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.
Peter Schaffrik
Welcome back everyone, and welcome to the latest edition of Macro Minutes called How long does this take? I'm Peter Schaffrik. I'm going to be your host for today's call, which is recorded at 9:00 AM Eastern Time, 2:00 PM London time on July 25th, 2023. So this business cycle and the rate cycle continues to be somewhat unusual, let's call it that some central banks have been stopping and starting in their hiking process.
And this week we're going to see the FOMC and the ECB almost certainly adding another 25 basis points to their respective tally. But the odds going forward have been greatly diminished about what's going to come thereafter compared to just a few weeks ago. And the question is whether we have reached the peak already or whether there's something coming thereafter. In the UK, the turnaround has probably been even more pronounced. The UK had been pricing quite extraordinary levels compared to their peers, but since the latest CPI data came out, had also seen quite a rally and more than 50 basis points have been priced out of the interest rates strip.
Meanwhile, though, the survey data most notably out of Europe in form of the PMIs has been quite disappointing to say the least. And in part, particularly in the manufacturing sector is now indicating sharply contractionary territory. And to make things even more complicated, the strength of the labor market continues. And there seems very little to indicate that a significant turnaround is in store in the near term over at the other end of the globe, in China, the problem seemed to be the opposite, where the economy rebounded less than expected after the Covid restriction had been lifted, and the PBOC tries to support the economy as best as it can.
So to make sense of all of this, I'm joined by some of my finest RBC colleagues and experts on their relative issues. And Blake Gwinn is going to kick us off in a second to talk about the US and specifically the upcoming FOMC meeting.
I'll quickly return to say something about the ECB. Simon Deeley has the latest on Canada and the Bank of Canada. And then Cathal, our resident expert on the UK, is going to talk about the MPC and the implementation of monetary policy. He's written a very interesting note lately about the lengthening of the implementation period. And last but not least, Alvin Tan is going to join us from Singapore to share his thoughts on China. And I'm particularly grateful that at this hour he's going to join us. But without further ado, I'll turn it over to Blake.
Blake Gwinn
Thanks, Peter. So I wanted to spend most of today's time allotted me talking about the FOMC, which will be coming up tomorrow. That's obviously the big folks in the US for markets this week. That being said, it should be a fairly quiet FOMC hike. A 25 basis point hike is fully priced. Just as a reminder, we're not going to get a DOT plot at this meeting, so we won't have that kind of shift in the dots that often drives a lot of the price action in response to an FOMC meeting.
Also on the statement, we think the changes should be fairly minimal, probably some marketing to market, some of the inflation language. I don't think that would be particularly market moving. And I think their kind of forward guidance section on races is already very well suited. So what I think is going to be a very data dependent approach going into the next few meetings. They changed that remember in a prior meeting and made that a little bit more open, a little bit more loose to accommodating this kind of stop-start potential skip type of pace that they have going forward.
So really any intrigue from this FOMC meeting's going to have to come from the PAL press conference. And I think the biggest things the markets are going to be looking for is any kind of signaling on what they're likely to do in September, but we think they're going to be pretty reticent to give any kind of guidance here. We think Powell will play his cards very close to the vest. There's two NFP and CPI prints before the September meeting, so they're going to have a lot of data between now and then.
So we just don't really see why Powell would want to commit or really start pushing markets in one direction or the other, but they still have lots of time and data before they're really going to have to make a decision. And not only that, but remember that he will have his Jackson Hole appearance in late August. So if we do see something in the first of those two sets of data that does start to change their mind and they want to see that market pricing shift towards a hike, he could always use that Jackson Hole speech to do that.
One thing I will be watching for though is any discussion around the two FOMC dots, which remember showed one more hike after July. We have seen Powell come out in the gate, the most recent dots in a press or before, remember November of last year he said committees rate expectations had moved higher since the September FOMC dots had been released. And I think with the soft June CPI print that we got, some people in the market might be expecting something similar this time where he basically comes out and says that the committee had softened their stance since those June dots came out and thus kind of negating that median showing an additional hike.
But I think if you look at the totality of the data we've seen since the June meeting, remember we did get a soft CPI, but remember we also got some positive labor market data and I think this soft landing narrative has really taken hold over the inter meeting. I really doubt many on the committee have significantly changed their views since they submitted those June dots. So if he does mention it specifically, I would expect him to basically reconfirm those June dots at least at this time.
And I would also say as for the June CPI print itself and how they're kind of reacting to it, I really think the FOMC is going to want to see a string of consecutive low CPI prints before they officially signal an indefinite pause or really let markets know that they're on hold for the time being. So again, just not something I expect him to do in the press conference. For what it's worth, our call still for July to be the last second cycle, but we're very open to changing our minds on that position if we get any positive surprises in the next two months of data that will come out before that September meeting.
But even if the data holds at the June levels and just kind of reinforces that soft landing view, I think the Fed's most likely action would be to skip September, slow down the pace a bit more, kind of tee up November, that gives them one more more month of data and kind of maintains this kind of view in June where they came out more hawkishly but at the same time decided not to hike in that meeting and instead pushed that additional hikes into future meetings.
