Jason Daw:
Hello and welcome to Macro Minutes. During each episode, we'll be joined by R B C 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. Address.
Blake Gwinn:
Welcome to the July 11th edition of Macro Minutes, uh, which I'm dubbing defying Gravity. I'm Blake Gwinn, head of US Rates Strategy, your host for today's call, uh, which we're recording at 9:00 AM Eastern Time on July 11th. So the big story over the last week, uh, has been a break higher of a number of global fixed income markets as central banks are left to deal with still tight labor markets and strong economic activity, uh, along with core inflation that's generally not falling fast enough for their comfort. While in some cases markets have started to come around to expectations for higher respected terminal rates, most of the streets that move higher yields has come on the back of markets finally starting to believe major central bank's rhetoric on not cutting rates in the foreseeable future. Of course, that goes hand in hand with the fact that economic data has generally remained robust, making near term recession calls harder and harder to justify, despite some give back.
Over the last few sessions, tens in both US and Germany are still well above April and June Ranges and back near levels reach just prior to the banking stress in March, while tenured yields have surpassed the highs and yields reached after the September 22nd, 2022 budget mishap. Notably, these moves have come against a backdrop of what seems to be a long bias in markets with positioning indicators pointing to long, uh, positioning across investors, the evidence of debt buying on yield backups, as well as a near unanimous consensus to be long rates coming from our compatriots across the sell side. So the question now is whether this breakout remains a short-lived sojourn with markets quickly falling back into prior ranges or whether old rate ceilings have now become the floors to speak to that and other issues. We have a great lineup of speakers for you today. We're gonna start off with Chase Doll, head of North American Rate Strategy to talk about Canada and the B BOC decision this week.
Then we'll head over to US economist, Mike Reid, to discuss last week's US labor market data, which partially helped to trigger the recent selloff along with expectations for tomorrow's CPI report. Then I'll have hop back on to briefly discuss the moving US rates and FMC expectations. Uh, then we'll have Peter Schaffrik, head of the UK and European rate Strategy to discuss the recent breakout from the European perspective. Then head of US equity Strategy, Lori Calvasina will discuss how equity markets are handling the economic data and rising yields. And finally, we'll pass it over to Chief Australian Economist Su-Lin Ong to discuss the move in Australian rates and the RBA outlook. So with that, I will hand it over to Jason Daw, uh, to discuss Canada.
Jason Daw:
Okay, thanks a lot, Blake. Uh, so today I'm gonna discuss, uh, the Bank of Canada meeting tomorrow and also the medium term outlook for the boc. So our forecast after the June meeting was for a follow on, uh, 25 basis point hike at the bank's, uh, July meeting, which is tomorrow. Their hawkish language in June, coupled with, uh, firm and sticky growth and inflation data, uh, does argue for them to not skip a beat and deliver another rate increase, uh, tomorrow. So market pricing, it has gravitated towards our view over the past week, and consensus is firmly in the camp of a BOC hike. So while a 25 basis point hike is consensus, and that's embedded in market pricing, uh, the BOC has shown a pension to surprise, uh, over the past year. So nothing can be truly ruled out as far as what they might uh, do.
Next question is, um, you know, what are the things that could surprise the market and potentially cause outside moves? Um, on the low probability kinda hawkish surprise side, that could include, uh, greater emphasis on higher neutral rates, materially stronger growth or inflation forecasts, and, um, explicit guidance for additional, uh, rate hikes. On the double surprise side, that could include, uh, the bank, um, focusing on policy lags and, um, even on the lower probability spectrum. Another conditional pause. So again, these are low probability events that could have, uh, outsized, uh, market moves. Now beyond July, the market's pricing a 50 50 chance of another, uh, rate hike, which seems, you know, probably fair, but I would say that, uh, the BOC is probably inclined to hike further, and the onus is on the data to come in materially weaker for another pause to unfold. Now, looking even further out, um, we have penciled in a modest rate cutting cycle that brings the policy rate down to 3.5% starting in the second quarter of next year. But the risk to that view is that the cutting cycle starts, uh, later, uh, rather than sooner. And with that, I'll turn it back over to Blake.
