Jason Daw:
Hello and welcome to Macro Minutes. During each episode, we'll be joined by RBC Capital Markets experts to provide high conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures.
Blake Gwinn:
Hello and welcome to the September 10th edition of Macro Minutes, which I'm calling back in sync. I'm Blake Gwinn, head of US right Strategy at RBC Capital Markets and I will be your host for today with the Fed and ECB set to follow the Bank of Canada's lead with 25 basis point cuts of their own. A number of the major central banks are now back in sync so far. These central banks look to be proceeding gradually along their respective cutting paths, but the possibility of larger cuts still loom should economic conditions start to deteriorate. Meanwhile, others are proving even more cautious with the next cut from central banks such as the RBA and Bank of England to even further a field. So we've got a great panel today to address the status of these cutting cycles across regions. I will start and discuss the US and the Fed, then we'll go to Canada rate strategist Simon Deeley, then to head of UK European Rates and Economics, Peter Schaffrik, and finally close out with Chief Australia economist Su-Lin Ong to discuss the RBA.
So with that, let me turn to the US and the Fed. Starting with the August employment report, which was out last Friday, was a bit of a mixed bag. I think there were aspects that both the labor market normalization camp and the doom loop crowds could hang onto, but I think for the Fed there really wasn't enough to scare them into cutting 50 basis points. At the September meeting coming up next week, we had some fed speakers out after the NFP release including Williams Waller Goolsby. All of them seemed to be leaning towards starting the cutting cycle carefully at least to borrow the word that Waller used to describe the cutting cycle. We moved our fed call from a pace of four twenty five basis point cuts at each quarter to now penciling in 5 25 basis point cuts at an every meeting pace starting in September. This is going to result in a four to 4 25 terminal pricing to be reached in March, which is still meaningfully higher than fed estimates and current market pricing.
Turning back to those Fed speakers, while they did tamp down expectations for 50 basis point cut in September, they all seemed to be leaving open the possibility of future 50 basis point cuts if labor market shows signs of deterioration, while it was very clear to say deterioration and not slowing in his speech. So we do think the bar to fifties remains relatively high if the labor data avoids any more significant deterioration, meaning payrolls move towards zero unemployment rate quickly rising, some anecdotal evidence or data showing the job losses are rising, the prime age, prime age employment as a percent of population, which has remained very strong. If that starts to decline, those are the kind of things I think the Fed would look to move off of that 25 basis point per meeting and start considering 50 basis point cuts. However, this also presumes that broader activity data continues to hold up well.
Also, I think for markets this persistent premium for 50 basis points of future meetings does allow the Fed to have their cake and eat it too, so to speak. They get the financial conditions easing that comes along from having these 50 basis points cuts priced into the curve and a much lower terminal rate priced in. But at the same time, by only going 25 basis points a meeting, they lower that risk of accidentally over easing should the data start to turn or inflation pressure start to pick up in the future. Longer term, I think we're still looking at the 95, 98, 20 19 style adjustment cycles as the best guidepost for this cycle. And because of that, I think this is going to be a shallower cycle than many people are expecting. We've previously been writing that the fed's stopping point is not really something they're thinking about in terms of a specific level, meaning there's not some neutral rate that they all kind of agree on and that they're on a clear cut path to get back there.
But I think it's really more a function of the contemporaneous economic conditions at any given meeting, meaning they'll cut 25, go to the next meeting, see how the data's evolved over that point, decide whether to cut again, rinse and repeat, do that at the next meeting rather than kind of starting the cutting cycle and then just being on a relatively straight line path down to that neutral type of estimate. The other thing I would add is that we do still see some potential upside risk to inflation, particularly in the first half of 2025. This isn't something that we're particularly worried about. We're not big inflation hawks, but those risks do exist and I think we've heard fed speakers addressing those risks in a way that does put a little bit more emphasis on these remaining inflation risks than markets who have almost completely written inflation off written inflation out of the narrative.
