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.
Simon Deeley:
Welcome to the latest edition of Macro Minutes, entitled to the Limit being recorded at 9:00 AM Eastern on May 16th. I'm your host Simon Deley. Debt limit talks are ongoing in Washington with financial markets. Order jittery on US banking concerns, admit restrictive policy stances across many developed markets. Recent ECB speakers have generally noted expected for their hikes while the BOE left the door open and is dependent stance. B OT communication over the last month has emphasized that another hike is very possible and any talk of cuts is premature. How close to the limit will Central Banks take policy? To navigate this environment, we have a strong mix of RBC experts. Blake Gwinn will start off with an update on the debt limits. Cathal Kennedy will discuss views on the BOE and ECB going forward, and I'll give the latest views on the BOCs following today's cpr report. Adam Cole will join from the FX side and Michael Tran will provide an update on the oil market. And so to start things off, we'll pass it over to Blake.
Blake Gwinn:
Hey, thanks Simon. Um, yeah, so before I get in the, uh, debt limit, just real quick, wanted to kind of update if we had a Fed meeting, uh, last week and kinda on the rate space, um, you know, also after, uh, last week's c p print. Um, that's essentially put us about halfway through the major data releases that the fed's gonna see before there's your meeting. Uh, we still have one more CPI print, one more NFP print, but as of yet, we really haven't seen any, you know, glaring red signals that, uh, the fed's gonna need to hike again. Um, you know, with that said, you know, it's very likely that we're currently at the terminal rate and I think the bar, uh, to both further cuts and also, um, in turn to starting the cutting cycle are both extremely high right now. Um, looking back over the last year, I think volatility that we've seen in both duration and the curve has largely, uh, almost entirely been a function of the Fed path.
Uh, and we've seen kind of more longer term factors, you know, long-term expectations on inflation expectations, supply and demand term premium, things like that have, have really fallen to the wayside. Um, and in that environment, we've seen kind of traditional fair value models perform somewhat poorly and, uh, some of the best performers of, uh, explaining volatility in, in both, uh, outright duration. And the curve has really just been, you know, expectations of Fed path. If you, if you look at models, uh, that kind of take into account, uh, terminal pricing, take into account the cuts that are priced over the next year or so, you know, those have really explained almost the entirety of the volatility. As I said, both in duration and the curve. I think that environment continues in the summer, but now that we have, uh, very likely reached that terminal level, that means that really all we're left with is top pricing.
And I think that's essentially what we've seen over the last few weeks where, you know, increased expectations of cuts on, uh, banking stress, and then the reversal of that has, has been driving most of the moves we've seen, uh, both in duration of the curve. But with that said, I do think the, you know, cutting expectations being pushed out to later this year, uh, we're really not gonna get confirmation in one way or the other on what that cutting cycle, you know, when it's gonna start, how deep it's gonna be, we're not gonna get confirmation on that for some time. And I think in the near term, uh, that leaves us a bit range-bound on the narrative around cuts. We've seen markets very unwilling to sustainably price more than say 80 basis points of cuts into this year. And very reluctant to also take that cut pricing out to anything above kind of 50 basis points.
So if, if that cut pricing is essentially range-bound and kind of locked until we get new catalysts, um, and that is the primary driver of, you know, of, of outright duration moves and curve moves, that means those are also likely range-bound, uh, until we get some new information. You know, with that said, I, you know, given that we have kind of a longer term bullish view on rates and do expect curves to steepen later this year, I think the consensus position has, has really been to play those ranges from the long side and the steepening side. Uh, when we get to those extremes, you know, turning to the debt limit, just wanted to note that, uh, we did get an update from Chair Yellen <laugh>, sorry, chair Yellen, secretary Yellen now. Um, so my old said mode, um, secretary Yellen did provide an update on the timing around that didn't really provide a lot of new information and mostly just restated things that we already knew, kind of highlighting the risk of, uh, early June x date.
