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.
Blake Gwinn:
Hi everyone. Blake Gwinn, head of US Rate Strategy, and I'll be your host for the February 20th edition of RBCs Macro Minutes, which I'm going to call Not So Fast. So that channel refers to the recent pullback and cutting expectations for some of the major central banks. Recall, the markets came into 2024 pricing in aggressive central bank cutting cycles, but continued resilience and growth in labor market data along with some recent wobbles in the downward march of inflation. As markets and policymakers pumping the brakes, at least in the US that has seen pricing for 2024 cuts go from roughly 7 25 basis point cuts priced as of mid January to roughly four cuts priced as of today. So we've got a great panel on today to discuss this and other topics across the regions. First we're going to go to Michael Reid, US Economist. Then I'll jump back on to briefly discuss the Fed outlook. Then we'll get Simon Deeley Canadian strategist. And finally we'll go to Peter Schaffrik, chief European macro strategist. So with that I will turn it over to Mike Reid.
Michael Reid:
This week we want to talk about some of the inflation prints we saw come out last week. First, it's worth noting there was a bit of seasonality at play given the revisions we saw to both CPI and PPI. But we also do want to talk more importantly about the weighting changes in CPI and how that's going to affect Core's path lower over the course of 2024. So first focusing on CPI, we saw an elevated print both in headline and core and it's really where cores is causing a lot of the worry right now, after seven consecutive monthly prints below four-tenths, we saw four CPI print four-tenths in January and I think more alarmingly. We saw the super core measure jump to over eight tenths on a month over month basis, and that's up from three-tenths the month prior.
So we continue to see a lot of pressure coming from services and this is really where the Fed has been focused. Surely we can write some of this off due to those seasonal factors that were revised. We saw the December print revised lower, but still, as I mentioned earlier, there was a waiting shift and we're going to see services gain a greater share of the weight in CPI and that's taking away weight from goods. And this is really important because services continues to be the bucket that is doing most of the damage about all. Meanwhile, goods prices continue to decline. So all else equal as services prices continue to remain elevated, that just means cores path lower to 2% is just going to take that much longer. Quickly, just talking about PPI, we did see another beat there. I would say the beat, it was slightly less concerning, especially when you take into context the year over year pace of PPI.
It remains well below 1%. So for now, we think what that means is for some of these calls for the pet to start hiking are a bit premature, but still this print from both CPI and PPI will feed into pc. We are expecting PCE to be rather elevated this month. We are looking for a monthly print for core PC that would be close to five tenths on a month over month basis. And this really resets the clock for the Fed in terms of the more good data that they are looking for. I did want to highlight just one other print, however, and that was the control group of retail sales that we saw come out last week that was rather negative in the sense that the control group had performed quite well. It had a nine consecutive months of gains. So really what that means to us is that despite some of the strength we've seen in wages, consumers are starting to pull back.
So this is something to keep in mind for the Fed as they do consider their next move here. If the consumer does continue to show signs of weakness, that is something that the Fed should take into account given the impact it would have on the labor market. So with that, I'll turn it back over you, Blake, to talk more about what this means for the Fed moving forward.
Blake Gwinn:
So yeah, I don't necessarily think that the inflation data the last week necessarily derails the broader theme, the downward tread that we've been seeing in recent months, but I do think that last week's big PPI and CPI beats do introduce some pretty serious questions for the Fed. And those questions are just going to take more time and more data to answer. As for the week's retail sales print, I think it might've been more impactful if the market narrative, if we hadn't gone two for two on inflation beats last week and also we weren't coming off a strong NFP and ISM prints in the weeks prior to that, the pull towards a later start to the cutting cycle, 3 20, 24 cuts higher terminal rate and this kind of bare flatter curve that we saw last week, all of that continues last week's inflation beats aside, I think the faster than expected improvement in inflation that we've already seen over the prior months.
Again, that longer run trend that I think is still intact to me, that still justifies at least starting to normalize rates. But at the same time, the resilience we're seeing in labor market activity data really takes away the urgency for the Fed to get rates meaningfully lower. Add to this, the fact that the Fed seems to be questioning neutral on a lot of their recent comments, these questions I think are pretty justified given how resilient the economy's been under a higher rate regime, the possibility of higher neutral along with this kind of big band of uncertainty around what neutral actually is, I think all argue for the Fed to really move more gradually. So the inflation data alone enough to start cutting, but these questions about neutral, the strength and labor and growth data, that's a reason for the Fed to go very, very gradually once they start.
So all of this is kind of why we're still comfortable with our call for our first cut June, but I think our conviction in every meeting cut beyond that has really taken a bit of a hit. Our expectations for that cut at every meeting was really premised on some slowing in activity of labor market data that at least at this point really has yet to surface. And if we continue to get data like we have the last month at some point we will soon have to fully concede to what the fed's dots are really suggesting, which is closer to three cuts this year. But for now, our motor call remains the same. We're still calling for a June start five cuts this year. But I think what's really has changed is our view of what fair value for fed pricing should be. I think we've long argued that 2024 should be pricing between five and six cuts.
That's because you have this big downside tail risk associated with a hard landing. But I think this recent run of hot data has that distribution potential outcomes. Shifting slightly to the high side, you have your hard landing risk falling at the same time at the probability of fewer cuts or even none while not our central call. Those risks have been rising near term. I think last week's inflation data probably solidifies this kind of soft no landing market narrative until NFP comes up in a few weeks. But given the extremity of the moves that we saw in the markets after that CPI and PPI moves, I think the coming weeks we might see a little bit of retracement in the form of both steepening. We saw that in the sessions between the CPI and the PPI print and we also see that again continuing to start this week, but overall I think the bare flattening is going to remain the dominant pressure as the front end continues to kind push back on those cuts and modest dip buying keeps that long end a bit more anchored. So there, lemme turn it over to Simon and let's hear about things on the Canadian side.