Blake Gwinn:
Thank you, Jason. Uh, and now we will go over to, uh, Mike re to discuss, uh, US data.
Michael Reid:
Great, thank you Blake. So, uh, last week, you know, we had a kind of a surprise in the payroll report in that, uh, expectations were quite high from adp. Um, but if you take that away, uh, the, the official NFP report was, uh, still quite solid, and we're seeing the strength in other labor market metrics, whether you're looking at the unemployment rate ticking back down at 3.6%, uh, the quits rate, uh, move back up. Um, and, and even claims whether initial or continued, uh, are, are drifting back down from their recent highs. Uh, still we have to acknowledge the, uh, the slowing in the growth of the, uh, headline there, and it's something we're watching closely. Uh, if you look at the, uh, diffusion index, which, uh, measures the percentage of industries, uh, that are growing, that fell to, uh, 58% in June. That's down from 69% just a year ago, and just below the median of 60% since 1991.
So what's really interesting here, it's really three, uh, sectors that are driving the growth. Uh, that's healthcare, leisure and hospitality, and government, state and local in particular. So these three sectors have accounted for over half of the total job gains we've seen since last July, um, but two in particular, and that's leisure and hospitality. And then the state and local government have yet to fully recover to their pre pandemic levels. Um, so much of the strength we're seeing right now in the headline growth might be better characterized as a continuation of the recovery rather than new job growth. So, you know, looking ahead here, uh, a slowdown in any one of these sectors will have a noticeable impact on the headline change. Shifting quickly to, uh, CPI coming out tomorrow, our forecast calls for an advance of three-tenths, uh, on the month in core as well as three-tenths.
Uh, in headline, this would bring the, uh, year over year pace down to, uh, 5% for core and 3.2% for a headline respectively. And while the, uh, three per the three-tenths, uh, advance for core would be a welcome deceleration from last month, we saw, uh, an advance of four-tenths in May, um, at 5% year over year core still uncomfortably high for the Fed. Um, most recently the, the path lower to 2% was stalled by, uh, the uptick in used car prices. Um, but we're looking for a reversal this month, and that should help push core lower. Um, we still see continued pressure in auto insurance, um, that has averaged 1.3% month over month gains, uh, this past year, uh, as well as, uh, shelter that's in the form of rent and owner's equivalent. Um, those have averaged about five, uh, five tenths month over month for the past, uh, three months despite, uh, the hitting their peaks last September. Nonetheless, in a sign that broad inflation pressure is easing the six month average diffusion, uh, looking at the 15 top line categories fell to six from 11 last May, and the one month diffusion count fell to five categories. So again, signs that, uh, price pressure is easing. And with that, I'll turn it back over to Blake to talk about what it means for the Fed coming up in July.
Blake Gwinn:
Thanks, Mike. Um, you know, so as, as we've, uh, heard from Mike here, I mean, I think the case for, um, you know, a a a near term economic slowdown and a case for, you know, rates to move considerably and sustainably lower from here, it's getting very, very difficult to make, you know, for one, the data's remained much more resilient than I think pretty much anyone had predicted earlier this year. You add onto that the fact that expectations around banking sector stress in, in early March, uh, having some type of large impact, um, you know, you know, greatly accelerating the tightening and financial conditions, that just hasn't come to pass. And I think doubts about lagged effects finally showing up are, are starting to crop up. And that's true even within the Fed ranks. I think we saw in the minutes and, uh, from Lori Logan's speech last week, basically just questions around whether or not, you know, the impact of these, uh, rate hikes that have already delivered has already largely been felt, or whether we expect that to, to come back and crop up at some point in the coming months.