You know, we have started to update our forecast to take into account some of the additional data they've been providing on, uh, cash flows and the available, the available extraordinary measures they have to, they have to use to, to, to fund more spending. And looking at our forecast, we actually see continued risks that that actually pushes to sometime in late July, early August. We see that kind of reflected in the bill curve where we see, you know, the, the primary cheapening occurring in those kind of June, in that June region, but, uh, also seeing another kind of kink in the curve in July and August. So it's clear that, you know, the markets are kind of agreeing with this bimodal expectation that, uh, the, the X day could actually slip out of June and into July and August. But for this time, it makes a lot of sense for Yellen and for treasury to be focusing on, on that earlier date.
For a forecaster on the sell side's perspective, uh, we have the ability to kind of give our best guess, but from her perspective, she really can't miss, uh, on the early side. Uh, if she were focusing on a July date and then all of a sudden it became June, uh, that would be very, very bad for, for market. So it makes sense to us that she's really kind of hammering home this June date to keep the pressure on Congress, uh, and, and to really keep the urgency up around that date. Discussions are ongoing, we're gonna keep track of that and, um, be providing a lot of further updates as, as that situation develops. But right now there's still a lot of moving parts. Uh, and with that, I'll pass it back over to Simon.
Simon Deeley:
Great, thanks Blake. Very insightful. Now we'll shift over to Cathal on the situation in Europe.
Cathal Kennedy:
Thanks, Simon. Um, and, um, greeting to everybody, um, listening today, you mentioned at the, uh, top of the call, um, about the BOE leaving the door open, I think was how you described this. So what I'm going to do today is just gonna focus a little bit more on the Bank of England because, um, last Thursday's we think marked kind of an interesting point or an interesting kind of departure, if you will, for, um, the bank. Now to go back to the actual decision itself, the policy decision, a 25 basis point increase in bank rate to take it to four point half percent, and the vote split, um, a 72 majority in favor of, of that decision was very much in line with pre-meeting expectations. The background here was that after a series of upside surprises in the data, particularly in the pay and inflation data here in the uk, since the bank's last forecast rather than February, expectations had hardened going into the meeting that the Bank of England would be forced to, to, to respond.
I mean, after all, the bank had strongly indicated in February's meeting that were the economic data to surprise versus the forecast they would respond. So really, um, it was a bank just following through on that guidance they had given us. Now, we also thought that the bank would retain optionality going forward over policy. Um, essentially they wouldn't paint themselves into a corner by, uh, promising any specific action, if you will. Um, and indeed they did that. There was no mention of any pause. Um, and the language, the bank's language retains what we would described as a soft hiking bias. Um, they're still in practice referring to what might cause further tightening than what might bring the kind of current tightening cycle, um, to an end. But, and this is probably crucial, there was no directional steer on offer. Now I mentioned where that previously the bank had said that they would, it would react if the economy turned out, um, better than forecast.
And indeed before that they had said they would react if the bank, if the economy just turned out as forecast. There was no such steer on this occasion as to how to, how they would respond to the data in reference to forecast. And this is important because I have worked some big revisions to the bank, forecast, some very significant revisions. The GDP was revised upwards by the most, um, of any forecast round in the bank's sort of history of doing GDP forecasts. And indeed the, the sort of the, the headline grabber, if you will, was that they took the recession, the kind of long recession they had previously forecasted for the UK out of their GDP profile. Similarly, in the case of liver markets, they now see a much more, a much more gradual smaller rise unemployment going forward. Indeed, they actually unemployment the unemployment rate flat to the end of this year in terms of inflation.
They now see inflation higher for longer and indeed not running, returning to target until the end of 2024. So from a markets perspective, what does that mean? Well, from here we have to, it's much harder to get upward surprises in terms of the data versus the bank's new upward revised expectations. So it'll be difficult for markets going forward to price in more in terms of, of bank race versus what's currently in there just because data surprises should be that much less likely. Indeed. One thing we also noticed from the press conference was a comment from the governor that the current part of reduction in c p i inflation shown in the forecast was, well he described as appropriate Now by extension, that would also suggest to us that the market pricing for bank rate or the path of market pricing for bank rate on which that forecast was conditioned is also appropriate.
