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:
Hey, everyone. Good morning. I'm Blake Gwinn, your host for today's edition of Macro Minutes, which we're recording at 9 a.m. Eastern on September 12th. Looking ahead, we have a number of central bank events on deck, ECP meeting this week, and then we'll have the Fed and Bank of England next week. Overall, it seems like we're coming up on closing time for global hiking cycles, but markets are still waiting to see if some of the major central banks are going to try to get one last round in before the lights come on.
That's why we decided to call today's episode Last call. We've got a great panel of speakers today. We're going to discuss the likely end of hiking cycle across the various regions. I'm going to start off talking about the Fed, then I'll hand it over to Cathal Kennedy to discuss the ECB Bank of England, then Simon Deeley to talk about Bank of Canada, and then breaking with the theme a bit, we'll hand it over to Adam Cole to talk about the yen and potential for Bank of Japan intervention, which is another topic, I think, has been on a lot of market participants minds recently. And then we will finally finish up with Su-Lin Ong, who will focus on the RBA.
So let's kick it off with the Fed, who are meeting next Wednesday. Recall that this is an SPP meeting, meaning we're going to get an update to the economic forecast and the so-called dot plot, which we last saw in June. Also recall that we just heard extensively from Powell Jackson Hole just several weeks ago. Given that not a lot's changed on the economic front since Jackson Hole, I think we're assuming Powell's comments also aren't going to be materially changed from what we heard at the end of August. Similarly, with the FOMC statement, we don't really expect major changes there, except perhaps some marginal marketing to market around some of the recent softening signs we've seen in the labor markets.
Given all of that, I think the market focus and likely price response around next week's FOMC is going to be focused around the dot plot, and specifically the 2024 median. The 2023 median, which is only going to cover two meetings at this point, it's almost certainly going to stay at the current level of five and five eighths. Assuming the Fed doesn't hike next week, this would be a massive, massive surprise. This leaves the Fed some optionality to hike again and also make sure that markets don't start pricing a more aggressive pivot.
Markets have generally been viewing the likelihood of this final hike at just below 50%, and regular listeners or readers of our pieces will know that we generally agree with this pricing. We think July will end up being the last cycle to cycle and put a pretty low bar, though, on getting another hike in November, December. As we said, though, 2024, I think, is going to be the much more interesting development. That's largely because the market conversation and, I think, the focal point of a lot of the market volatility over the last month has really shifted from the conversation on terminal Fed funds rate out to the expected path of cuts in 2024 and beyond.
Recall that the median dot in June showed 100 basis points of cuts in 2024 and the markets appear to be using that gap as pretty important framing for what's priced for 2024. If you look at SOFR pricing, that's generally seen a pretty strong ceiling around 106 basis points since SVB. To be sure, I think the median 2024 dot is very likely going to rise. It only takes one or two participants near the current median to raise their submission to push that median dot higher.
But what I think is going to be more important for markets and what they'll be more attuned to will be the entire distribution. If many members are now starting to pair back on cutting expectations for 2024 relative to what they saw in June, that may finally provide the catalyst for a break to the top of that market range that we were discussing that's held since SUB. But we think markets are largely set up for this, to be honest. Trading cuts has been a fairly popular trade and I think the bigger pain trade and market reaction may come on a lack of upward movement in the 2024 dots rather than that median simply shifting higher.
And this, again, returns us to a point I think we've been focusing on for much of the summer, that the fed narrative is likely going to remain stable for some time and it may take awhile for either cut fading or, in contrast, the hard landing steeper thesis to really play out. And with lack of major movement or confirmation on those themes, the recent ranges are likely to hold and the chop within those is going to be driven by secondary themes, second-tier data prints, quick shifts in and out of tactical positions, which we think has really been the major driver over the last few weeks.
