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 and financial markets and the global economy. Please listen to the end of this recording for important disclosures.
Jason:
Hi everyone, and welcome to the September 13th edition of Macro Minutes that we called Full Throttle. So central banks are clearly in full inflation-fighting mode and have been engaged in delivering outsized rate increases over multiple meetings, and their job isn't over. And more policy tightening should be forthcoming over the next few months.
In today's discussion, you'll hear about our views on monetary policy yields and other topics from myself on Canada, Blake on the US, Peter on the UK and Europe, Gordon on Australia, and Adam Cole and Adam Jones will tell us about what this means for FX and US credit respectively.
I'm going to kick off the call today with an update on Canada. So last week the BOC delivered a hawkish hike, which is exactly what they should have done. And the policy statement was short and sweet; there was no room for misinterpretation and it sent a very clear message that inflation remains the bogeyman and that the policy cycle is not over their communications.
They've been on point the last few months. Again, very clear message, not muddying the waters as far as discussing the growth outlook all that much. The policy rate currently at three and a quarter percent is now just slightly in restrictive territory based on the Bank of Canada's two to 3% neutral range. And their recent guidance did indicate that policy needs to become more restrictive in the near term. So we do think that the BOC is going to try to engineer a steady step down path. So we think 50 basis points in October and 25 basis points in December, that would bring the policy rate to 4%. That's our base case scenario now but the size of the move in October, whether it's 25 or 50, right now, the markets are gravitating more towards 50, similar to our view... Actually, are able to deliver another hike in December is going to be dependent on how quickly excess demand is eroded and how quickly core inflation shows signs of peaking.
The OIS market in Canada right now, pricing in the terminal rate between three and three quarters and 4%, which seems broadly fair to us and is not really worthy of any high conviction trades at this point. Aside from the inflation data, which is obviously the primary focus, activity and employment data before the next meeting on October 26th is going to be stuff to keep an eye on, but we do think the October MPR will be a key event for the Canadian market, whether October ultimately marks the last hike in the cycle or whether that meeting sets up the market for December to be the end game. The messaging in October will need to be highly nuanced in our opinion. It's going to have to indicate a conditional pause, a conditional end to assess the impact of past policy moves that the skew is to tighten more later or that rates will need to stay elevated for longer in order to dissuade the market from pricing in near or medium-term rate cuts.
As far as what this means for bond yields, we think the two year will be dragged higher as policy rates are increased further but the belly to long end of the curve should remain fairly well anchored. So obviously 5, 10, 30s they could bounce around but we do think a situation where there's a structural steepening move is really probably a 2023 story.
We think two tens, which is currently around minus 45 basis points could get as inverted as minus 70 and twos fives currently at minus 35 could possibly reach minus 55. And just on a closing note, generally, history has been unkind to those that attempt steeper before a rate-tightening cycle is over. With that, over to Blake on the Fed call and views on the treasury market.
Blake:
Yeah, thanks, Jason. So obviously, today the attention in the US is all going to be on the PI print. I think CORE is really now the more important focus. Consensus right now is for a 0.3% month-over-month. Our own forecast is for a very high 0.2%, meaning you're just kind of missing out on that rounding up by a couple small points. Headline a lot less relevant given some of the recent energy moves, I think that's pretty well backed by markets. They're largely going to look through any kind of big misses or beats on headline, really focusing on that CORE number.
Given kind of where our forecast is, where consensus is, I think that 0.2 to 0.3 range month-over-month is likely in the range of kind of a Goldilocks outcome. I think on the downside, you know get down to a 0.1 or even a low 0.2, I think you probably extend the rally that's already in progress this morning, maybe some slight little steepening flavor to that.
But I think the bar's really pushing September FOMC back down towards 50 basis points in the market is actually quite high. On the other side, it beat almost certainly going to prompt some return-to-bear flattening. I think a lean of markets coming into this is to continue to sell off, so it wouldn't take much there on the high side to kind of reverse today's rally and get back towards yields grinding higher, particularly in the front end and belly.