So to go from the bank's decision, the forecasts sort of market, market interpretation to trades. Now we put out a note in the wake of the bank meeting arguing that the underperformance of guilt cross market is coming to an end. Um, and essentially kind of the reason for that is that a large part, um, or a large driver of GI underperformance in the February bank meeting was that economic data that I mentioned previously beating expectations or at least clearly beating the expectations that the bank had. But for similarly, for the reasons I've just outlined, that relative surprise is unlikely to continue. So with 10 year guilt bond spreads at historically wide levels, we like 10 year guilt, uh, bond and tightness here, and have actually added a structural 10 year plan guild bond spread partner in our trade portfolio. And with that summary, reason Simon, I'll hand back to you.
Simon Deeley:
Awesome, thanks very much Cathal. I'll go ahead. Now switching to Canada BOC communication since and really including April meeting has emphasized their concerns on whether policy is sufficiently restrictive to get inflation all the way back to 2%. They've noted, you know, getting to 3% is, is is more easy, not that they've used that terminology, but you know, getting it all the way down to 2% is certainly what they're concerned about. Now we have seen a pretty sizable move lower in headline inflation in recent months. So that did sputter in today's DPI report where headlined inflation and actually edged up to 4.4% in April year. On year core measures are starting to move lower as strong monthly gains from a year ago roll off. But if you look at some shorter term core measures, three month annualized, um, they have actually edged up in today's report and month on month we're up four tenths, which is certainly higher than what the bank would want to see.
The main risk to persistent inflationary pressures or the main risk that would bring persistent inflationary pressures to remain to labor market where wage growth is trending around four to 5%. Headline, uh, rate in the main LFS report employment report above 5%. And these are definitely well above the above 3% level that would be consistent with 2% inflation. Financial system concerns have risen globally, but the BOC to data seen the impact on Canada as muted though acknowledged that larger than expected tightening condition would need to be taken into account by their rate setting, uh, the banking sector. So housing, mortgage, household debt and financial conditions will be in focus in this week's, uh, annual financial system review on Thursday. Uh, Marcus always look for monetary policy takeaways from the fsr. Um, and with the focus on risk vulnerabilities, these kind of tend to naturally, but with a doish interpretation though, given the CPI data today and the B C's messaging of late, uh, that may not be the case this year.
Our base case remains that the BOC is on hold for 2023 and we see the Bo C's communication as leaving them the option to hike if they deem necessary, and also attempting to avoid excessive pricing of cuts in the near term through this lens, the communication has been a success with the next three meetings up until this morning, pricing small chances of a hike and only 15 basis points of cuts by year end. You know, the move today, uh, with June and July meeting moving higher July, you know, roughly at 50 50, it's hard to argue with given what we've seen from the CPI report. Uh, but there is a decent amount of data including q1, GDP at the end of the month. Uh, so we do think there remains more to be seen and generally the bank would like to stay on hold unless the data really pushes them, uh, towards a hike.
The risk to our call, um, for cuts starting in Q1 of 2024 is that it ends up at a later start date. So overall, we have a hundred basis points in the first half of next year, and certainly given the bank's emphasis on making sure inflation comes back down to 2%, uh, the risk is there that that starts may be Q2 rather than q1, though we're, we're pretty comfortable with our call for now. Uh, signs of activity have slowing have been clear, so even before the recent pizza strike that's now settled in Alberta wildfires. Um, but uh, we we'll remain to watch the activity data and, and see if that is following what the bank expects, which is a slowing, uh, in terms of our market views. Um, recent yield rises leave us kind of leaning back towards long outright right positions in term yield. So for example, 10 year at 3 0 2 currently, uh, versus our year end forecast of two 70, though we are, you know, generally content to be on the sidelines for the moment. Uh, and with that we'll, uh, shift over to Adam to discuss the latest enough X.
Adam Cole:
Uh, thanks Simon. Um, so my, my comments, um, this week really followed directly from, um, castle's comments on the Bank of England and, um, the trade idea from Peter that followed from that. And, um, the, um, guilt versus buns has a direct ally really in, uh, Euro sterling in, um, our markets in fx. And for a couple of weeks now, Sterling has been outperforming the Euro and I sense the analysts are turning, um, more in that direction also. Um, bearish Sterling has been very much a consensus trade recently, and I think that's being called into question by a couple of weeks of out performance. I see that stir out performance and, and the reason to think it continues hung on various different, um, hooks. Um, partly it's clearly a rate story, but also people are citing more stable politics in the uk, uh, certainly compared to last year and some of the Brexit tail risk having diminished, um, in recent months, which I think is probably true also.