Lastly, we'll just leave with a caveat that we will have CPI tomorrow. So everything we've just talked about, a lot of that framing could change into the meeting if we get some kind of surprise on CPI, but for our part, we're expecting a 0.2 month-over-month print, which I think is right in that Goldilocks range where it really wouldn't change a lot of the discussion on the Fed headed into next week's meeting. With that, let's talk a little bit about Bank of England and Europe. Hand it over to Cathal.
Cathal Kennedy:
Thanks, Gwinn. We, in Europe, if you like, get back from our summer holidays in earnest over the next fortnight or so, ECB in focus this week and with the Bank of England then following next Thursday. And in the case of both, we're eyeing, if you will, the end of the current hiking cycle, trying to get a pinpoint, if you will, on where the current hiking cycle comes to an end. Now, for the ECB, we think that they've already reached their endpoint and we actually expect them to keep rates unchanged at this week's meeting. And if they do so, that would mark the first time since July, 2022 that they have held rates at a meeting. So a significant milestone, if you will.
Now, there are splits in terms of the view ahead of the meeting. The market is pricing around a 40% chance of a 25-basis-point rate hike. Analysts, similarly, divided roughly 60/40 in favor of a hold. So worth just saying why we think the ECB will forego a rate hike, and a couple of reasons. One is just the very important change in the language that we saw at the last meeting way back in July, the ECB moving from saying that rates will be brought to sufficiently restrictive levels to saying that they will be set at sufficiently restrictive levels. So this is something which is very much very heavy emphasis put in this by President Lagarde in the press conference. And we saw the ECB moving from where it was discussing where rates needed to get to to really beginning to focus on how long they needed to be held there.
Now, in addition, there are growing concerns about the growth outlook here in Europe in the face of a marked weakening in activity indicators. And I think one notable thing about this meeting is that it will see updated staff forecasts published alongside. And in particular, we expect those to show significant or, so we said, meaningful downward revisions in the 2023 and 2024 GDP forecasts, really just reflecting the weakening in the activity indicators that we have seen. So [inaudible 00:07:07] language from the last meeting will give the ECB, we think, room for a pause this time around.
Now, I mentioned there a split in the market and analyst expectations, and I think it's just worth saying that that really just reflects the inflation backdrop here in both Euro area and across Europe as a whole. Inflation is falling, but we did see some upward surprise in the August data. So it still has a propensity to surprise, and also, in addition, coal inflation proving much more stubborn in terms of coming down. So no change from the ECB, but equally, we don't expect any explicit messaging, if you will, calling a pause at this stage. You mentioned [inaudible 00:07:53] of the Fed, the desire, if you will, to retain optionality, and I think that's the watch word for European banks, as well, for European central banks. So the ECB would expect it to retain its hiking bias, giving it the option going forward to respond to the data, should it need to.
Now, Bank of England next week, and unlike the ECB, well, like the ECB close to the end, unlike the ECB, we think probably has one more rate hike left. Now, the tone of the August meeting meeting minutes was quite significant in that it saw the NPC express a degree of confidence that what has announced to date was having an impact on the economy while also there is this consciousness within the bank that there's still a lot of the impact to be felt going forward. So the bank feeling more confident that it has, perhaps, done enough and also conscious that much of what it has announced has still to be felt in the economy.
Now, Governor Bailey followed up that with comments to a parliamentary hearing last week, at which he basically said that the bank was on the balance of current evidence, much nearer to the top of the cycle than it was. And I think that just really reflects the mixed data. I mentioned the weakening outlook for activity in the Euro area, seeing a similar, if less pronounced deterioration in the forward-looking indicators here in the UK, but in particular, we see labor market cooling in the UK. We had labor market data this morning showing a pickup in the unemployment rate, fall in employment, and what we might term a broad loosening in labor market conditions.