For September, FOMC can be expected given the comments I just mentioned, the run of relatively positive activity data in the US, some of the easing and financial conditions we've seen since the July FOMC Meeting. And I would say lastly the article that Nick Timiraos of the journal posted last week suggesting 75 basis points was a possibility at the step FOMC meeting and recall that he was the one that wrote the article back in June during the blackout period that completely rearranged market expectations heading into that meeting.
I'm sure he came out with another suggesting 75 basis points. Now all those things have gotten the market to a very strong base case. The 75 basis points is going to be to move at the September meeting. After that, we expect to downshift the 50 basis points in 25 at November, December, and then from there out into 2023, I think further 25 basis point hikes are going to be highly data-dependent. They're going to need either some type of retrenchment inflation data or even just kind of a lack of deterioration and labor data and the labor market continuing to rumble along to keep getting those additional 25 basis points.
But we don't currently have that penciled in, even beyond that as we go out into the second half of 2023, either the Fed has been relatively successful and pushing some of that cut pricing out but we find that pricing relatively fair in the ballpark of one to two cuts in the second half of 2023.
Despite the Fed's kind of insistence that they're going to keep rates high after reaching that terminal rate, we think these are really based entirely on trying to keep financial conditions tight, keep them from kind of slipping to easier stance as they did earlier this summer. They're trying to jawbone that up with this communication about leaving rates high, but when it really comes down to it, this is not going to be something that they view as a commitment in the face of a slowing economy, so if we do get that kind of slow down in 2023 that we expect, despite what they're the Fed is telling us now, there's no reason that we should expect that we wouldn't see cuts in the second half of the year. So that pricing there is relatively fine in the kind of one to two-cut region.
So where does that kind of leave our forecast? We've moved up from 50 to 75 base case for September but we've also seen a very modest horizon in our modal terminal expectations, which we now see settling in at 3.75, 4% by the end of this year and for now, kind of staying there into the first half of next year, but with a very low bar to adding in some additional 25s if the data will allow it. Along with some of the marking-to-market with the sell off we've seen over the last few weeks, we've also revised our year-end rate forecast higher. We now think markets are set to kind of end the year with tens around 3% and two's tens pushing further flatter and kind of inverting down to that negative 55-basis-point level by year end and remaining significantly inverted until we kind of start approaching that cutting cycle that we just described in late 2023. And I'll leave it there and pass it along.
Jason:
Okay. Thanks a lot, Blake. Next up is Peter to discuss all the fascinating developments in the UK or Europe.
Peter:
So what I want to discuss first of all is the ECB. Secondly, the latest development in terms of price caps for energy and then the potential path going forward in our trades. So first of all, last week we had the ECB meeting and I think suffice to say it was relatively on the hawkish side. I mean obviously, the first thing that they did is hike rates by 75 basis points rather than 50, so the second time in a row that they've been surprising the market on the hawkish side.
Secondly, however, was previously the ECB was guiding to get rates in the terminal rate to neutral without being drawn into the debate what neutral is, but it was generally understood to be around 150. Lagarde has now said... She has danced around the issue and has now said that they want to continue hiking multiple times, and she said it's not going to be two, it's not going to be five, so let's say somewhere in between and the rate hikes are probably going to be of a larger proportion. So if you just do the math from where we are currently from the 75 and [inaudible 00:10:12] rate, that brings you well north of the previous assumption of neutral of 150.
We have changed our call. We now think that the ECBs going to high 75 basis points again and we'll bring the terminal rate to 250. So that's higher from where we previously see, and slightly higher with the market [inaudible 00:10:29] currently about 225 and 230.
Now the other thing that the ECB surprised about however was that they have said that a debate about QT is going to start fairly soon. So she had said that in the Q&A when she was asked both about the outstanding repos, the RTROs as well as about the bond portfolios.
So nothing has been decided yet but you can clearly see how nervous the ECB is about the liquidity that's been created because they started to remunerate government holdings which amount to about 500 billion. They're basically parked with the ECB in order to prevent them from being placed in the open market if they were continuing to remunerate them at zero. And they give the explanation that they don't want further dislocations in the funding market. So you can clearly see that this is a topic that is irking them, and I propose that this will be at the next or the latest at the December meeting become a very live issue. So QT will be a theme here.
