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 closures.
Jason Daw:
Hello everyone and welcome to this edition of Macro Minutes called Easing into Easing. I'm Jason Daw, your host for today's call, which we're recording at 9:00 AM Eastern time on February the sixth. The narrative from Central Banks has decidedly shifted from the risk of further tightening to signaling. The next move will be lower. And to paraphrase the message that Powell gave us last week, we have confidence and our confidence has increased that inflation will meet our objective, but we need more confidence before we start to cut. With central banks expecting a soft landing, they're generally easing into the easing cycle. So when will central banks have enough confidence to pull the trigger and where will policy rates ultimately land? To answer these questions and more, I'm joined today by Peter, Cathal, Blake and Su-Lin. I'm going to kick off the discussion today and mention the lay of the land for the Bank of Canada and touch on two topics.
First, the policy rate, the clear message from the Bank of Canada's last meeting was that they are more confident that policy is restrictive enough and that rates would likely be lowered this year, but more time is needed to bring inflation down to 2%. Even with a weak growth trajectory. Core inflation and wage trends have been stubbornly high and argue for patients. It has long been our belief that the Bank of Canada should air on the side of waiting longer and cutting less compared to starting earlier and doing more in the rate cutting cycle. Our base case is for the rate cutting cycle to start in June with greater risk of a delay until July compared to an earlier start in April. The second topic is on QT and funding markets in Canada. Recently, the Bank of Canada has revived a pre pandemic liquidity program to auction off part of the government's cash balance, which may help alleviate pressure on Cora.
This could provide up to 25 billion of more stable liquidity with longer tenors compared to ad hoc overnight repo operations. This does mean that the probability of QT ending at the March meeting is lower than before, but in our opinion, it does not solve the underlying problem. It is our belief that QT is a fundamental cause of funding market pressures, so providing a liquidity offset is just a bandaid solution. Ending QT sooner rather than later is still advisable from our perspective. Moving on. Last week we heard from Powell along with a strong employment report in the us So Blake, what's your take and view going forward?
Blake Gwinn:
Yeah, thanks Jason. I mean there is a ton that we could talk about on the US side this week we had another quarterly refunding announcement from treasury. The FMC Powell showed up on 60 minutes on Sunday. We had the flare up of some banking fears last week and also amongst all that, some very strong data including N-F-P-I-S-M services and I might also tack on the fact that the Atlanta Fed's GDP tracker was upgraded from 3.0% of 4.2% last week, but we're largely going to skip over the quarterly refunding and the banking fears. I think both were relatively benign because it's a pretty short podcast, but if you want deeper dives on either issue, we did do some analysis on those. So please reach out to your RBC sales contact and we can get that in front of you if you're interested. I'm going to focus a little bit more on the FMC and Powell in the context of the recent data prints that includes last week's very strong NNP and also Monday's ISM services prints where we saw beats on every component, specifically prices index, which had the largest monthly increase that we've seen since August, 2012.
Starting with FMC, the big takeaway was Powell's pushback on a March cut. I think there was still some lingering view coming out of that FMC meeting that maybe Powell said that accidentally or that some type of mistake. It came late in the press conference during the q and a portion, but anybody who viewed that as accidental, that view was crushed when he basically repeated those comments on Sunday 60 minutes saying there really wasn't their base case, they were going to be in a place where they felt comfortable cutting by that March meeting. Combined with the strong data that I just mentioned with some supply weighing on things Friday and Monday, I saw the largest two day selloff in yields, and that's true essentially across the curve since June of 2022. So very big reaction in markets to that. The other big change there was that what we're seeing priced in for the Fed as far as the cutting cycle basically took out 35 basis points of cuts from peak to trough, and we really don't know how much that would've been without the renewed banking fears that we've mentioned last week, which probably moved a little bit in the other direction as longtime listeners will know.
