by Marc Chandler
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All three major central banks that meet in the coming days will hike rates. The question is by how much.
The Reserve Bank of Australia makes its announcement early Tuesday, September 6. One of the challenges for policymakers and investors is that Australia reports inflation quarterly. The Q2 estimate was released on July 27. It showed prices accelerating to 6.1% year-over-year from 5.1% in Q1. The trimmed mean rose to 4.9% from 3.7%, and the weighted median stood at 4.2% from 3.0%. Starting in October, the Australian Bureau of Statistics (ABS) will begin reporting a monthly estimate released four weeks after the end of the reference month. It will cover 62%-73% of the weight of the quarterly basket, which will remain the key measure. Methodological differences will mean that the three-month average of the monthly CPI will not equal the quarterly estimate. Still, it will offer more timely insight into price pressures, and over time, ABS will expand the coverage of the monthly estimate. This leaves only New Zealand among the high-income countries without a monthly inflation estimate.
The labor and property markets are showing signs of weakening, but the consumer appears to be more resilient. Last week, Australia reported a 17.2% collapse in July building approvals. However, July retail sales jumped 1.3%, well above expectations and the strongest rise in March. The Reserve Bank of Australia began its tightening cycle in May with a 25 bp hike. At the following three meetings, the RBA delivered half-point hikes, and a fourth one is likely to be delivered now. The cash futures market is discounting an almost 2/3 chance of a 50 bp hike. It will not be the last. Assuming that the cash rate is hiked by 50 bp to 2.35%, the cash rate futures market is pricing in almost another 100 bp to be delivered in Q4. The risk is that with signs that the past hikes are having effect, the RBA signals that it may soon be appropriate to moderate the pace. The swaps market has the terminal rate near 4% in 2023.
The day after the RBA meeting, Q2 GDP will be reported. Economists expected another quarter of solid growth. Australia's output rose by 0.8% in Q1 and appears to have accelerated in Q2 to around 1.25%-1.50%. The record trade surplus is bolstering Australian growth. Australia reported a Q2 trade surplus of A$45 bln, a 55% increase from Q1. The July trade figures are released on September 9.
The Bank of Canada meets on September 7. It surprised the market with a 100 bp hike in July, which brought its target rate to 2.50%. This is the middle of the 2%-3% range that the central bank considers neutral, which means the long-term equilibrium rate. However, even if prices have peaked, Governor Macklem warned that inflation will remain "too high for some time." After the July CPI showed a pullback to 7.6% from 8.1% in mid-August, Macklem explained that by "acting forcefully now," the central bank is "trying to avoid the need for higher interest rates" and a sharper economic downturn later.
While the US economy contracted in Q1 and Q2, the Canadian economy expanded by 3.1% in Q1 and 4.4% in Q2. That appears to be the peak, and growth may average closer to 1.3% for the next several quarters, according to the median forecasts in Bloomberg's survey. The August manufacturing PMI fell below the 50 boom/bust level for the first time since June 2020 (48.7). Canada is enjoying a positive terms-of-trade shock. Canada reported a nearly C$20 bln trade surplus in H1 22 compared to a little more than C$400 mln in H2 21 and a C$12 bln deficit in H1 19. It will report July's trade figures shortly before the Bank of Canada meeting.
The market remains wary of another 100 bp hike by the Bank of Canada. That would bring the target rate to 3.50%. However, after the Q2 GDP disappointment, the market has settled on a 75 bp move. The market has the year-end rate near 3.75%. This is very close to what is now seen as the terminal rate: 3.75%-4.0%. Canada's 2-year offers almost a 15-20 bp premium to the US. It has only briefly offered more than 20 bp this year. Yet, our work shows the exchange rate is more sensitive to the general risk environment (S&P 500 proxy) than the rate differential. Still, the correlation between changes in the interest rate differential and the exchange rate is not stable and, sometimes, opposite of what one would intuit. On the other hand, the rolling 30-day correlation of the changes in the exchange rate and the S&P 500 has not been below 0.50 since mid-March.
The August employment report is due a couple of days after the Bank of Canada meeting. There were small losses in full-time positions in June and July after a surge of 135.4k in May. The jump in May looked to be a function of a constructive shift from part-time to full-time employment. Part-time jobs fell by almost 100k in May. While there is merit in that, the Canadian labor market appears to be losing momentum. In the three months through July, it lost an average of 11.3k jobs a month, the first three-month job loss since Q2 21. The participation rate, which was at 65.5% before Covid, recovered nearly fully and was at 65.4% as recently as March. However, it has fallen for three of four months through July to stand at 64.7%, the lowest since May 2021.
The European Central Bank meets on September 8. Recall that the ECB raised rates in July for the first time since 2011. The 50 bp hike was greater than many initially expected and lifted the deposit rate back to zero. Price pressures, inflamed by the multi-faceted energy shock, continue to accelerate even as the economy appears to be entering a recession. Before the weekend, Gazprom announced that the Nord Stream pipeline, which had been shut for three days and was to re-open on September 3, won't. It cited a new technical issue was discovered. The market had long anticipated a half-point hike after the summer, even before expectations swung toward 50 bp in July.
Around the Jackson Hole forum, some of the hawks on the Governing Council pressed their case in public for a larger move. The upside surprise to the preliminary August CPI, the continued push by the hawks, and the recognition that the staff's updated forecast would project higher inflation, may have successfully delivered a fait accompli for the larger move. The swaps market has 125 bp of rate increases over the next two meetings fully discounted.