But equally, that gave us the reason why we think the Bank of England will continue the hike at this meeting, and that is simply that wage inflation is still too high for comfort here in the UK. Private sector wage inflation growth with the private sector wage growth, which the bank has told us they are focused on, is still above 8%. So even if there is some cooling at the labor market, that will take time to feed through to wages. So while the bank may feel a little bit more comfortable about the evolution of wages going forward, in the here and now, it can't be complacent, if you will, which is why we think there's one more left in the barrel, as it were.
Now, in the case of both the markets pricing about 20 basis points more for the ECB from where we are at present and just under 40 basis points for the bank, which we think is broadly fair value, given the balance of risks around the outlook to both, but like I said, this Thursday ECB, next Thursday Bank of England very much marks the end of the European summer, if you will, and both at or close to the end of their cycles, but I'll leave it there.
Blake Gwinn:
Great. Thanks a lot. Now, let's turn it over to Simon. Talk about Canada.
Simone Deeley:
All right. Thanks very much, Blake. Definitely, we'll hear some consistent themes with the Bank of Canada and the Canadian economy to what we just heard from Cathal and Blake. We expect the bank is done hiking following moves in June and July after coming off of their conditional pause that they announced in January, but similarly, we think the Bank of Canada is unlikely to give an all-clear anytime soon, though with explicit consideration of further tightening, an important and effective strategy to keep cut pricing further at the curve and less pronounced.
To be fair, there are important economic reasons to keep the flexibility to hike further, as well. Still, sticky core inflation and wage metrics are their main concern, with little progress on either of these fronts in recent months. The softening of the labor market, so a half a percentage point increase in the unemployment rate in the past four months, and slightly negative Q2 GDP with flat consumption, and this was out on September 1st, provided the bank with a clear case for a hold last week, but they will need to see the softening in activity, one, not reversed in the upcoming data period and, two, flow through to the price and wage metrics.
As Cathal mentioned for the UK and elsewhere, this typically happens with a lag, and the key question is, how much tolerance will the Bank of Canada have for sticky core inflation and wage growth? If the activity side continues to move in the right, that is the softening direction, then we think they will have some patience. In other words, we don't need core inflation at 3% on a three-month annualized basis or wage growth at a particular level in upcoming reports. If activity bounces back materially, then they will be more sensitive to the price metrics, as well, and that is the main recipe for another hike.
Our call here is pretty clear. We expect activity data to continue to soften, the GDP growth forecasted to be small negative in Q3 and Q4. Alongside continued rises in the unemployment rate, we expect around 6% by year end. Bank of Canada has warned about the implications of higher oil prices for headline inflation, and we agree with that, but we do see core inflation trending towards 3% year-on-year by the end of 2023. This scenario is a clear case for a pause through this year and into the first half of 2024. And that's it for me on Canada and I'll flip it back to Blake.
Blake Gwinn:
Great. Thanks a lot. Now, let's go over to Adam to talk about BOJ in the end.
Adam Cole:
Thanks, Blake. So a couple of reasons for broadening out to include Japan in the debate. Firstly, as Blake mentioned, the threat of intervention is becoming very real in dollar yen. And then secondly, the comments from BOJ Governor Ueda at the weekend, mentioning the unmentionable exit to negative interest rate policy, and the two kind of tie together. And so far this year, by far, the strongest theme in FX markets has been yen weakness. The yen is down against every G10 currency and virtually every emerging market currency this year. And these two things have emerged as potentially standing in the way of that trend going any further.
So last week, we had several Ministry of Finance officials stepping up verbal intervention to what is normally the highest level, so watching markets with a sense of urgency, that latter phrase typically being as high as they go in terms of verbal intervention before physical intervention. Looking at the factors that drive MOF intervention historically, again, they do suggest the risk is high. So our model puts the probability at around 20%, which is historically very elevated, and it would be entirely consistent with the pace of appreciation we've been seeing for dollar yen for the MOF to intervene at these kind of levels.
