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.
Simon Deeley:
Hi everyone. Welcome to the latest edition of Macro Minutes titled, Extreme Dependence being recorded at 9:00 AM Eastern on June 13th. I'm your host Simon Deeley. Hiking cycles are extending or restarting later in 2023, that many expected for the BoC and Fed with terminal points heavily dependent on the evolution of data in the near term. The BoE is in a similar boat while the ECB looks set to extend its cycle further developed market economies have generally outperformed in the first half of the year with expected weakness failing to materialize in hard data so far. To provide guidance in this complex environment, we have a strong mix of RBC experts. Blake Gwinn will start off with a look at this week's FOMC after today's cpi report. Cathal Kennedy will discuss views on the BoE and ECB. And I'll give the latest on the BoC following last week's hike and softer jobs data. Adam Cole will join from the FX side, and Adam Jones will provide an update on how credit markets are looking as we approach the halfway point of 2023. Over to Blake to kick things off.
Blake Gwinn:
Thanks, Simon. Yeah, so starting with the Fed, uh, we just got the C P I print this morning. Uh, does not look like there's anything in that report that I think would've forced the fed's hand into hiking at this meeting. So it looks like we are a go for a pause at this meeting. Um, just kind of running through, uh, some of the FMC events. Um, on the rate decision. Like I said, uh, we definitely see a pause there. I think that's mostly a non-event for markets. Um, even this morning post cpi, we've priced out a lot of, uh, that kind of lingering June probability outta the market. So it does look like we're converging on that, um, in market pricing. Um, as far as the statement goes, we don't really expect meaningful changes here. Um, we recall that at the last meeting, they changed the, uh, language around additional policy firming.
Uh, we think what they added there gives them plenty of optionality that they need for the next few meetings. So there's really nothing there that needs to be changed, that that pretty much works into a pause or, um, a skip or, or a restart in July. That language should cover all of it, so I don't think they really need to change that language. Uh, we wouldn't be surprised to see some marginal upgrades to the economic language given, um, where the data's come on in over the inter meeting period. Um, and also, you know, you could potentially see some changes in, uh, the way they talked about the banking sector, uh, risks. So some removal of, uh, this kinda assertion that the banking system sound. But overall, uh, we don't expect major catalysts coming from the statement. Um, I think there is a possibility, um, given the pause, you know, it, it, it's certainly possible that we see a dissent.
Um, cash Kari is a voter. Um, he's certainly somebody who had been supportive of a hike and is definitely on the hawker side, so that is possible as well. But again, I don't think that's a major market mover. Um, but really I think most of the attention around this meeting is going to be on, uh, the update to the s sep dots where people will be focused on the 2023 median. Um, this is kind of a rare setup, um, given that, um, you know, usually we can't tell a lot from the s e p dots aside from September, uh, about the next meeting because it really covers, you know, they only give us the year end forecast, which means it covers all the remaining meetings of the year. Uh, but this, in this instance, um, given that we are, uh, kinda nearing the end of the cycle, should they increase that and show an additional hike, um, I think markets will pretty much take that as a, uh, very strong signal on on the July meeting.
Um, so we'll be looking at that dot if it moves from five and eighth up to five and, uh, 5.375, we would, um, certainly be interpreting that as their expectation, uh, that they would hike in July. I think at this point, that is a pretty strong consensus that it's gonna move up to 5 3 75, um, some possibility that, um, they, you know, they stay at five and an eight, but, um, the way we're looking at it, it really only takes three of the, um, you know, three of the, uh, um, members who were at five and eight last time to increase their dot, to push that median up. Uh, and given that over the inter meeting period, the data has been relatively strong. We got the strong nfp. Um, you know, uh, uh, uh, CPI inflation prints have basically, uh, showed kind of holding in at, um, you know, a level that's probably stronger than the Fed would like.
Um, and also the banking sector risks have have diminished. Um, remember that into that March meeting, uh, we had SVB into the May meeting, we had frc, um, so a lot of banking risks, those last few meetings, those have calmed. Um, so I wouldn't be surprised if three of those, um, you know, at least three participants have moved that dot up to five and three, um, 5.375. Um, a little bit of risk I think as well that, uh, it could move further than that. Um, not something we're expecting, but, uh, I think one of the primary hawkish risks out of this meeting would be them, uh, moving that dot up 50 basis points rather than 25 basis points. Um, that brings us to the Prop Powell Presser. Um, you know, this, this is kind of an odd one because I think, um, with that.giving us so much communication about what's likely to happen in July, uh, it almost kind of diminishes, um, you know, diminishes the importance of Powell's press conference to some degree because there's really not a lot he could tell us, uh, about July.