A few of those we know that shelter, which is going to be providing a lot of the likely drag on inflation in the second half of 2024 that is going to start to turn around in 2025 and become additive to inflation. Again, we could see a repeat of this kind of Q1 seasonality that we've seen the last few years where we have very hot inflation data in q1. We're already starting to see major reversals in immigration trends. As we've discussed in past calls, immigration has been a big reason why we haven't seen more inflation pressure in the us. So to the extent that that reverses could put upside risks on inflation out of the election, we have risks of even further cuts to immigration tariffs. And I would also say geopolitical risks generally represent some potential upside risks to inflation as well. So taking all this together, I think the Fed may find themselves in a similar situation to that, to those 90 cycles where you get a run of troubling data, they get a bit worried about downside risks, they start the cutting process, but then those risks don't actually fully materialize and we kind of stabilize in economic terms and they stopped cutting rates with the Fed funds rates still very much in restricted territory when you look across the full constellation of current data, not just some of the other measures of labor markets that we have, but outside of labor markets, I think it's just very hard to think that we are really circling the drain on a hard landing or that we've kind of crossed this point where a hard landing is inevitable.
We still have very resilient growth. GDP is still printing with a three handle consumption has been strong. Consumer balance sheets are still quite healthy. Household wealth is high, corporate profits are very high, bankruptcies are low, are very low. There's just a lot of reasons that I find it very unlikely that we're really on the precipice of a hard landing. Even if all of these things I've been discussing these fed and economic views that the economy is going to turn out to be all right, we don't tip over into a hard landing. The Fed has a shallower cutting path than expected. I do think the path of lease resistance right now for rates is towards new yield lows and maintaining these lower ranges and yields that we find ourselves in as well as these higher ranges for the curve as well. Fed communication that's keeping this possibility of 50 basis point cuts consistently alive I think really allows markets to continue to price in and continue to roll forward this premium.
So basically every meeting we're going to converge to 25 basis points. We'll continue to price 50 basis points cuts at future meetings and this really limits the degree to which rates can really sell off because markets will just push those 50 basis point cuts out to the next meeting as soon as it's realized that each meeting's going to be a 25 basis point cut. I would also say that with these two employment ports, which really didn't provide a clear cut direction in either way, pretty tepid and with the start of the cutting cycle, I think it does give a little bit of a green light to real money buyers in particular who've been remaining on the sidelines. So given all that, I think it's going to be very difficult. It's going to take quite a bit of accumulation of positive data to really challenge this bias that markets have right now towards lower rates and steeper curves. I still think over three to four month timeframe our view that yields can move higher, curves can move flatter. I do think that's realized, but in the very near term I think things remain very tactical and we're likely to hold onto these ranges and continue to trade with a bullish bias and a bias towards curve deepeners. And with that I will pass it over to Simon.
Simon Deeley:
Thank you, Blake. There have been several key developments in Canada in the two short weeks since the last episode, and then we have seen Q2 GDP print reasonably well for headline growth at 2.1% annualized, but this was driven more by the government sector adding 1.7 percentage points while private consumption struggled. Non-residential investment was the pleasant surprise on the domestic side. However, that was followed by A BOC meeting last week where the central bank reiterated concerns from the on excess supply and to ster future growth percent, they highlighted the symmetric nature of the 2% inflation target. Importantly, governor Mackla openly discussed alternative to 25 basis point cuts with more emphasis throughout the press conference on downside growth risks while not in the same realm as what led the BOC to deliver as largest 100 basis point moves in the latest hiking cycle, the degree of slack consistently lackluster growth and a still restrictive policy rate make larger cuts a very distinct possibility.
This cycle. The meeting was followed by further deterioration in the labor backdrop. The unemployment rate rose two tenths to 6.6% as the 20 2K job gain last week was dwarfed by a 60 K increase in unemployment hours worked were a little changed and wage growth has moderated to about 5% year on year in this report that is still higher than the three to 4% level seen in most other wage metrics and something the BOC will want to see moderate further from here. Returning to the cut size discussion is deterioration needed or more of the same sufficient to get a 50 basis point cut this cycle on the growth side, continued sub potential prints. So 2% or less would be enough for the BOC to consider larger cuts. Same goes for the labor market in our minds with a consistent rise in unemployment rate and in long-term unemployment and deterioration in the job finding rate all pointing to an already weak job market inflation is the more difficult variable given volatility in the monthly prints this year, but the general downward trend, so 5 0 7 core prints at two tenths month on month or less this year, and BOC tolerance of some choppiness suggested BOC would not overreact to a higher print if the next two months print at two-tenths month a month.
So marginally above the average for the year year on year rates for them would be two tenths lower for each of CPI trim and CPI median. The two measures would also be averaging about 2% even on a three month annualized basis. So overall market pricing has about 33 basis points for each of the next two meetings, which reflects about a 60 to 65% probability of a 50 basis point cut at one of them. Well, not our base case scenario. We can certainly see how a 50 basis point cut could occur at some point and we could see how it could rise as incoming data comes in and so we would not push back on market pricing here.
