the upper chamber goes before the voters. The speculation is for a JPY10 trillion (~$82.7 bln).
The dollar has risen by about 6% against the yen this month. If sustained, it would be the best month for the greenback since November 2016. At the press conference following the recent BOJ meeting, Governor Kuroda said that the yen's depreciation was benefitting the Japanese economy. He repeated this at the end of last week before the Diet. At some point, this will cease to be the case. The natural question that arises is where the official pain threshold is. Some suggest it is around JPY125 based on some comments Kuroda made in 2015. That was the last major dollar high (~JPY125.85, June 2015). It culminated in a rally from the record low (~JPY75.35) in October 2011 (~67%).
Conventional wisdom holds that Japan's monetary policy is not going to change ahead of the end of Kuroda's term a year from now. Yet, pressures are building. Global yields are rising, and the yen has been depreciating. Both developments are lifting Japan's 10-year yield toward the top of the approved range under the BOJ's Yield-Curve Control. It may become less tenable if global yields continue to trend higher.
A 0.25% cap on the yield arguably makes sense when inflation is low, but it seems less defensible when inflation is running closer to 2%, as it will likely do in the coming months. Its tolerance for a depreciating yen in the face of rising food and energy prices may also be challenged. The IMF has previously advised targeting a short-term rate instead of the 10-year. The window of opportunity to take the initiative was lost, but even in a reactive posture, it will likely face increasing pressure.
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