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.
Simon:
Hi everyone. Welcome to the March 7th edition of Macro Minutes entitled Stretch Run being recorded at 9:00 AM Eastern. As hockey and basketball into the last weeks of the regular season, central banks themselves are approaching the end of their hiking cycles. There is a significant divergence among global central banks, however, ranging from a conditional pause from the Bank of Canada in January, which we expect to be reiterated this week, to ongoing tightening messages from the ECB and the Fed to navigate the global central bank environment, FX and credit markets. We have a strong slate of RBC experts. Cathal will kick things off with discussing the updated ECB forecast ahead of this week's meeting, followed by Su-Lin's take on the RBA meeting overnight. I will discuss the Bank of Canada and why the conditional pause message is very likely to hold. Elsa. We'll discuss the latest on the FX side and Adam Jones will provide an update on, on the IG credit side over to Kaha to start.
Cathal:
Thanks Simon. And, uh, hello everybody. Simon, you mentioned that differing message from the ecb, um, I think the ECB increasingly of late, um, very keen to tell us, very keen to point out to us that it has furthered a goal in terms of its hiking cycle and we've seen that reflected with a hardening of its of its rhetoric, um, in recent launch, which is turned, um, much more hawkish. Now, as you mentioned, also, we've just adjusted our, our ECB call now seeing it going higher and, um, further than before. So why now? And in essence, kind of, you know, it's the inflation backdrop in in the Euro area that explains why we've adjusted the call at this juncture. Now, inflation in the Euro area is falling. That's important to point out. Um, and it's actually falling more rapidly than the e ECB was expecting in its last forecast round.
So having peaked a little under 11% in in October, it's now down to 8.5% starts going in the right direction. What's not going in the right direction for the ecb however, is core inflation. Core inflation is rising over the same period that headline's been falling. Core has risen from five to 5.6%. So that's essentially because it's energy prices that are doing most of the work in bringing down headline inflation and obviously they're not counting in core. So where does that leave us? So we've pushed our expectation of the ECBs terminal rate higher to 3.75%. Now what we see, um, in coming meetings is a 50 basis point rate hike at the meeting this month, followed by three more 25 basis points, red hikes after that. Now that endpoint we foresee it's still below the market, is, um, pricing terminal. Currently it's, it's, it's, it's putting the ECB terminal rate a little over 4% and it's also below where some of the more hawkish members of the ECP two go.
But right now, core inflation is probably the key to the outlook for the e eccp rather than a headline inflation. And our take is that the e eccp will keep going until it's convinced the core inflation is falling. Now we are our judgment, our call at the moment is that core inflation will begin to fall, it will follow IFL headline inflation lower, but it will do so well like now. Ultimately we see core inflation beginning to fall around the middle of this year, and that's Simon. It's why we see the ECP bringing it cycle hiking cycle to a halt and little after that at this meeting in July.
Simon:
Great, thanks very much for those insights Cathal. Uh, now we'll shift to Su-Lin on the RBA.
Su-Lin:
Thanks Simon. The RBA hiked by another 25 basis points today after its March board meeting that takes a cash rate to 360. It was though a pretty dovish shift from the RBA following an equally abrupt hawkish shift last month. We had expected some watering down of the previous reference to multiple hikes ahead, but it was the addition of, um, when further hikes may occur. That's opened the door for a possible pause or peak in rates at any point, uh, which really caught the market a bit off guard. The domestic data in the last month have mostly surprised to the downside with emerging signs of a much desired moderation in household consumption, but it remains pretty early days and we're of the view that demand needs to weaken much more to ensure inflation returns to target over the medium. Term inflation in Australia remains far too high uncomfortably.