You know, you, you, you take this kind of, uh, idea that, that that case is getting much more difficult to make. And I think it does argue that the risk to terminal are certainly to the upside, but I think even if market pricing for terminal is currently correct, you know, rates could continue to rise if the data remains strong. I think a lot of that comes on, cuts getting continually pushed out, but I think eventually markets could start calling into question longer, run our star, that kind of neutral rate that's priced further out into the fed curve or even, um, you know, start to push higher on inflation expectations if the Fed is basically seen getting behind the curve or, or, you know, remaining stubbornly, stubbornly slow in the face of data that's remaining strong, stronger than expected, or, or even reaccelerating. You know, even aside from from that, I think hawkishness at other central banks around the globe could, uh, keep us yields moving higher as well, even if the Fed is resistant or further tightening.
And lastly, I would add on that supply, uh, demand dynamics are likely going to start serving as a headwind for rates with, uh, treasury likely to start upping coupon issuance again, and some of the major sources of demand, um, you know, whether that's Japanese investors due to, uh, uh, hurt currency, hedging costs, you know, China, given what's happening in the currency and banks who are shrinking asset portfolios, you've kind of lost those, those major sources of demand and we see those remaining largely out of the picture. So, um, again, supply and demand, uh, dynamics also serving as somewhat of a headwind here. So, um, overall I think we see, uh, you know, a pretty strong case for, for rates continuing to grind higher, but at this point it's very difficult, um, to position. And one of the reasons why we have fairly low conviction on the outright level of duration right now is that even though, you know, we, we put fairly low probability, especially in comparison, uh, to the probability for, for higher rates, the probability for, uh, a move lower rates we see as fairly low right now.
But if that case does come to pass, uh, the degree to which rates can move in either direction is very skewed. I think the slowdown in the fed's pace this kind of, uh, fear among investors that they're going to miss this big turn in the rate environment. And, you know, we see that kind of manifesting in dip buying and other things. I think that essentially caps how much the sell off can really move. But in the downside, if we do have, you know, some kind of unforeseen event risk, uh, crop up, uh, the degree to which rates could rally is quite sharp. So, you know, higher rates we see a higher probability, but a lower degree of move lower rates, we see a lower probability, but a much greater degree, degree to which rates could move in the downside. And that leaves us, as I said, with, with fairly low conviction on the outright level.
Just real quickly on curve, I think I'm a bit more comfortable saying that the recent steepening at some point, um, seems like it needs to run out of fundamental steam here. Um, notably the re steepening we've had over the last week has, has been a bearish one, and I just see very little economic or policy just justification for that type of move to continue. That is really a, a full on re-acceleration trade in my view. This is in contrast to the, the prior periods of res steepening where, where we've seen the curve and investors try to get in and, and re steepen that curve. Those have generally been in the bullish variety. They've come on events such as SVB where, uh, really what was happening was, uh, markets were seeing a much greater risk of cuts coming, you know, pulling up that cutting path, deepening that cutting path in the near term.
Um, this is much different than that, but like I said, I, I just really don't see the case for either one of those moves right now. I don't see this as being, uh, signs of a, a significant re-acceleration trade, but for this to really switch over to a bullish deepening, which I think would have more legs, you know, without that economic case for a downturn and without those cuts being pulled back forward, there's really no reason for that as well. And with the cutting cycle so far off, I still feel it's, you know, we're still in this kind of flattening environment and at some point this steepening does run outta steam and, and we probably return back to, uh, some of the flat of cycle. With that, uh, I will pause and we will pass it on over to Peter.
Peter Schaffrik:
Thank you, Blake. So the perspective from Europe, um, is roughly as flows. So we, as you mentioned at the very beginning, um, we have seen a noticeable selloff and a breakout of the trading rangers that we had in the Europe market buns were now or out are our trading, um, north of the 2 55, um, level that has capped them for most of the time over the last 10 months. Um, in the uk we've seen a break high of after four 50, which was the high that we've seen, uh, in October, September, October time when we had the minutes budget situation. Now, ironically, this has not been triggered by our domestic data. It has been triggered by the labor market data coming out of the us. In fact, when I look at the underlying data that comes out mainly out of the Euro area, and I'll say something specific about the UK in a second, it has been, um, showing some signs of weakness, um, particularly the survey data, uh, so the survey data, but the PMI or other surveys that show, um, confidence, um, in, um, in businesses and, and consumption has pinged up, um, around q1, um, and in late q2, but has for the last two months or so started to come off the boil.
