Speaker 1:
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:
Hi everyone. Welcome to the October 24th edition of Macro Minutes, which I'm calling Finding Footing Global Yield Curves have generally been moving higher and steeper since our last call, despite new geopolitical risks and a dovish tilt in recent central bank rhetoric, at least here in the US for the last few sessions, there may have been some very nation signs that the momentum may be starting to waver a bit. So can bonds find some solid ground to stand on here or do they still have further to fall? So I'm Blake Wynn, head of US Rate Strategy. I'm going to be joined today by Jason Dahl, head of North American Rate Strategy, Euro area economist, Gordon Scott and macro rate strategist Robert Thompson. First of I'll kick off speaking briefly about the US and first I wanted to address the FMC meeting that's coming up next week. I think that that meeting should be relatively tame.
I think Powell and other speakers over the last few weeks have signaled a very clear preference for a pause and markets are essentially priced for that Now. We also, if you remember, do not have any SEP dots at this meeting. So I think most of the focus is probably going to be on PAL discussion around rise and rates and financial conditions. And I think there might be some focus on any verbal updating or confirmation of the September dot plot. To the extent that he does talk about that. Recall that the September dots still showed another hike this year, which as of the November meeting, assuming a pause would have to be that December meeting. Our view however remains that July was the last hike in this cycle. There's also over the last few weeks been a lot of focus on the rising term premium. Mostly given the bare steepening that we've had and the fact that after the September FOMC rates have continued to sell off, even though FOMC pricing for the Fed over the near term has remained very, very little change on that.
This conversation about term premiums mostly come in the context of both supply. We know there's lots of treasury issuance coming down the pipe. We've got treasury refunding announcement next week where they're expected to once again raise coupon auctions and the context of demand where we have the Fed pulling back as they complete their quantitative tightening program YCC relaxation from the Bank of Japan. Well-known this very well-publicized story about demand out in Japan and China where they basically remain offline for buying treasuries and banks shrinking asset portfolios, et cetera. Interestingly, I think we may have entered a bit of a different phase of this term premium story where I think further rises in term premium might be coming more from upside growth and inflation risks rather than this kind of supply and demand story that's basically that would basically come to pass or continue if the data remains strong while the Fed seems very, very axed to stay put and not hype rates.
Again, I think we saw a microcosm of this in the response to Powell speech last week where dovish message was met with bear steepening rather than the bull steepening you might expect on dovish SP speech. I think that's largely because that speech came on the back of strong retail sales, which itself was following strong CPI and strong NFP data. If you kind of sum that all up, I think from a very simple level, good data plus a fed resolutely on pause basically equals upside risk to gross and inflation, which could continue to show up as higher term premium. But I think all of that is really more upside risk to term premium at this point. At a higher level, I think the supply and demand impact should largely be priced at this point with the risks around that factor being much more two-way from here, we're likely to see some continued flow effects as this new supply continues to come online over the coming years.
I think after some very significant growing pains over this last year, investors and the street broadly their deficit and issuance forecast shouldn't really be playing catch up as much. I think we really right-sized those after some major upward revisions over the last year. Moreover, I think a lot of these downside demand concerns that I was mentioning before with overseas demand, particularly out of Japan and China banks shrink asset portfolio et cetera, that's all extremely well socialized and I think broadly expected to continue, which to me really means that the risk may be more skewed to the upside now if we do see demand from overseas start to pick up or if we see any kind of developments which start to move that in the other direction. Moreover, I think what many seem to be using the term term premium very interchangeably with supply issues, it's actually worth noting that supply issues on the long run are not really a great explainer for sustained moves in term premium.
If you look at the long run declines in term premium that's been going on since the both years in the seventies, I think it's been driven a lot by other factors such as central bank transparency and credibility, regulatory changes, demographics, growth in global demand for reserve assets, other things like this. If you look at those factors, very few of those are likely to reverse from here. So really the only kind of bump you get in term premium is from the supply and demand story, which as I said tends to be very temporary. So I don't really expect term premium to be returning to say pre GFC levels and think we may be closer to the end of that story than the beginning. Overall though, still pretty neutral on duration curve right now. I think there's just a lot of chop in the markets right now.