So overall, I think the Fed narrative is relatively stable for now, at least until Jackson Hole in late August. But perhaps even further than that, if the data continues to suggest a soft landing, and when I say it's stable, I mean combined pricing for a hike in September, November around 50% and 2024, cut pricing around five or so cuts. And for rates, I think that means yields and curves largely chopping around in a range for the next month or so with that chop really being driven by things that are happening overseas, potential overreactions to US data and technical factors like positioning, supply, et cetera.
So after the last few sessions of price action, I think yields are probably closer to the top end of those late summer rate ranges in the bottom. And I would say vice versa for many of the curves. And with that, I will pass it back over to Peter.
Peter Schaffrik
Thank you Blake. I could take the first part of your statement and just apply it to the ECB as well because when we look forward to the Thursday meeting, what's most likely going to happen because it has been defacto pre-announced, is that the ECB is going to hike interest rates by 25 basis points. And then the question really becomes just as with the FOMC, what are they going to do thereafter and are they going to give us any guidance.
Now as there's quite a lot of data in between this meeting and the one in September, just equivalent to what Blake was just saying about FOMC, I think it's very unlikely that we get the same kind of firm guidance for the next meeting. The ECB will probably try to play for time here. And also keep in mind that we won't get any staff forecasts this time round. They will be coming in September.
And when we look forward to that, one of the things to notice that with the latest survey data that has been coming out and the activity data that has been coming out, it seems quite likely to us that the ECB staff forecast in September will have to be downgraded. And if that's the case, it obviously makes the case for firm guidance now even less likely. So overall we reckon that we'll get the 25 as promised and then everything else will be very data dependent indeed.
And that's to some degree already what the market is pricing because we're pricing the 25 and then we're pricing a sub 100% probability for the next move to occur in one of the next two meetings. So either in October or then in the subsequent meeting in ... Sorry, in the September or subsequent meeting in October. So that's roughly speaking in the near term. Just very briefly, if I look at the market, just as Blake also was saying, the bond market has been between roughly two and 255.
We were trying to break out most recently to the upside, but that hasn't really gotten hold. And I think the chances are going into the summer after this meeting, particularly with this forward-looking data being on the weak side, that the market is probably trending back towards the middle of the range. However, in order to break out, I think we would need to see a confirmation of either a very significant weakening of the data of the actual data, not only the survey data from here onwards or indeed the reverse where the ECB would guide us towards a higher peak before the year is out. And neither of that is likely going to be confirmed over the next couple of weeks.
So I reckon what's going to happen is the ECB meeting's going to come and go and we're going to drift and then the market is going to take any clues from the data that comes out in between until we get any closer to the September meeting. And with that, I'll hand it over to Simon to speak about Canada.
Simon Deeley
Great, thanks very much. Peter. Canada certainly fits into the how long will it take topic, this edition with the Bank of Canada hiking by 25 basis points each at the June and July meetings after holds in March and April as part of their conditional pause announced in January. So is the BOC done now? As with other central banks, they're highly data dependent at the moment. So the answer is depends on what your expectations are for macro data. We found the BOC statement and MPR on July 12th quite hawkish with the latter, including greatly upgraded growth, so plus 1.5% in each of Q2 and Q3 and inflation.
So three per 3.3% year-on-year in Q3, 2.9% in Q4 forecasts. The 2023 full year growth forecast was revised up 0.4 percentage points to 1.8%, with that increase coming from household consumption, something that the Bank of Canada would hope to be softening from the already completed rate hikes. So there are two ways to look at the upgraded forecasts. One is that in reflecting the Bank of Canada's expectations, it shows that they expect growth and inflation to continue to outperform and they may need to do more to slow the economy and return inflation to 2%.
The other is that it represents a high bar for economic in the six remaining to the September meeting. Indeed, our economics team's forecast are much larger than the BOC on both growth. So we have plus 0.5% in Q2, minus 0.5% in Q3 and inflation. Consensus expectations are between BOCs and our own. Ultimately the softening we expect to see in the macro data means our forecast for the BOC is that they are on hold going forward before cuts starting next July.
Note, this is noticeably later than the March median in yesterday's market participants survey published by the bank. But if data evolves more in line with the BOC's projection, then another hike in September would be likely. The caveat here is that the BOC's NPR press conference was particularly more balanced than the statement and NPR, noting concerns on both over and under tightening and that they discussed the hold at the meeting itself. Key data points to watch before the September 6th meeting are May GDP this Friday, which includes the June now cast, July labor force survey on August 4th, July CPI on August 15th and the full Q2 GDP report on September 1st.
The June CPI report last week saw headline on the softer side at 2.8%, though core inflation printed on the firmer side at 0.3% month on month for all three core measures including trim, median, and super core. In our view, this leaves all to play for on the inflation side in next month's report and ahead of the September 6th meeting. With that, I'll send it back to Peter.
Peter Schaffrik
Thank you, Simon. And moving over to this side of the Atlantic, Cathal, I know you've done some work on the transmission policy transmission path, so why don't you fill us in on your latest findings, please on the UK?