Now that is particularly true for services, um, because the manufacturing sector has been in the door dumps anyway. So the question that presents itself is we have an environment in which, um, as is everywhere the case, the labor market remains very firm, inflation is coming down, but remains too high for comfort. The central banks remain in a hawkish environment, but the forward looking indicators, um, seem to be turning down a bit. Now, the, the, the one additional, um, caveat, uh, I would say particularly for this survey data is that over the last year or so, it has not been a particularly good, um, um, indicator for where ultimately activity is going, where GDP is going, because it has, um, surprised to the downside when the indicators were on the way up and has, um, surprised the upside when the indicators were on the way down.
So, um, the market I think has quite a few question marks over the reliability of that. And that leaves us in a situation where you have to take the guidance from essentially the central banks and the market is pricing 4% for the ecb. Uh, again, I'll say something more about the UK in a second, and that seems to be a reasonable estimate. It's also our forecast. So we think two more rate hikes are coming over. The next two meetings before pause will set in. I think that leaves us also with a slight drift to the upside, although we haven't seen a follow through, um, after the breakout, um, that we had last week. Uh, but it probably leaves us with a bit of a drift to the upside in yields, just like Blake has just been describing for the us. Now, the one additional caveat I would like to make for the UK is that the UK data generally speaking, has surprised to the upside the market has been pricing a, a very aggressive path for the Bank of England.
Obviously the Bank of England to some degree has obliged the last time around when they hiked 50 basis points. Um, and the market is now pricing a not 100% probability, but a pretty high probability that they would go by 50 basis points again. So what that means is that the monetary policy setting or the um, financial, um, policy setting in the UK appears quite tight. Um, and it is a question mark, um, about the time lags rather than anything, um, that this sping, and this is exactly the discussions that we are having with our clients. Um, about how long does it take in the UK before these relatively high interest rates have an impact on the economy? I think it's fair to say that at this point, um, we haven't really seen the impact yet. And when you look at the, um, surprise indicators, the data has continuously surprised to the upside.
I think that also leaves the UK market with a bit of a bias to upside in yield. Although given that the sheer level that we are already at, um, it's much more harder, I think, than for the Euro market. So I have even less conviction, um, on that for the UK market. Bottom line is we see sometimes some a little bit of weakening in the, uh, in the underlying data. Whether that has any meaningful legs remains to be seen. In the meantime, the central banks remain on a hiking path and remain relatively hawkish. Would you give the market an upside bias in yield terms and we'll have to see whether or not the activity data and particularly the labor market data going forward, we can sufficiently to change that bigger picture. And with that, I'll leave it and hand it back to Blake.
Blake Gwinn:
All right, thanks. Uh, let's go over to Lori for the view from equity space.
Lori Calvasina:
Thanks Blake, and good morning everybody. So I just wanted to share two quick thoughts from a US equity market perspective. Um, take away number one, since the jobs report we've been talking a lot about, and we're gonna get a lot of inbound questions frankly on why the Russell 2000 has been so strong and what we've told people. It's not just the Russell 2000 that's been, you know, showing some good movement. You've actually seen outperformance, the s and p 500 from cyclical sectors like energy materials, industrials and financials. We have seen some underperformance from growth sectors like tech and communication services, but the real underperformers that we've noticed, especially relative to tech, um, have done some of the defensive areas of the market. So on balance, I think the internals are pretty health are pretty healthy. Uh, we're seeing signs of desire to rotate within the equity market, not necessarily, uh, panic about the fed's next move.
And we think that's interesting. Um, just from the perspective of, you know, we've gotten a lot of questions about the breadth in the market recently, how it's been so narrow, does this portend really negative things for equities? And we've told people, you know, if you actually look, when we have very few stocks making new highs on a 52 week basis, you actually do tend to see equities up over the next 12 months. That narrowness is not necessarily, um, a sign that the market is about to crack sometimes that there's a sign that the market is about to rotate. Um, I have actually, just in terms of my own calls, like small caps, I've been overweight them relative to large. We've liked energy, we've been overweight there within the s and p 500, and we actually upgraded financials to overweight this morning within the s and p 500.