So with core inflation near 7% and the cash rate at 360, we would characterize RBA policy settings as really only mildly restrictive. A pause at this juncture we don't think is prudent and it adds uncertainty over the RBA a's reaction function and policy trajectory at 360. We'd also argue that any pause is very different to the conditional pause adopted by the Bank of Canada with a cash rate at 4.5%. Still it's pretty hard to fight central banks. Our base case remains for a final 25 basis point hike in April with terminal at 3 85 in Australia. But we do still see upside risk to this with Australian policy rates low by dollar block standards, but the RBA path is now more uncertain and it's likely to be looking for reasons to pause. It may well already be in the stretch, run somewhat sooner than we thought. We continue to hold our short may ibs, but we acknowledge the riskers that they'll struggle to perform if the R B A opts to pause in April. And we also prefer to be strategically long, but having missed the opportunity when three year futures were around 96, 34 current levels are not really compelling and we prefer to wait for a pullback. Thanks, and back to you Simon.
Simon:
Thank you Su-Lin. Now I'll discuss the Bank of Canada. Um, so we're in line with consensus and market pricing and seeing no change in the overnight rate at tomorrow's statement only Bank of Canada meeting the chances of a rate hike are, are significant. Shift in language or guidance at this meeting is extremely low. The B O C gave a relatively firm conditional pause message at their January meeting and has reiterated the core aspects of that in subsequent communication over the last month. Now when we're looking ahead, you know that you can give a case for the next move being a hike, which is, you know, likely more in the short term if that is gonna happen or the case for the next move being a cut from the bank, which is likely to be a little bit further out. Uh, the case for the next move being a hike, um, is that although a lag indicator, the labor market is very tight by historical standards and at about 4.5% wage growth is well above the 3% rate consistent with 2% inflation.
Uh, moreover, momentum has remained strong in 2023 in the labor market. Uh, and higher wage growth is a key domestic inflation risk. Uh, as well price deflator data in the Q4 national accounts, so including personal consumption and final domestic demand have not shown the same amount of moderation as the in the CPI data underlying activity in the Q4 g d report was better than the headline print. So headline came in that just flat, but consumption was up about 2% annualized and also January plus three tenths. Now cast suggest positive growth in q1. Now those are, those are the case for the next move being a hike for for the next move being a cut the case is really the Bank of Canada's delicately balancing right now a desire to see more information with a willingness to move if it deems necessary. So it really wants to assess whether it's done enough tightening it thinks it has, but doesn't want to completely rule out, uh, another move.
So we think with enough patience it will weight out the firmer labor market data period and they're already completed. Rate hikes will slow the economy and the labor market as 2023 evolves. The BOC is well aware that monetary policy works with a lag. The issue is whether they will have the latitude from price and wage data to stay on hold for now. If they do wait it out, then steady rises in the debt service ratio. So crimping household consumption and inflation moving towards 2% should see them leaning cut by the end of this year. We ultimately see them on hold in 2023 before delivering a hundred basis points of cuts in the first half of 2024 and 150 basis points in total in 2024. Uh, now in terms of our recommendations, given the lofty level of yields, we do like being long duration here with an active recommendation in the tenure sector in cash on the curve. We continue to see it as too early for front end related steeper. So twos, fives or twos tens, but do think five 30 and tens 30 steep nurse can perform from here. Uh, now, uh, we'll shift to Elsa on FX. Elsa.
Elsa:
Thank you Simon. And hi everyone. I'll keep my comments brief but focused on the Canadian dollar. You just heard from Simon about the balanced outlook for the Bank of Canada. We just got back from one week speaking to Canadian investors in Toronto and what stood out to us was that the domestic investor base does lean a bit more towards a pause from the banks Canada than perhaps international investors do, who expect the bank to follow the signal from the rest of the global central bank complex. We've gone with short CAD Swiss for automatic trade of the week and it may sound like a very strange cross. It's not one that we typically tend to do, but there was a good reason for choosing it. In the current environment. FX markets are very dollar directional, US dollar directional and the US dollar in turn is taking its queue from the signal from rates and equities.