The ECB's record of the July meeting suggested that the 50 bp increase should be understood as expediting the rate hikes, not increasing the terminal rate. But this assumes that there is an agreed-upon terminal rate, and this does not seem to be the case. Comments by Bundesbank President Nagel support this skepticism: "And I have to say, I do not really know. It's much too early to think about where is, more or less, the terminal rate." He warned that German inflation could hit 10% in Q4. The Bundesbank had forecast German CPI would reach 4.5%, but Nagel warned it is now likely to average over 6%.
In the first review of its monetary policy strategy since 2003, the ECB indicated at the end of last year that its corporate bond purchases will take into account climate criteria. In July, the ECB announced that starting in October, it would begin giving preference to corporate issues "with better climate performance." A report at the ECB meeting should provide more color (details, metrics, etc.). The Eurosystem owns almost 350 bln euros of corporate bonds and nearly 25 bln euros of which mature in 2023. Assuming the ECB is committed to reinvesting maturing proceeds, these are the funds that can show a greener preference.
Central banks are worried that higher inflation will get embedded into wage demands. The ECB said that overall, there was no evidence of this, yet remained concerned that continued upside surprises and/or signs that inflation will be more persistent increases this risk. The large German services workers union (membership of around 2.2 mln people) struck a deal with Lufthansa for gross base salary increases of 8.3% for workers earning 6.5k euros a month and 19.2% with monthly wages of 2k euros. Negotiations will begin soon with Deutsche Post and the public and retail sectors.
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A few other data points will draw attention in the days ahead. First, one of the Bank of Japan's Kuroda's chief arguments against believing price pressures are sustainable is because of weak wage growth. As we have noted, private sector economists surveyed by Bloomberg have similar inflation forecasts to the BOJ. To wit: The BOJ's latest forecasts are for core inflation, which excludes fresh food, to fall from 2.3% this year to 1.4% next year. The median forecast in the Bloomberg survey found an identical median core CPI forecast for 2023. The median projects core inflation to fall below 1% in 2024. The BOJ forecasts 1.3%.
Japan reports July labor cash earnings and real cash earnings. Labor cash earnings initially were reported to have risen by 2.2% year-over-year in June but were revised to 2.0%. In the past decade, cash earnings have only risen above 2% year-over-year twice, and both times (July 2014 and June 2018) preceded a sharp fall. Still, it bears watching. On August 1, Japan announced a 3.3% minimum wage increase (to JPY961 an hour or about $7.20). It will take 2-3 months for the local governments to adjust accordingly. An estimated 2.8 mln employees may directly benefit or a little more than 2.5% of the workforce. Japan also reports July household spending figures. The recovery in Q2 was aided by recovery from the omicron-inspired weakness. Household spending year-over-year from March through May. It is difficult to see a strong underlying trend.
China reports August reserves, trade, and inflation. These are not the fundamental considerations driving policy or the yuan. Officials seem genuinely spooked by the recent data showing weaker than expected growth. It is offered more loans and infrastructure projects. It shaved interest rates. Yet, the main problems remain. The property sector, a vital growth engine, has collapsed and remains offline. The zero-Covid policy continues to disrupt unpredictably, and the fourth-largest city entered an indefinite lockdown at the end of last week. At the same time, China's CPI has risen from 0.9% year-over-year in Jan-Feb to 2.7% in July, the highest since April 2020. However, inflation is primarily and food and energy story in China. The core rate has risen by 0.8% year-over-year. The energy story is well known, while food inflation has been elevated by rising food prices, which are tied to pork prices and the extreme weather. Producer price inflation has slowed every month since peaking last October at 13.5% year-over-year. It stood at 4.2% in July. The problems in the property sector are an important driver.
September 5 is a holiday in the US and Canada. The market seems interested in two things: the trajectory of Fed policy and the state of the US economy after two-quarters of contraction. August ISM services and the July trade balance may help solidify expectations for a Q3 expansion. The ISM services look solid, while the preliminary July merchandise trade figures suggest Q3 has begun with a sharp improvement.
The Fed's Beige Book, released a few hours after the July trade balance, inevitably draws some headline attention, but it is not the stuff that spurs changes in expectations for the central bank. After the strong JOLTS data and the August jobs report, the market is back to pricing in a roughly 75% chance of the third 75 bp hike later this month. Looking further afield (September 13), flattish headline consumer prices in August, for the second month in a row, could see the year-over-year pace ease a few tenths of a percent but will likely remain north of 8%. The core rate will prove stickier, and the year-over rate could push back over 6%. Hence the combination of general robust labor market readings and elevated prices will give the Fed reason to maintain the larger pace moves.
The UK will have its fourth prime minister in a little more than six years at the start of next week. Truss has been the favorite to replace Johnson since very early in the contest. Numerous ideas have been floated, including a VAT cut, deferring next year's corporate tax increase, and boosting oil and gas activity in the North Sea. An emergency budget is possible toward the end of the month. Truss is not only inheriting a mess but also seemingly low confidence that the situation will turn around any time soon and more pain is experienced.
Tags: Bank of Canada,China,ECB,Featured,inflation,Japan,macro,newsletter,RBA,US