Simon Deeley:
The ebbs and flows of cut pricing Canada have tended to follow the Fed, but with less price for the bank Canada then their southern counterparts. So about 25 basis points over the next year or so. Generally the gap has lessened. However, on today's weaker CPI report, the macro situation in Canada has been different from the US with GDP growth below potential or steady state for the last few quarters and per capita growth has been in clear negative territory for six straight quarters for the labor market. Although the rise in unemployment rate has stalled in recent reports, employment growth continues to be unable to match high population growth from immigration. Indeed the tick lower in the unemployment rate for January came alongside a decline in both the participation rate down 0.2 10 to 65.3% and employment rate down a 10th to 61.6%. Inflation generally remained more elevated in Canada throughout 2023 with softer core readings for September and October, giving way to firmer prints in November and December.
Today's January CPI report was decidedly on the softer side with core measures around one 10th month on month. The BOC sounded more confident in January that the current 5% overnight rate setting would bring underlying inflation back to 2% with softer growth forecast. Likely the main reason for that confidence, although growth is likely to come in firmer than the B C'S January MP projection for Q4. So the early stat scan estimate there is at plus 1.2% annualized the week growth trajectory still looks intact. Ultimately, we think midyear is the right timing for a first cut with a more sustained move towards 2% inflation needed. June remains our point forecast at the same time. Attention on the timing for the end of QT and return of steady state balance sheet policy has been high since 2024. Started with core settings remaining elevated most recently at 5.04% and a large upcoming maturity on April one.
So the bank has 23 billion maturing off of its balance sheet at that time. Measures to limit upward pressure on Cora have included one day liquidity provisions, which were more in the first half of January and tomorrow. Reintroduction of morning receiver general auctions where there's a lending a portion of the GOC cash balance to market participants while the RG change and reintroduction should provide some temporary help and allow the BOC to get through the April maturity, we see the need for the bank to end QT sooner rather than later. A speech from deputy Governor gravel on balance sheet normalization on March 21st should outline the bank's plans for returning to purchases of replacement assets with an expected announcement of the end of QT at or around the following meeting on April 10th. That's all for me and I'll send it back to Blake.
Blake Gwinn:
Thanks. So Peter, traffic, what do you have for us?
Peter Schaffrik:
Thank you Blake. Well, I could go down the easy path and say in Europe over here it's pretty much the same as was before, but that obviously would be too easy. So if we look at the pricing for central banks, both for the ECB and for the Bank of England, your title is very apt, not so fast. So when we look at it, we priced out about 60 basis points for the ECB about 80 basis points for the Bank of England since the start of the year. By now, we think we're probably closer to fair value. We're price in about 110 basis points for the ECB, which we think is probably still a little bit too much. We price in about 75 basis points for the Bank of England by the end of the year, which we think is probably a little bit too little, but by and large it's much closer to fair value.
So that begs the question, what has changed? And here the counterintuitive answer is not a great deal, but neither has the supportive side changed nor has the part of the economy or the data set that it's arguing against. Rate cut changed and given where we came from, the latter has won the day. So let me quickly run through that. When you look at the first supporting factor, the central bank rhetoric that has turned more dovish lately. We've seen that particularly in the latest central bank meetings that we talked about in an earlier episode and all the communication that we've heard since has not really been all that different. Now also, the inflation numbers that have come in have actually been supportive of the rate cut story, particularly in the UK lately. Inflation has also surprised to the downside where the market was quite worried about the inflation picture and certainly in the Euro area, inflation keeps coming down.
So what has also not changed however, is the strength of the labor market. You mentioned that earlier in the case of the US Blake, and the same is true over here in the uk. We've got a bit of difficulties because we had incomplete data sets, but the latest data that has been released was surprising on the firm side and for the Euro area. The ECB is stressing wage growth in particular, and the latest data, in fact we got some data today, is not really suggesting that wages are coming down and the ECB in the last meeting has stressed their own internal data set. And just last week they released a research paper where they talked about it and most of the data that they have been releasing suggests that wage growth is still on a relatively high level plateauing but not really coming down as a consequence.
What is going to happen going forward? Well now that we're closer to fair value, we think we're probably seeing less impetus to the upside for yield than we had before. We probably see more relative market moves. As I was mentioning earlier, we think in the UK there's probably a bit too much priced out in the Euro area. There's probably a bit too little priced out, but by and large I think we'll probably hit a plateau in yields relatively soon. The risk remains slightly to the upside. We are calling for a June start for the ECB 75 basis points. So that means not every meeting will be a cut. We're calling for an August start from the Bank of England. We think it's much more likely that by that time the bank will come around and start cutting, following where the Fed and the ECB are going and therefore have to do every meeting. But by and large we think that's, as I said, closer to fair value and we think in that environment spread products will probably continue to do well. Strategies that benefit from a sideways market move will probably do well and some of the more riskier assets in the fixed income space over here, they'll probably also do well. And with that I'll probably leave it, but I'm pretty sure we're going to return to that subject for the weeks to come.
Blake Gwinn:
Great. Thanks a lot Peter. So that concludes today's podcast. If you have any questions on these or any other topics that you'd like to discuss with today's speakers, please feel free to reach out through your RBC sales contact. Thanks again for joining and keep an eye out for our next episode in two weeks.
Speaker 4:
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