There's very crowded positioning which kind of spooks me and shorts and deepeners. We've got this whole kind of back and forth between strong data, looming geopolitical risks and dovish fed. I think overall the market just seems very antsy and without strong conviction. I think you just have to look at yesterday's yesterday's session where we saw a major reaction to an offhand tweet by a large investor. I don't think you get that kind of reaction to something so minor unless markets are very, very jittery. I think more medium to horizon, we're still expecting data to slow a bit into year end, not something very bad or a significant turn in the data, but at least what I would consider some continued normalization and enough to pull yields back down towards the bottom of this new higher range that we seem to be in. So there, let me go ahead and turn it over to Jason. We'll talk a little bit more about the Canada side.
Jason Daw:
Okay, great, thanks Blake. So today I'm going to dedicate my time discussing the Bank of Canada outlook, what they'll do tomorrow, what surprises to look out for in the statement and MPR and what is expected after the October 25th meeting. So our view since the last hike in July was that the bank would be on hold until they started an easing cycle in the second half of 2024. And over the past week, market pricing has moved from a 50 50 chance of a hike to now pricing a no change outcome. That's consistent with our long held view. In our opinion, it's been clear that the Bank of Canada doesn't want to hike anymore unless they're absolutely forced to. And the evolution of data that we've seen over the past couple of months below trend growth. For example, loosening in the labor market, no smoking gun from the recent business outlook survey and a favorable CPI print on sequential core measures does provide enough room for the bank to stay on the sidelines.
We think then the question becomes what will the policy language be and where could the surprises be? So in the policy statement they should retain optionality to hike further, even if they think it's a low probability outcome, there's absolutely no incentive for them to remove or alter the phrase that more hikes might be needed. And if anything they could bolster their hawkish rhetoric by complimenting the risk of more hikes with a discussion about hire for longer now the Bank of Canada Growth Forecast, they have been optimistic they should be revised of materially lower in the MPR. The biggest downward adjustment should be Q three followed by downward adjustments to Q four and that would have a knock on impact to 2024 as far as lowering that on the inflation side, they could be revised up in the short term, the forecast from the bank but sticking in the long term.
So we think the endpoint for 2024 probably stays unchanged. If the Bank of Canada does not hike tomorrow on October 25th, we think the window of opportunity for them to hike again is effectively closed. And the reason for that is that our economists think that Q three prints a small negative for GDPQ two already printed a small negative. So optic is going to be challenging also from a political angle for them to do anything in December or January. And the reason for that is one can a vision the media headlines, we get the GDP data in early December. The bank meeting is later in December. The headlines are going to be Canada's in a recession possibly, even though it's a small one and it's very technical in nature, that's going to be the spin from the media and that really will make it difficult for the bank to do anything.
So the only reason they could hike going forward, if we get a big balance in growth, which we think is quite unlikely, or that price pressures would have to escalate quite materially to tilt the balance towards them going again, I do think that sticky inflation is probably insufficient. We need to get price pressures increasing. And lastly, I wanted to highlight the insights from our central bank AI site product and this automatically reads and quantifies and scores central bank communication into a hawkish and doubler spectrum. And the bank's overall stance on this metric does remain quite hawkish, but the degree of hawkishness is less than what we saw six to 12 months ago. And this is consistent with our qualitative view that the bank will retain a hawkish stance, but the nuance of their communications is tilting towards more neutral given what's happening on the growth side. And since the last meeting on September 6th, the quantitative scoring has been broadly unchanged and this has been more consistent historically with a no change outcome at the next policy meeting. And with that, I'll turn it back over to Blake.
Blake Gwinn:
Thanks for that Jason. And also thank you very much for highlighting our new central bank AI site tool. Please check that out or ask us if you have any interest. With that, let's go over to Gordon and talk Europe.