Our base case is long been for 5 25 basis point cuts in 24 starting in June, and then quarterly cuts in 2025 until the Fed reaches about a 3 25, 3 50 range in 2025. But our confidence in that call, at least what happens beyond that first cut in June is definitely starting to wane a bit. I think it's because the landing really seems to be shaping up even softer than we had envisioned 2, 3, 4 months ago when we put that call into our year ahead outlook. I think the risk that the Fed actually does move as slowly as they're telling us, at least if we go by the median SEP dots or that they stop cutting short of 3 25, 3 50 range that we're calling for, and I think it's currently priced to the market, those risks are certainly growing. If you'd asked me a month ago what fair value for 2024 pricing is, I probably would've told you that it's for more cuts than the five embedded in a protocol because it incorporates some kind of downside hard landing risk.
Now, I think that fair value for 2024 is probably closer to four cuts or even three. That's not our call that it's just that the risks are certainly skewed towards a slower pace of cuts or higher terminal rate. I think that also means that the likelihood of a meaningful steepening around the time of the first cut, which we were forecasting some continued steepening throughout the year, I think that also is coming off a bit. To be very clear, I think the Fed still can and will start cutting slowing inflation alone and that they're going to do so by June. But I think that without that weakness on the other side of the mandate, as long as growth of labor are made strong, the urgency to go every meeting or to kind of set rates on an autopilot path towards 3 25, 3 50 range really may not be there. And I think that's especially true if you believe that neutral rate is higher, which has been a topic we've seen pop up from a few fed speakers after the F Om C meeting. I think that might've been a topical neutral race, might've been a beautiful topic of conversation at the FMC meeting and given how the economy has been performing and continuing to perform with fed funds rate above those kind of neutral levels for over a year now is a very legitimate debate. So I'll leave it there and pass it along.
Jason Daw:
Thanks a lot, Blake. The market is pricing a similar path for the ECB compared to the Fed. So next up is Peter to tell us if this makes sense.
Peter Schaffrik:
I'll try to take it from where Blake left off. He just said that the risks are probably skewed towards maybe later or less, given what the Fed is saying. But what we see and hear from the ECB is almost the opposite. One typically would expect that the Fed to be more nimble and move before the ECB, but in the last ECP meeting, I would suggest that the rhetoric from the ECB has shifted quite meaningfully indicating or indicating maybe too strong a word, but opening the door for an earlier cut. So how did they do that? Whereas previously what they have always said is that they need to be, and to paraphrase Powell again, be more confident, but one of the things that they have always quoted as key data to bolster their confidence is wage data and the data that they previously had or were pointing out was always the one that would come out only after the meeting in April.
Now what they've now said is that they have in-house data that they can rely on and that this in-house data is already showing some kind of weakness and what we think it's definitely too early to expect a rate cut at the March meeting. We have changed our call to June as the first cut. It is clearly possible that April could be the time when the ECB will start pulling the trigger, which would then probably be before most other central banks do. So now I would hasten to add that the activity data and the forward-looking activity data such as survey data have been coming out decently. They've been coming out slightly stronger. They're indicating that the economy which has not been growing or mostly not been growing at all is bottoming out, but nevertheless, with inflation having underperformed the ECBs target and that gives them some cover to do something. Now, just to wrap up, our official call remains now for a June start with probably a smaller path to lower rates or a slower path to lower rates than the market is currently pricing. But clearly the risks have increased that the ECB would start earlier than that's June point. And with that I'll probably leave it and hand it back to you.
Jason Daw:
Okay, excellent insights, Peter. Now over to Cathal on the Bank of England
Cathal Kennedy:
As Peter there just contrasted the ECB with the Federal Reserve. Similarly, I think there's kind of an interesting contrast between the ECB and the Bank of England. Now heading into the bank's meeting last week, coming after the ECB, the focus was really on how the MPC would evolve as language evolve with its rhetoric. At the meeting now in advance, ROV was they had a relatively difficult communication strategy to try to pull off. In the event they did change the language quite significantly. In particular, the hiking bias that was previously there was dropped in the guidance and they did. They actually went further than we thought they wouldn't advance. They also dropped the reference to bank ratio needing to be held sufficiently restrictive for sufficiently long. So reflecting that new rhetoric from the bank, we also changed our Bank of England call pulling forward where we see the first rate cut from the bank into August.