But really looking at the performance of Sterling in 2023, it has primarily been a short term interest rate expectation story that explains the great bulk of the variation in Euro sterling. And if Cattle's view is right and Peter's, uh, view on the, the relative performance of guilt is right, there are probably reasons to question that, uh, sterling out performance and that that indeed is where, uh, we come from that we are. If the debate in the UK is over, uh, one more hike or no more hikes rather than one more hike or two more hikes as we're priced in the Sonia forwards, then the risk is that some of that support from rate expectations that Sterlings has starts to, uh, fall away as we get through the, the indicators leading into the next Bank of England meeting. So we take the sterling out performance over the, um, the last couple of weeks as an opportunity to play our more medium term view, which is sterling negative.
Um, the medium term negative case builds on factors, um, like imbalances in the UK economy, the need for external funding for the domestic deficits, questions over the valuation of Sterling, which on the most important measures are towards the top of their 30 year range. And, um, several of these medium term factors are the difficult time in terms of how they play out, but does leave us looking for, uh, opportunities to express a negative sterling view. Um, and I think, uh, that's, um, that's something that we will be looking at, uh, the current conjuncture on the, um, basis of the, uh, mispricing of, uh, of rate expectations on a relative basis. So, uh, we played it tactically, uh, this week and last week through a short sterling position against the dollar. Longer term we'd be more inclined to pay in Euro sterling as the vulnerability to external shocks is more symmetric in the UK and Europe. So should, uh, should be as a longer term trade, more robust to, um, to those kind of big ous shocks. And with that back to Simon.
Simon Deeley:
Great, thanks very much Adam. Uh, now we'll finish up with Michael Tran on the oil market.
Michael Tran:
Hi everyone. So to say the oil market remains tricky is really an understatement. I mean, WTI prices have have traded both above $80 a barrel, followed by a plunge below $70 barrel, not once, but really twice over the course of the past two months. So here are three things to know for the oil market. The number one thing is the dearth of investor appetite. So in other words, positioning remains weak and investor conviction remains really low. Liquidity and volumes traded in the oil market are well below historically normal levels. Currently, investor length remains near the lowest levels on record. Now, many oil traders were bullish earlier this year, but not many were long. Not many were deployed. So we've said for months now that we simply need to see more players on the field. Now, just to, just to kind of shed more light on this, uh, a quant fund recently shared with me that he said the absence of fundamental investor activity in the oil market right now means that the price signals that we typically look for are being created by ourselves systematic funds.
I think that's both amazing and scary at the same time. Second point is on global crack spreads, which is indicative of demand and how that's been turning lower over recent months. Now this is a corner of the oil market that we've been bearish on for several quarters now. Many of our leading real-time indicators of travel mobility such as our goat index or get out and travel index have been inflecting, uh, lower heading into the summer, we can track everything from search interest for hotels to rental car bookings to fight interest, and those leading indicators have been trending lower at a rate of about eight to 10% on a year over year basis. So as such, we're bracing for a softer, um, than normal summer for mobility. Third and final point here is, uh, China's reopening. Now this was that this was and still is one of the biggest stories for the oil market this year.
We continue to see China's oil demand improving given the reopening, but we're seeing clear signs that a bifurcation is emerging between discretionary versus non-discretionary mobility. And we think the Chinese consumers pinching their wallet tighter than the market realizes. Look, we were really bullish on China following the exponential recovery of leading mobility indicators following Lunar New Year earlier this year. And then we saw a bearish inflection point in early April. We saw total 2023 flight counts flipped from a a run rate of 8% above 2019 levels to current levels that are about 4% below pre covid 2019 levels. The path towards normalcy in China is being pushed further into the future. Now to be clear, the year over year changes on Chinese oil demand should still be very, very impressive, even if it is not as strong as many were previously expecting. Now with that, uh, Simon, I'll pass it back to you.
Simon Deeley:
Excellent. Thanks very much Michael. And thank you all for listening to the latest macro minutes.
Speaker 7:
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