Would it work? Well, it didn't last September and last October, when they last intervened. And I think the generally accepted wisdom is that intervention has the greatest chance of working when it's pushing in the same direction as domestic monetary policy, which it very much wouldn't be at the moment with the BOJ still pursuing ultra easy policy whilst central banks are holding policy actively tight in the rest of the world.
If that changed, or is there any prospect of that changing after Ueda's comments at the weekend? Looking at what he said, his comments were heavily, heavily qualified, unconditional, and his comment was that it's possible that the BOJ could see conditions under which considered exiting negative interest rate policy starting to develop by the end of the year. And what he's talking about in particular is the labor market. And I think it would be quite revolutionary if that were to be the case.
So on the indicator that I'm watching most closely, nominal wage growth is currently running at around 1.5%, real wage growth in Japan is running at minus 2.5%, and the latter in particular is not in any way consistent with the medium-term inflation targets. So it may be that the wager is setting up some conditions for far in the distant future under which they could consider exiting their negative rate policy, but I don't see that as a near-term prospect.
So long as that's the case, the best that we can hope for from intervention is that it interrupts the decline of the yen and manages the pace of decline of the yen rather than having any hope of turning it around. Our core view remains that the trend of yen weakness, which has been so entrenched this year, runs to at least the end of the year. And in our refreshed forecast we published last week, we've extended both yen weakness and broader dollar strength out to the middle of next year. So on our forecast, we do make new highs in dollar yen to the north of 150. So intervention risk is high. The chance of intervention doing anything other than briefly interrupting the trend in the end is low, in my view. And with that, back to Blake.
Blake Gwinn:
Great. Thanks a lot. And finally, to round things off, let's go to Su-Lin to discuss Australia.
Su-Lin Ong:
Thanks, Blake. RBA Governor Lowe delivered another steady rate decision last week, the third in a row, leaving the cash rate at 4.1%. That's mildly restrictive and still well below its dollar block counterparts. In his last board meeting with his term finishing at the end of this week and coupled with the final speech, the governor continued to hint at a central bank reluctant to tighten much more and prepared to tolerate a slower return to within target inflation.
The hurdle to hike further is high and it continues to rise, reflecting three factors in our view. The first is dollar block central banks that have probably already reached terminal, the second is the ongoing signs of weakening in the consumer, which has hit stall pace, and the third is signs of loosening in the labor market with inflation moving in the right direction, although it still remains fairly elevated.
At the margin, we'd also add that a weaker than expected China and still underwhelming policy response from the authorities is adding to the risk that the RBA cash rate is pretty close to its peak. This is underpinning a wait-and-watch approach from the RBA with a lingering tightening bias as [inaudible 00:18:34], like other central banks, as we've discussed, maintains optionality until they're more confident that inflation, especially services, will move lower.
We don't really think much change is on the policy front and the debate in the coming months is the new governor, Michele Bullock, takes over. In our view, she also [inaudible 00:18:52] dovish. We've long argued that policy settings in Australia should probably be more restrictive and that our fundamentals are not that different to much of the dollar block with additional challenges when we think about Australia's strong population growth, the increase in household utility prices, which is emerging now, and the high minimum wage decision that was delivered not that long ago.
That's why we've left a final 25-basis-point hike in our profile, but it is pretty hard to fight this dovish central bank. Aussie bonds have mostly tracked global moves of late with an outperforming bias, as the RBA's pause extends. We will obviously keep a close eye on the domestic data and developments, but really, we think it's offshore that will be more important, especially developments on the Bank of Japan front emit increasing discussion of a further shift in YCC, and probably more importantly, the possibility of an earlier change to the negative policy rate stats. Back to you, Blake.
Blake Gwinn:
All right. Thanks a lot Su-Lin. And I guess, with that, we will close today's call.
Speaker 7:
This content is based on information available at the time it was recorded and is for informational purposes only. It is not an offer to buy or sell or a solicitation and no recommendations are implied. It is outside the scope of this communication to consider whether it is suitable for you and your financial objectives.