Now the second topic I want to discuss quickly is that we are now seeing quite significant interventions, fiscal interventions as regards to energy situation and there's a clear distinction, at least up to now what the continental Europeans are doing, what the UK is doing, whereas the continental Europeans are basically giving money to needy households to supplement income, the UK is now moving to instigated price cap.
Now that has different implications for the path of inflation and since that was announced by the UK, we've seen sort of the upwards drift on SONIA's pause to some degree. We have put a trade out on the bank of the ECB and that development that we have recommended to close, first of all the trade that we had previously where we will receive euros against SONIA and we have recommended to close it and reverse it but also bring it down the curve where we now recommend selling June 23 EURO rivals against SONIA futures against the backdrop that we think the terminal rate in the Euro market is probably higher than what's priced and again, on the backdrop of the price cap can come down a little bit in the SONIAs.
And last but not least, I recommend staying attuned, if you are interested in the European markets, what the interventions of future interventions in the gas market in particular but the electricity market will bring because this is a moving target at the moment and could well be but also the Europeans are trying to implement price caps that's at least sort of the latest chat that it's going around, but there's no clear decision has been taken yet. And with that, I'll hand it back to Jason.
Jason:
Okay. Thanks a lot, Peter. Next up is Gordon to tell us about the RBA.
Adam:
Thanks, Jason. So there are a couple of things I'd like to talk about today. So firstly, changes to our RBA call, and then secondly, why we think terminal in Australia is likely to peak lower than in the other dollar bloc countries. So firstly, for those who aren't necessarily following the Australian market so closely, the RBA voted to raise rate 50 base points at its meeting this month, taking rates to 235. And that however wasn't the only significant RBA event this month. Governor Lowe gave a speech later in the month to the Anika Foundation which was actually extremely significant. So firstly, he noticed that rates are now in the neutral band and he also observed that the RBA has been raising rates quickly. But more importantly, he said that given this, the RBA's likely to slow the pace of rate hikes going forward.
Now for some time we've had the RBA stepping down from its current pace of 50 basis point hikes to 25 basis points in October. And we really kind of take that as further evidence in favor of our view. So we retain a step down to 25 basis points in October, another 25 basis points in November but we've also added in a 25 basis points final hike in December, basically marking to market obviously this global shift towards needing to take policy further into restrictive territory. So that means we now have terminal at 310. And that's obviously a way below both what we expect for the other dollar... RBC expects for the other dollar block countries and what the market is pricing as well. And we think there are really a number of reasons why terminal is likely terminal is likely to be lower in Australia than in Canada, New Zealand and the US.
So firstly, Governor Lowe himself highlighted facts that wage pressures are less pronounced in Australia than elsewhere and explicitly use that as justification for why the RBA could slow the pace of hikes while other countries are either increasing or maintaining the pace of hikes. Now we've placed less weight on this wage growth argument but it is nonetheless a fact of feeding into the RBA's decision.
What we would probably placed most emphasis on is the quicker transmission of monetary policy and relative to the other developed economies and particularly through the housing market and where you have the kind of normal mortgage structure is variable rate and then potentially extending at most out three years. And so considerably shorter duration than elsewhere, implying quicker transmission and hence less need to go as hard as in other advanced economies. Now the market's very much latched on to Lowe's comments about slowing the pace of rate hikes. The Aussie-US one year, one year is now collapsed to about flat Aussie US at 10-year spread is down at 25 base points. We wouldn't necessarily recommend chasing these moves at these levels but we think it's something that's interesting to monitor going forward potentially where we could see a widening in those spreads. I think it's definitely something that's worth keeping an eye on given the likely lower terminal in Australia than in other advanced economies. And with that I'll pass it on to Adam next.
Jason:
Okay, thanks a lot Gordon. Over to Adam on the FX side. Thanks.
Adam:
Okay, thank you. So we've had another month of extremely strong dollar gains into the end of last week and obviously, a lot of central bank view changes to take on board. Where are we in terms of the FX views? Well, we also have a new forecast deck out at the end of last week, and there is a bit of a contrast between our tactical and our strategic views on FX.