In the current moment, we find that both rates and equities are some going sideways. We're lacking that directional signal for the dollar and there's quite a lot of us event risk coming up in the week ahead. So our reason for choosing CAD Swift is that it's the most neutral CAD cross to general US dollar direction. From a positioning perspective, our internal positioning metrics show the market still pretty long dollar CAD around 44%, um, but also similarly long dollar Swiss around 47%, so roughly similarly sized short CAD and Swiss positions against the US dollar. And finally, just to mention the employment data that we have coming up this Friday. This employment report comes on the heels of two upside surprises and significant upside surprises, both larger than two standard deviations. Typically what we found in past experience, and admittedly the sample size is very small, but typically we tend to see a bit of pay back in the data. And so given the event risk coming up in the week ahead, our desire to have a US dollar neutral pair, um, we have gone with short CAD Swiss on a tactical one week horizon more broadly. We still retain, uh, somewhat constructive view for CAD on the crosses, but we're selective about how we play it. And for our latest forecast, I'd refer you to our currency report card, the March edition of which was published just late last week over, back to you Simon.
Simon:
Great, very interesting, Elsa. Now we'll finish up with Adam Jones on IG credit. Adam,
Adam:
Hey, yeah, good morning. Um, yeah, credit's been interesting. I mean we've had, we've had a giant rally, uh, starting basically October of last year. Um, most, most obvious in Europe where we saw like a hundred basis points in, uh, in their equivalent of Corp os, you know, European bond spread index. Uh, in the us you know, we came in from wides of 1 65 into like one 30 just to start the year. And people definitely came into the year thinking, well, we just had a rally. Um, that's probably just some kind of, you know, bear market rally and we probably go wider from there. And in fact what happened was we, we just continued the rally all the way through January, February. Europe total rally was like over a hundred basis points in the us We came into 115 on Corpo is so like another 15 or 20 bits from, from the kind of range we were in on the way into the year.
Um, and in some ways it's had people scratching the heads, you know, I mean we've obviously seen the rate backup recently. Um, we've seen stocks pull back from, from peak and credit as far as you know, as far as any give up in spreads has been very marginal. US only widened 10 basis points when, uh, when we saw s and p drop a good 300 or almost 300 points from the peak and we withstood a 60 bit backup in rates. Um, why have we had that? I mean, what people are pointing to, first of all, they've been inflows into the asset class. I think we've seen about just shy of 40 billion of inflows year to date. And frankly, it's, it's yield driven. You know, for the first time in a long time. You look at the all in yields on, on the investment grade paper and you, you see some attractive looking numbers.
Um, and that is just pulling money in. And you know, just anecdotally, I know many individuals who have been allocating capital to fixed income who previously didn't really consider it an investible asset class because everything was artificially tight. Now, against those inflows, there has been decent issuance. February was particularly robust in the US We had like, I think about 140 billion in February, which was a very heavy February. Um, some of that is probably March issuance being pulled forward just because the conditions were there. Uh, but it's all been absorbed very well now. We've, I mean, there've been a couple of deals that perhaps haven't gone so well, but broadly speaking, it has been well received. Uh, we're still awaiting, you know, financials to come a bit more that's been a bit lighter than expected. Uh, there are also some tech deals in the pipeline, but they're all kind of fairly well telegraphed.
And for me at least, there's this sense that, you know, too many people have been looking for a widening and the pain trade therefore is just tighter. And that seems to be what we're getting. And you know, if you just, if you trade this, technically the charts look good. The the pullbacks have been light, frankly, things feel pretty good. Uh, so the, you know, the only bit that people are grappling with are things outside of credit. You know, there's the, the backdrop of is there an impending recession? People are, you know, there's doom and gloom all around and credit is wondering, you know, are we the asset class that's getting this wrong or not? But nevertheless, the technicals have remained supportive and the performance has been there. So, you know, we're probably meant to ask ourselves, well, what if credit's right? And actually things aren't as bad as everybody's worrying about, you know, if, if we do see a balance in stocks from here with credit already where we're trading, you know, it's not inconceivable that we, that we take out recent tights and maybe see cor os through a hundred basis points, uh, which I think would be a tremendous pain trade all round.
Um, therefore to me at least it's worth thinking about.
Simon:
Great. Thanks very much Adam. And thank you very much for, uh, joining the macro strategy call.
Speaker 7:
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