That's not going to be apparent in those dots. Um, if it moves up 25 basis points, it's a pretty strong signal that the rest of the committee's on board with an additional hike. Um, so if he comes out of as ish, that would be largely ignored. Uh, if he comes out as hawkish, we would've already known that at 2:00 PM uh, when the statement came out and we saw that dot increase. So it, it does take away some of the, the importance from Powell. And I would also say that over the last few meetings, it's been very adept at avoiding saying anything that's particularly market moving. So, um, you know, we, we, we, we expect that most of the price move is, um, is, is likely going to be on those dot releases and not Powell. Um, just really quick with regards to the market risk, uh, with July, you know, now pricing around 20 basis points, I think the main dovish risk is that that dot does stay at five and eight.
Uh, you can see a pretty decent front end rally is that July gets priced out. Um, you know, certain, certainly some, uh, uh, bullish steepening there on the Hawker side, we're looking for the potential of that, um, you know, uh, increase of the dot 2020 three.by 50 basis points. But also, um, you know, we could get some price action on Powell using the word skip. Um, if he describes June, a June pause more as a, a step down and pace or, or, um, you know, kind of signals that July hike is, is imminent. Um, you know, that could certainly add to Hawkishness. I think if there's a lot of focus, um, on the strength of the labor market data or persistence in some of the month over month inflation prints. Um, if he talks a lot about, you know, upside risk to inflation risk management approach, um, or if he kind of gives, um, you know, gives a nod to the fact that these, these concerns around the banking system and credit tightening, uh, have lessened a lot since the last meeting that would all read at slightly hawkish. But again, um, I think that dot moving up is, is really where most of the intent will lie. Um, so with that, I will pass it along. Back to you, Simon.
Simon Deeley:
Great, thanks Blake. Very insightful. Now over to Cathal.
Cathal Kennedy:
Thanks Simon. And, um, thanks Blake. Um, I think kind of, you know, here in Europe, um, you know, sort of once the, um, the, the Fed meeting is over, um, tomorrow, um, we move, um, to, um, having two, um, of our main central bank meeting this weekend next, and the ECBs meeting is this Thursday, and the Bank of England, um, is next Thursday. Now Blake spoke there of the likelihood of the Fed pausing, um, at his meeting this week, but at the top of the call, Simon spoke about sort of central banks, particularly back in Canada and going further, um, in terms of the hiking cycle than was or two expected. I think here in Europe, we're very much in that kind of latter camp, um, with the policy, um, cycle, um, continuing, um, here, um, over the summer, certainly no talk of, um, a pause or consideration of pausing here just yet.
Now with the ECB this week, um, we expect them to deliver another 25 basis point rate hike. Now, we have seen some ECB governing council members, including some of the more hawkish ones, arguing that the, um, ECB might be close with terminal rate. And the reason for that is that inflation has begun to fall in the Euro area and, and fall quite materially. Um, it was down to 6.1% in April, sorry, in May from 7% in April. And more importantly, core inflation is falling, um, and it has fallen in each of the last two months. And those falls are still more modest, um, than the, those in the headline core inflation was 5.3% in May, down from a peak of five, sorry, in May, down a peak of 5.7% in March. But still, you know, moving in the right direction, um, for the, for the ecb, even if it is still, um, too high.
And indeed, sort of know in, in that vein, if you will, president Lagar recently, inflation is too high and is set to remain so for too long. So hence the ECB still on the front foot, if you will, in terms of its inflation fight. Um, and that language from LA Guard is still signaling further tightening. So we see not only a 25 basis point rate hike at this meeting, um, the meeting this week, but also, um, following up another 20 points basis point rate hike, um, for terminal of, um, 3.75% in, um, in, in, in for terminal rail 3.75%. Now, the ECB is unlikely to offer explicit guidance, um, as elsewhere they have become more data dependent, um, at that data dependency will we think be the what word, um, from the, um, press conference. Now, there are, um, new staff forecasts due, um, but we don't think they will be sort of, you know, materially revised from the ones we, we, we, we we already have.
So we're not expecting kind of, you know, a big signal from the start forecast in terms of policy going forward. And one final thing I would flag into, in respect to the ecb, we did have this revised GDP data, um, which showed Euro area experiencing a, a, what we described is the most technical technical recessions, um, over the winter months. But, you know, that is very unlikely to dissuade the ECB from, uh, further tightening, um, in the here and now. Now switching focus to the Bank of England, the bank meeting is next Thursday, but I think it's fair to say that the, the, the data we've had since the last meeting in May has pushed them even further, uh, pushed the bank even further from any consideration, um, of a pause, um, in its, um, hiking, um, cycle. Um, now at the mayor press conference, the, the, the, the bank essentially backed away from, um, providing, um, any kind of firm guidance, but they did say that they were looking at three things in particular.