So a lot of this price action I'm seeing in the, in the data just makes a lot of sense just based as well on work I do on things like earnings revisions, valuations and flows. Um, I'll move on to takeaway number two. I did wanna flag to the group that this morning we did publish our first RBC global equity analyst survey, which captures the views of our analysts in the us, Europe, Canada, and Australia, um, on a number of different issues, just really basic outlook questions as well as some hot topic, uh, issues as well. Um, we did aggregate our analyst industry views up to gig sector level one details, and we also aggregated them up to regional views. And I would say on balance, that report got me more excited with about the idea of taking on cyclical risk. Um, in terms of some of the main takeaways across the globe, our analysts still did tilt slightly positive in terms of their outlooks for performance over the next six to 12 months.
They also had a slightly positive tilt on valuation, the current state of demand, the impact of artificial intelligence. And it wasn't just tech analysts who felt that. Um, we had a question on company liquidity in the aftermath of the banking crisis. And generally the interpretation of what's going on there was pretty favorable. We had another question on are you seeing evidence of recession pressure in your industry? And generally our analysts were pointing to the lack of that evidence. The only issue our analysts really came out negative on, and these were very, very slight tilts, uh, were margins. Um, and then also just how their own views on the macro and its impact on their industry have shifted in recent months. So frankly, that was closer to flat within the US In terms of sector views across the globe, our analysts were most constructive on healthcare and most negative on consumer staples.
Regionally, their performance outlooks were strongest for Europe, but it is worth noting that the US was seen as the biggest beneficiary of AI and had the had the lowest or best score in terms of perception of recession pressures. Um, there's a lot of meat in this report, too much to run through here. I would urge you to check it out. Um, but I would just say a lot of the sectors when we looked region by region, that jumped out to me in terms of looking good in the eyes of my analysts as well as my own quant work were cyclical in nature. So that was financials in the us which as I mentioned, we upgraded today. Um, also we had, um, uh, sort of a constructive view on financials in Europe and materials in Australia. And that's it for me and I'll pass the call back over to Blake.
Blake Gwinn:
All right, thanks a lot. And lastly, uh, let's head over to Su-Lin for, uh, the anti podium perspective.
Su-Lin Ong:
Thanks, Blake. The Australian bond market has traded pretty poorly since the RBAs steady rate decision last Tuesday. It's broken through some key levels and it's underperformed much of the global fixed income sell off last week. PO positioning may be part of it, but we also think the stop start nature of the RBAs tightening cycle at this juncture is not particularly helpful and it definitely adds to the uncertainty over the likely peak in rates and the timing with core inflation above 6% a labor market that's well beyond full employment with an unemployment rate down at 3.5% rising wages and unit labor costs and annual population growth pushing above 2% policy needs to be a little bit more restrictive. The prudent thing in our view would be to move to a tighter stance sooner rather than later. By dollar block standards, the cash rate is still quite low at 4.1%, we think at least one more hike is likely and the curve can flatten further.
The Aussie curve has broken through some key levels, flirting in negative territory for the first time since the global financial crisis. But by global standards, it still remains pretty steep. It should also lag any global steepening when this global tightening cycle peaks and markets inevitably think about easing for investors looking for duration. Australia is not a bad place to get some exposure. Also in focus in Australia at the moment is who the next R B A governor will be with an announcement by the treasurer expected any day. Now, governor Lowe's term finishes in mid-September, and while there is the possibility of some kind of extension, the odds favor a new governor, the head of the Department of Finance as well as the treasury secretary plus the current deputy governor are all considered front runners with the possibility of an outsider that's not from the official family. Also in the mix, there may be some immediate implications for R B A policy, um, and markets as well. Some potential governors earn more dovish than others. In our view. The current governor still has two more meetings in August and September, and we expect a hike at at least one of these meetings, probably August. Back to you, Blake.
Blake Gwinn:
All right, thanks ly. Uh, and that wraps up, uh, the, the, uh, prepared comments section of our call.
Speaker 8:
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