One major difference between ECB and the bank is that the MPC stopped some way short of the ECB. So while the rhetoric last week, if you will, held out the possibility of rate cuts being the next step for bank policy, the MPC also tempered any idea that those cuts might be in some way imminent. Now, that was Spike New Forecast published alongside the region, which was short inflation falling back target in the middle of this year. Instead, the A PC said they would keep under review how long rates would need to be held restrictive for. So I think the most obvious thing for us is the Bank of England, the NPC, still much more cautious than the ECB that reflects still elevated measures of domestic inflation, that the bank is still dealing with. Wage growth and services inflation have come down, but are still at levels at which the NPC can't really feel comfortable with both wage growth and services inflation peaked higher in the UK than in the Euro area.
And now coming down somewhat more slowly down there, it also reflects the split in the MPC. We now have a three-way split amongst the nine member committee. One vote for a cut, but still two votes for a rate hike. Whereas the debate in the ECB is more over the timing of the first cut. The MPC is still split as to whether rates need to go up or now. Peter also said that there was no fundamental change in the outlook for the economy behind our change of call. And similar in the case of the bank, indeed the Bank of England actually revised their forecast for UK growth up. And the other thing I think as well that's supports a later start for the bank is that labor market in the UK remains tight. Indeed. Just yesterday we had new estimates from the Office of National Statistics, which showed the unemployment rate actually falling in the second half of this year. A little bit of a surprise given the problems we had with the Labor Force survey here since July of last year. I think overall, bringing forward our Bank of England rate cut in view of the change rhetoric from the bank, but at the same time, we think the data broadly supporting the view that the Bank of England will begin to cut rates later rather than sooner.
Jason Daw:
Thank you very much, Cathal. Last but not least, we're going to hear from Su-Lin on what she thinks about the RBA.
Su-Lin:
Thanks Jason. It's been a big week for the Reserve Bank board. It met for the first time this year. It's released an updated set of macro forecasts and its quarterly statement on monetary policy, and the governor did her first press conference for us. There's been three key takeaways from the raft of communication this week. Firstly, while the cash rate was left unchanged at 4 35, a tightening bias has been retained. The bank notes that a further increase in interest rates cannot be ruled out. It's resisted moving to a clear neutral bias in line with a number of its counterparts, but we think this tightening bias is pretty weak given the downward revisions to its GDP and inflation forecasts and upward revisions to their unemployment rate forecasts. Core inflation is now expected to return more comfortably to within target in 2025 and around the midpoint by mid 26.
Secondly, despite the revisions, the raft of communication this week was largely around inflation and the outlook. The bank's language is cautious similar to other central banks. It's encouraged by the progress, but inflation's still above targets. So the sector inflation's elevated, they're worried about inflationary expectation, and there's a long list of uncertainties about the outlook. There's also some new discussion around the output gap and excess demand and a discussion as well about a pretty tight labor market and all of that permeated much of the RBAs language this week. And thirdly, we suspect the mild tightening bias is partly designed to temper market expectations of any near term cuts to ensure financial conditions remain restrictive and continue to weaken demand. On that note, the governor's reference to the US Fed being in a different position to the RBA we thought was noteworthy. So all of that communication looks consistent with our base case that the RBA will likely lag the dollar block easing cycle, and it'll be a more shallow cycle given that policy settings at 4 35 are only mildly restrictive and well below the rest of the dollar block.
We've put 2 25 basis point cuts back into our RBA profile in the fourth quarter of this year, kicking off in November, given the mark shift in the global central banking narrative. But this is well after when we expect cuts from the Fed Bank of Canada, ECB, and Bank of England. We look for another 50 basis points of easing in the first half of next year, taking terminal to 3 35 by mid 2025. So from a rates perspective, we prefer to look for opportunities to fade market pricing of cuts in the first half of this year, and when there's much more than three cuts priced in for 2024, we also think 10 year Aussie yields at near flat to the US is too tight. The RBA is prepared to be more patient than markets expect.
Jason Daw:
Okay, thank you, Su-Lin. Great stuff. Thank you to our listeners for tuning into this edition of Macro Minutes. Monetary policy expectations has been the key driver of bond yields and curve shape, and central bank expectations are going to remain fluid this year. So please reach out to your sales representative or us directly for further insights.
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