One was the overall tightness of labor market, two was private sector wage growth, and three was services inflation. Now we'll just take each step and turn. Now, the first, we had new labor market data for the UK this morning, which showed the unemployment rate falling unexpectedly to 3.8% and made continuing strong employment go growth. So hence, you know, whatever evidence we had at liver market is loosening just disappeared in in the release this morning. On the second point, uh, private sector wage growth, um, wage growth in the private sector rolls to 7.6% year on year in the three months to the end of April, um, up, um, from the, from the previous period. Um, so while we, um, while we think that that private sector wage growth will abate in coming months at the moment, momentum is still towards higher pay in the uk. Finally, the third point services inflation.
The last inflation date has showed both services and headline inflation ahead of the bank of England's expectations for the last forecast forecast round. So at the moment in the uk that data flow combined with a length of lack of guidance for the bank has seen the market price in a much more aggressive path for bank rate. Um, over, um, recent weeks we're now pricing between 95 to a hundred basis points of way high covered the next three meetings. And the market is, is actually signaling in that that it is attaining catching a high probability to a 50 basis point rate hike at one of those three meetings. So rather than pausing the market is actually seeing the NPC picking up the pace from here, we will continue to question whether or not solar pricing will actually be realized. Um, but you can see how in the absence of guidance, um, this new data dependent approach, um, can lead to some pronounced market moves.
And we've seen that in the UK over over recent weeks. So in summary, ECB this week, um, expecting 25 basis point ray hike, um, and the future path for the ECB becoming we think somewhat more clear. Um, although we will look to this meeting for a little bit of steer. Um, in terms of kind of the future path of policy for the Bank of England, we are also expecting 25 basis points on its meeting next week. But the policy part for the bank, the policy part from here for the bank now looks a lot more, um, um, uncertain on the back of the latest station. And with that, I'll hand it back to you Simon.
Simon Deeley:
Great, thanks very much Cathal. Um, now switching to Canada. Discussed last time that a 25 basis point hike from the bank was possible after the strong CPI report, uh, with the subsequent firm Q1 G P report and April nowcast increasing that risk. The bank ultimately delivered the 25 basis point hike last week, citing more persistent excess demand and sticky core inflation as increasing their concerns. They had not done enough to get inflation sustainably back at the 2% target. Furthermore, they noted that they're conducting policy on a meeting by meeting basis in the associated economic progress report, refusing to be drawn in on the likelihood of a follow up pike in July. This extreme level of data dependence puts additional attention on the releases leading into the July 12th meeting. Enter last Friday's jobs report with headline weakness. So down 17 [inaudible] uh, in the employment change unemployment rate rising for the first time in, in a while to 5.2%.
Uh, so clear headline weakness, but details much more mixed as the softness was driven by youth and the self-employed while wage growth was still firm, uh, at above 5%. In this report, though other reports are highlighting it as slightly lower than that. So the labor market is, is clearly tight, but whether this report is a head fake or the start of a weakening trend remains to be seen, uh, with one more LFS release this, uh, before, uh, the week before the Bank of Canada meeting, year on year wage growth is likely to soften in that report as the month on month comparison is quite high from June twen 2022. Other key DA data in the intermitting period includes May C P I on June 27th, the April GDP report plus the May now cast on June 30th and the Bo C's own business outlook and consumer expectation surveys also out on June 30th.
BOC communication currently scheduled comes before these releases with a summary of deliberations, their form of the meeting minutes on June 21st and a panel appearance by Deputy Governor Koki at Centra early on June 27th. Ultimately, we expect the situation to remain concerning enough for the bank to hike one more time at the July meeting, but we do think softer data is forthcoming and see that as making the July hike the last one in the cycle, which would end it at 5% with a later endpoint. We have also pushed back the timing of expected cuts from the bank by one quarter to Q2 2012 to to Q2 2024 with 50 basis points per quarter in each of q2, q3, Q4 resulting in a cumulative 150 basis points of cuts next year. And with that, I'll flip it over to Adam Cole to discuss the latest in fx.