Tactically, we are fading the dollar value for the last month and think it has further to correct lower from here. So in terms of specific recommendations, we put out a long euro-dollar recommendation yesterday, and that's our preferred way of playing a pullback in the dollar rally. The move-up over the last month, once again was a reflection primarily of the interaction of asset markets and the fact that we had a month or four straight weeks of losing trends in both bonds and equities, which as we've said many times before, tends to be associated with across aboard dollar gains.
If we are reaching something of a top in terms of pressure from fixed income markets here, then there is a little bit more to go for in terms of near-term dollar weakness. And again, it ties in with being fully priced for the 75 basis point next week, fully priced for a 4% terminal rate cetera. So tactically, we want to be sure via long euro-dollar position. Strategically, we are still biased towards longer-term gains, so that's been our bias all year, of course. And beyond the very near term, that's still our bias. We don't have that combination of weaker bonds and equities driving it much more, it is just the normal cyclical worries that we've had, particularly in the Europe still overhanging into the longer term correctly in gas prices near term is much less pronounced if you look into the medium term, and we'll still be a concern we're living with some time and those cyclical pressures haven't really changed.
So tactically as I say, we have a near-term dollar negative bias but longer-term, the dollar positive overarching theme we've had for the year is still with us. Putting it into context, DXY is up about 15% year to date. We've got about another 5% to the tentative peak that we've got in the early months of next year. So moderate compared to where we've come from but directionally, that's still the strategic view and that's all in our monthly currency report card that came out on Friday including forecasts for all the EM and G10 we cover. I leave that back to Jason.
Jason:
Okay, great. Thanks a lot. To round down today's call, I'm going to turn it over to Adam Jones on the credit trading side.
Adam Jones:
Yeah, good morning. So I mean credit has actually not had a whole lot to talk about for the last couple of weeks. If you rewind a couple of months, we had a lot more going on. There were some struggles in the new issue market, especially in high yield, which was basically closed for quite a while. Into the backend of summer, there was an expectation of supply in September and so people were kind of positioning into that, getting ready for the supply and frankly, so far it's been a little bit underwhelming. In the US, we're expecting around 150 billion for the month. We've only had 45 so far. The first week it was very high quality. It's been kind of underwhelming, and that's led to a bit of a squeeze as people have not had perhaps the [inaudible 00:21:22] that they were expecting.
The asset class is kind of attractive on a yield basis. It feels like we're a bit of a race product to be honest at the moment. We've definitely seen yield buying in the US. Asia is largely sidelined. One of the factors impacting credit in the US that is the hedging costs where these guys tend to look at three-month cross-currency swaps and obviously with the rate moves at the front, that's less appealing. So we've not seen Asia as active in the US, which is kind of a slug of demand that's kind of been removed.
Europe's been a kind of similar story. The supply has been underwhelming, in composition, this cash on the sidelines and so since the 6th of September we've kind of squeezed in. There is some M & A that's worth watching. The Citrix deal has been largely talked about and that's been something that people have been waiting for in the high yield space that's being marketed right now.
And frankly, it's gone better than feared. And so that's also helped with the lift that we've seen. In the US, we've kind of got Oracle hanging out there as well though obviously that's a lot higher quality and they have time because they use a one-year facility to kind of buy themselves a while when they didn't like the market. Frankly, that's an issue that could kind of come when it wants. It's just one that is worth bearing in mind before you rush in.
So we kind of sat in the middle of a range. We've had a 50% retracement from our recent types to Y and now we're waiting for the same CPI print, everybody else is.
One final point on the derivative side for those who watch CDX as an index for USIG, we're going into the role and it's actually a very steep role because we've got some foreign angels coming back in. So for the first time in a while, the new index is going to be a solid 10 bits wider than the one prior, which creates some optics of its own and kind of causes a squeezy behavior just because when people see a headline that goes 10 wider on the index that they're watching, it looks cheap, and sometimes the market can be as simple as that. That's all for me.
Jason:
Okay, thank you everyone for joining today's call. Central banks are trying to find the level of rates that is sufficient to contain inflation, which leads to the high possibility of over-tightening and causing a recession. So there are going to be wild times ahead for the bond market and other asset classes, and we will continue to address these in upcoming Macro Minutes series.
Speaker 7:
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