Cathal Kennedy
Yeah, thank you Peter. I mean, you mentioned at the top of the call the significant reaction we saw to last week's CPI data here in the UK. I think one of the uncertainties we have is in identifying kind of where terminal might be because we know now that monetary policy in the UK setting is working with a much longer lag than what was previously the case. There has been two very important changes in the UK housing and mortgage markets that explain that lengthened lag in terms of transmission since the last time the Bank of England undertook a significant hiking cycle in the early to mid 2000s.
The first of those is in respect of housing tenure. The most common form of housing tenure in the UK now is owner occupancy. I'm sorry, outright ownership. That is people who own their houses outright without a mortgage. Almost 35% of all UK houses are owned in that way. So what that means is that the proportion of households with a mortgage is smaller than it was previously, 30% now versus roughly 40%, 20 or so years ago.
So that transmission mechanism is resting on a much smaller portion of households. The second is that we have seen a change in the mortgage market. At the beginning of the last decade, some 70% of all mortgages in the UK would've been on variable rates. So what that meant was that changes in Bank of England policy transmitted very quickly to households and to the interest rates they were facing on those mortgages. What we've seen over the last sort of 15 to 20 years is a shift to fixed rate products. 85% of UK mortgages are now fixed and most of those fixed for between two and five years.
So for those households, they only face the increase in mortgage rates once they go to renew their mortgages. So there's a delay in the transmission of monetary policy to households compared to what was previously the case. Our bank equity analysts estimate that only around 40% of residential mortgages in the UK so far have refinanced onto higher rates. But then even by the end of this year, it'll still only be 55% of mortgages will have refinanced onto higher rates.
So even by the end of this year, by the end of 2023, only about half of the impact of the policy measures the Bank of England have announced thus far will have been transmitted through to households. So it gives you some impression of the lag in that transmission mechanism. So two implications for the MPC one, as they have admitted themselves, it takes longer for their policy to feed through.
And two, it may be that policy is blunter as well. And just in terms of respect of we have the Bank of England meeting next week, akin to what you mentioned in respect of the ECB, we see the Bank of England delivering two more rate rises at this meeting in August and the next meeting in September. We felt it was enough in the language in the minutes of the June meeting to suggest that the bank, the MPC, thought that the 50 basis point rate increase they announced at that meeting would've been a one-off. We held that call through the labor market data and indeed sort of since the CPI data last week, we've kind of firmed up that view that we will get a 25 basis point move next week.
Peter Schaffrik
Thank you, Cathal. Very insightful. And last but not least, let's turn it over to Alvin to a central bank that has a very different problem. It's not trying to cool the economy but support the economy. Alvin over to you.
Alvin T. Tan
Hello. Hi. Good morning. Good afternoon. So, yesterday we had the payment from the Chinese Public Bureau. They did not unveil a big bazooka stimulus, so to speak. And it essentially recapped the penalty of measures that have been announced so far to support the economy. Still the market seems to have taken heart that the Public Bureau's statements did make the point that it recognized that the lack of confidence is at the heart of China's economic maze.
And the market has given the, probably benefit of the doubt as you can see from the significant rally in Chinese equities and also in the running piece over the last 24 hours essentially. And just to recap very, very quickly, the main values has been announced over the past few weeks that, for example, debt forbearance to facilitate the completion of housing projects by indebted developers, targeted measures to try to promote consumption of cars and household electronics, relaxation of the regulatory crack down on internet firms and quite a big one was what was said by both the central government and The Communist Party together to support private enterprise in China.
And finally, of course there's been various monetary easing in terms of reserve ratio cuts and interest rate cuts on the part of the PBOC. Also, of course, behind all this, there's also been currency depreciation, not so much in the form of dollar CNY exchange rate, but more importantly the trade weighted wouldn't be, has fallen to its lowest level since January of 2021. It's been basically falling quite steadily over the past two months. And of course currency depreciation is another form of monetary easing.
So instead of the big fiscal stimulus that some have been calling for, Beijing's focus does seem to be on a combination of positive support measures that it hopes will be enough to address the growth slowdown that we are seeing in China and more importantly to divide the animal spirits and the economy on [inaudible 00:20:11] firms and households.
Certainly though, given that it is not one big stimulus package, it's not a recipe from a drop reversal of the economy's trajectory, in my mind. It's more about trying to halt the current deterioration in the growth momentum. And certainly, I'm not fully convinced that the current measures as announced ideally enough to see it holt this slow down that's underway. In particular, I'm not that convinced that prejudice about supporting private enterprise would be enough to really trigger a revival of private sector investment and confidence after what has happened in the past few years, both in terms of reflectively cracked down and the more general strengthening of the parties, the primacy in the economy and over economic policy, or even that the various targeted housing and consumption measures will be enough to unlock household spending and divide household confidence after the deprivation of the Covid years and the ongoing housing sector malaise.
And as a result of this, I do think that the further currency depreciation, again, in particular the trade weighted [inaudible 00:21:30], it would definitely be needed. And so I think we iterate the 95 target in the trade rate index for example. And that's it for me.
Peter Schaffrik
Thank you very much, Alvin. Thank you everyone who is dialing in and thank you to everyone who is listening.
Speaker 7
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