Adam Cole:
Thanks Simon. So, um, very clear view on the Fed from Blake and, um, on the ECB from capital, there's a third central bank meeting in G 10 this week, um, on or in the early hours of Friday morning, um, that being the Bank of Japan. So let me spend a couple of minutes on that and what the implications of that might be for the outlook for the yen. So this is the second meeting under new Governor uda and looking at, uh, analysts expectations. Back at the time of the April meeting, there was a very strong expectation that the BOJ would further relax, yield curve control at the meeting this week. That expectation is mostly now being pushed into the July meeting. So there is a very small minority looking for, uh, a change on Friday, but, um, a strong majority looking for a change at the July meeting.
And I think that's probably reasonable as a central case, but um, certainly wouldn't want to rule out, um, the BOJ modifying its yield curve control on Friday. And I think the strongest case for that comes from the fact that the BOJ is no longer, uh, backed into a corner by markets i e the, the 10 year jgb yield is no longer sitting at the upper limit of the yield curve control band at the moment. And in that sense, the BOJ is not being pushed into changing policy by speculative positioning in, um, in jgb futures. So that does leave, I think, um, a, a small but non-zero probability that they do modify yield curve control at this meeting. Um, and the, uh, if they don't then it's probably a sensible expectations that they do in July. The more critical question from, um, an FX market perspective is how important is that and is that, um, the key driver of the outlook for the yen or for Dolly end specifically?
And the answer, uh, I think is that it's less important than many people believe. Um, firstly, because I think J G B yields are probably not far from where they would be, uh, absent yield curve control at the moment. So, um, yields may rise slightly, but with some trading away from the yield curve control ceiling for three months now, um, it does increasingly look like y CCC is a non-binding constraint and the moves will not be large if the band is widened or, or even abolished. And the second reason I think it's of limited importance is as we've talked about before, the real revolution in investment arithmetic for a yen based investor is not so much the few basis points moving jgb yield, but the 500 basis point increase in the cost of hedging a dollar asset, 300 basis point increase in the cost of hedging a Euro asset over the last year.
And the way that has turned the world upside down for a yen based investor. And in our view, the flow associated with that change is not yet mature. We are still in the process of local investors un hedging their foreign asset holdings to reflect the shift in the cost of hedging and the behavior of yen based investors, uh, is not indifferent to Jgb yield, but they have a much bigger issue to deal with in terms of what's happened to the, um, uh, final, the affordability of, of hedging in their foreign asset portfolio unbalance. That means we still think local investors are Dolly n buyers, not to say dolly y wouldn't have a knee-jerk move lower if we were to see yield curve control modified or abolished, but I think for the two reasons I mentioned that would fade relatively quickly and in the longer term, um, the outlook for rates in the US and the Eurozone is more important I think for dollar yen than the outlook for yield curve control from the Bank of Japan. And with that hand back to Simon.
Simon Deeley:
Thank you very much Adam. And now we'll shift over to Adam Jones on the credit side.
Adam Jones:
Uh, yeah, good morning. Um, yeah, credit's been an interesting market recently. You know, we're kind of, we're mid-range on the year in US ig, um, with spreads around 135 pips. Um, but over the last couple of weeks, you know, we, we've seen a reasonable rally, like 10 basis points, which is pretty good, but it's been completely non-uniform. Uh, it's been very much a sort of credit pickers market. You know, I have credits, some credits that are at their 30 day wides, others at their 30 day tights. It's a very kind of unusual complexion. Um, you know, you could say it's just the breadth isn't consistent, um, perhaps similar to what we've seen in equities, uh, but that's definitely made it a bit more challenging to trade. Um, one other theme that we've seen in the rally in IG is that, um, you're definitely seeing better performance in high yield.
So, um, you know, most of the, uh, lower rating sectors are pressing 30 day tights, whereas we're not seeing that consistently across the Triple B and the single A space. And so we're kind of getting some upward pressure just because high yield is sort of squeezing spreads tighter, um, in investment grade. Um, I think now, you know, we're heading into the summer. We've had heavy issuance last month and decent size issuance so far this month. Um, you know, I think over the, over the summer that'll become more of a tailwind because the issuance is outta the way the calendar tends to slow down and then you get that natural reinvestment dynamic that can help, you know, with the inflation data outta the way unless the fed throw a complete curve ball. It does feel like the, the outlook is favorable into the summer, although it's perhaps a bit more of a carry market than necessarily expecting a, um, expecting a giant rally. Um, and that's certainly how people seem to be setting up. I think, you know, the recent movers perhaps caused a lot of people by surprise and, and in turn that's, you know, likely to lead to, you know, further investment in the space. Um, but yeah, broadly that's it.
Simon Deeley:
Great. Thanks very much Adam. And thank you all for listening to the latest macro strategy call.
Speaker 6:
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