Gordon Scott:
Thanks Blake. Similar to the picture outlined earlier by both Jason and Blake, the focus in Europe at present is on central banks on hold. Over the next week and a bit we'll get two central bank meetings in Europe starting this week with Thursday's ECB meeting. Now we expect the ECB to keep rates unchanged at their current level of 4%. The ECBs forward guidance has made it pretty clear that they think that they've now reached and the terminal rate and data and since the last meeting has really done little to shake that impression. Core inflation for example, is tracking slightly below the ECBs projections while the leading indicators for growth also continue to remain weak. Instead, the debate within the governing council is shifting to QT and measures to address excess liquidity in particular within the governing council. At present, there's been quite a vigorous debate over the potential early end of reinvestments of maturing securities from the ECBs emergency Pandemic era purchase program.
There's also as well a debate in the governing council around the possibility of tweaks to banks reserve requirements. Now we don't expect any of these changes to be announced at this month's meeting, but we think it's likely to be an area of discussion and certainly something that is likely to feature in both the post-meeting press conference and the subsequent meeting minutes. Looking slightly further ahead, the focus next week we'll move to the Bank of England. Now before the September meeting, we thought that it was likely a case of one and done in terms of rate hikes. Now the Bank of England unexpectedly opted to keep rates on hold as its last meeting and we now think it's a case of none and done IE. We expect the Bank of England to keep rates unchanged at a current level 5.25%. Indeed we think that the bar is likely quite high for the Bank of England to revert to rate hikes again and we think that you would need potentially quite big upward surprises in the data for it to do so. And with that I'll pass back to Blake.
Blake Gwinn:
Alright, thanks a lot for that. And finally we will jump over to macro strategist Robert Thompson.
Robert Thompson:
Thanks Blake. We're a slightly different approach in Australia to working out where yields can or should get to and in particular in benchmark tenure space, we really are a hostage to what treasuries are doing where we essentially price as a spread to them. So it's a bit, it's a cop out, but it's entirely true to say that where Aussie yields can get to at least from the belly up, is almost entirely dependent upon the price of money in the US at the moment. Further down the curve it's more aligned with RBA expectations, so there is some more independence there. We have some views there we can outline as well, but we're coming to the curve. It leaves the curve as a bit of a residual in that sense so it can have some quite different shapes to elsewhere in the world. And indeed at the moment, given the RBAs cash rate is only 4.1% versus five plus for most dollar block type peers, it's leading to quite a steep curve in Australia.
But just focusing once more on that Aussie US spread dynamic at the moment, just to set the scene a bit, so that spread's been in a plus 30, minus 30 range since about September, 2022 with no clear catalyst for breakout. We tend to think that Aussie should actually underperform a little on the breakeven side given the RBA cash rate is so much lower. We talked about that a couple of weeks ago in this call, but in reality it seems at the moment the price is more being determined by the real yield spread, which has probably got some supply drivers there with Aussies bond supply quite low versus obviously much higher in treasuries and that's keeping that spread on the negative side. But like I said, in the broader scheme of yields, we really are just being led by the US moves there. So wherever treasuries get to is very roughly about where Aussie yields should be at the moment in 10 year space.
Then further down at the front of the curve, we do have a very key inflation print coming up on our time Wednesday, which will set the scene for the RBAs November decision. And there we think the market which is pricing in about a 30% chance of a high right now and was as high as 40% yesterday is if anything slightly overplaying the chances of a hike. There's been nothing in the data run so far since the last meeting to suggest the RBA needs to hike. We know they don't really want to hike again despite them being so far below most peers. So we suspect the hurdles high for CPI, it's going to have to be a pretty big beat for them to be convinced that they need to hike again at this meeting. Certainly doesn't relate the chance of hikes later, including into next year, but that means in the short term we actually see some potential for Aussie app performance.
So yields a bit lower in the very front end here, but the back in a different story. So that's our sort of views on the curve for now. We just have to reemphasize that broadly speaking, the globe sets the price for us rather than Australia specifically, especially from the belly up. But yet the front end that we do think that although the risks are that there might need to hike again a little bit later and indeed we think the IBA will be cutting quite a lot later than other central banks. There might be some short-term tactical opportunities as to run in long. Thanks. That's it for me.
Blake Gwinn:
Alright, thanks for that Robert. And with that we will wrap up this October 24th edition of macro minutes. Thanks for dialing in.
Speaker 7:
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