Blake Gwinn:
Alright, thank you Simon. Now let's head over to Peter to talk about Europe.
Peter Schaffrik:
Thank you Blake. So what I have in mind is I would like to talk obviously about the ECB meeting that's coming up. Secondly, I would like to talk about a new way of thinking that seems to have developed within the ECB as regards the deflationary disinflationary, I should say impact of China. And then thirdly, I would like to look ahead to the next Bank of England meeting that's coming up next week. So let's dig into it. So for ECB meeting that's coming up, the rates decision seems to be the easiest thing. Pretty much everyone is expecting a 25 basis point rate cut and the market is priced for that and most of the speakers that have been out lately have been indicating that they're on board. So anything else but a 25 basis point rate cut would be a major surprise. We have been expecting that essentially since January, so we certainly would be surprised as well.
However, the devil is going to be in the detail as always. Not only will the ECB update their own staff forecasts and they will probably also look to guide markets for the times ahead and I think the decision here is a little bit more complicated. So first of all, when we look at the staff forecast, it seems likely that both headline inflation as well as headline growth is going to be revised down at least in the near term. That's just because the data that has been coming out since the last update suggests that they would have to revise it down and particularly with the drop in commodity prices that we're seeing, it seems likely that particularly headline inflation could also be revised for next year to the downside. However, as I said, the devil is in the detail because one of the things that we've also seen is that the core inflation measures that have been out surprising to the upside service inflation has been surprising to the upside and that chasm between core inflation and headline inflation has if anything increased.
So they will have to probably increase their core inflation forecast, which leaves them in a bit of a predicament how to explain that and how to guide that because we know that different factions within the ECB anyway, some that are stressing the propensity for headline inflation to be low and want to cut rates and they're stressing the weakness of the economic data that comes out and we'll come to that in a second. And the more hawkish leaning members who are stressing the stickiness of the core inflation measures, so that will leave the ECB or will leave the guard more specifically with a bit of a explanation dilemma. Now having said that, we think that they'll probably keep their cards very tight to their chests, will not really deviate from the guidance that they've been given before that the data is their guide note data, not the data point as they said before.
So they created some leeway for themselves and that they also will have a meeting by meeting approach. However, having said that, the market is currently pricing about seven basis points, eight basis points for rate cuts in October, the meeting that we expect them at the moment to skip and it's been priced again with a full 100% probability for a 25 basis point rate cut in December. So the big question for us is whether they guide the market towards an accelerated pace where they would not skip the next meeting but would be open to subsequent rate cuts. Again, we think it's less likely, but given the data how it's been coming out lately, that cannot be ruled out. And that leads me directly to the second topic I raised. There seems to be more people in the ECB now worried about growth. It's not necessarily that growth has been bad.
We had positive growth in Q1, we had positive growth in Q2, the leading indicators in the form of the PMI in particular pointing to a similar growth pattern in the third quarter. However, that is weaker than what the ECB has been forecasting. They've got point fours on the quarter in their own forecast profile, which probably has to be revised down as I said earlier. And in particular the recovery and the manufacturing industry seems to have stalled before it really got underway. So at the beginning of the year we've seen a slight improvement, but that seems to have petered out before we even crossed. So the 50 divide in the leading indicators or before we even got really growth back underway and what the ECB has stressed lately is that this has something to do with China in particular. So what they're saying, and I think there's a lot of merit to what they're saying, is that not only is currently the Chinese economy very weak, which means that the European exporters have a hard time is also that their exporting firms are pushing harder and harder into the export markets across the globe where typically European firms have been strong and they have presented evidence that shows how European firms have been losing market share.
That obviously is not great news. And then thirdly, they also point out that the relative exchange rates really favor the Chinese companies and disadvantage to European firms at the moment, which also leads to the aforementioned loss of market share. That seems to be a structural problem that doesn't really go away. And if you then look at the share in certain economies, particularly in Germany of the manufacturing part of the industrial complex, you can see why that is going to be a very difficult ride for them. And you can also see if that part of the economy is not really chiming in to the recovery, it's going to be very difficult for the economy as a whole to turn out very strong growth rates. That's what the ECB seems to be much more concerned about, frankly I am concerned about as well. And when you then add into the mix last but not least that the weakness that's coming through from the Chinese companies from China itself is probably also weighing down on the commodity complex, which in itself is a bit disinflationary.
You can see why the dovish ECP members are arguing for stronger or at least faster rate cuts. So we'll have to see whether that's going to be incorporated in their guidance as well. Last but not least, before I hand it back to Blake, let me quickly look ahead to next week when we'll have the Bank of England meeting. If you recall, the last meeting produced a rate cut by the narrowest of margins five to four and we think that they will be inclined to skip the next meeting. When it comes to rate cuts, we have canceled in another rate cut in November for quite some time and we think that's still the most likely outcome. Now on top of that, however, we will also have an announcement as far as the next QT envelope is concerned, which is what the market is really looking for. We think that's probably going to be a repeat of the 100 billion grand total for the next 12 months. That shouldn't really surprise the market, although it might be a little bit too low for some market participants. But otherwise we think the real action is going to be going forward into November meeting and we'll have to see how the data develops in the uk, which so far has been quite strong on pretty much all fronts.
Blake Gwinn:
Thank you Peter. Finally, let's head over to Su-Lin.
Su-Lin Ong:
Thanks, Blake. Unlike its dollar block and European counterparts, the RBA is unlikely to be joining the rate cutting party anytime soon. I think it's less about the RBA being out of sync and more about it lagging the global easing cycle and also probably delivering a more shallow cycle than a number of its counterparts given the relatively low starting point for the cash rate at 4 35, still well above target core inflation and a slightly tight labor market. We have though brought the start of a likely RBA easing cycle back to February of next year from May. And it reflects three key reasons on their own. Each of these factors was not enough to shift our view, but in total they are probably more meaningful. So firstly, we had pushed back the start of rate cuts to may following some quite high monthly inflation prints, but the slightly better core inflation data for Q2 and the early July read has been welcomed, although they are still too high.
I think. Secondly, the contraction in household consumption in last week's Q2 national accounts did surprise us and it's driven really the downward revisions to our GDP forecast for this year and next. They're pretty subdued now and they sit around one and a quarter percent for this year, two and a half for next year. But the weak starting point for consumption isn't great, but it's really more about the uncertainty over the outlook for consumption. We are forecasting it to lift over the coming quarters assisted by income tax cuts that began on one July and some cost of living relief that we've talked about in these podcasts for a while now. But there is a great deal of uncertainty and I think finally, as Blake has outlined in his revised US Fed funds view, a larger US cycle of 125 basis points of cuts delivered sooner with the risk of the odd 50 has.
All of that's tipped us back to a February start and also sees a shift to a 75 basis point easing cycle from the RBA rather than 50. The bank is driven largely by domestic considerations, but clearly monetary policy works through several transmission mechanisms and a fed that cuts by at least 25 basis points by the first quarter of next year is likely to see a stronger Australian dollar and tide of financial conditions than desired if the cash rate differential turns negative. We think really the shift to our RBA view is pretty marginal. It's consistent with our long held view that it will likely lag and deliver only modest easing in this cycle like the Fed, the Bank of Canada and others. It'll be labor market developments that become increasingly important for the RBA as it thinks about when it's appropriate to move less restrictive, not withstanding a lift in the unemployment rate to 4.2% currently, as the labor force continues to grow the broad suite of labor market metrics firm, we've got ongoing job creation here concentrated in full-time jobs.
The part rate has hit a new high employment to population's not far from a record level. And hours work also continue to increase. And we've got to remember that at 4.2% the unemployment rate is probably slightly below full employment. It's well below its pre covid level and it's low by historic standards. The labor market really needs to show more sustained signs of loosening for the RBA, I think to be more confident about delivering some accommodation. The leading indicators do point to further some moderation in the labor market ahead and we got another decline in this week's A NZ job ads. But the starting point's pretty good, so we'll be watching next week's August Labor force closely. It's the next piece and actually it's the last piece of key local data before the RBA a's September meeting. Front end bonds are starting to look a little rich, but we wouldn't fade it yet. The global easing cycle is spilling over here and it does suggest we can probably price in one to one and a half cuts by year end even though we don't think it'll be delivered and threes could test a hundred through cash.
Blake Gwinn:
Thank you, Su-Lin, and to the rest of our panel. And thank you all for joining this edition of Macro Minutes. Institutional clients of RBC can find additional content on all of these topics and more on RBC insight or by reaching out to your RBC sales contact. Hope you join us next time. Thanks.
Speaker 6:
This content is based on information available at the time it was recorded and is for informational purposes only. It is not an offer to buy or sell or a solicitation and no recommendations are implied. It is outside the scope of this communication to consider whether it is suitable for you and your financial objectives.