Peter Schraffik:
Welcome to our first edition of Macro Minutes in 2024 titled two. Good to Be True. This session is recorded on the 9th of January, 2024, and my name is Peter Schraffik. I shall be your host for today's edition. Bonds and equity markets have rallied sharply at the tail end of 23, essentially based on a soft landing scenario that see inflation back at target as early as Q2 24 in most cases, while growth is weakening but not descending into a fully fledged recession, this scenario would allow central banks to cut rates according to current market pricing as early as March or April and we'll see up to 150 basis point of rate cuts before the year is out from the feds and the ECB respectively with other central banks such as the Bank of England following hard on the heels. That being said, early in 24, most parts of the financial markets struggled to continue this theme and we think for good reasons incoming data was not as weak as some might have hoped for.
Particularly in Europe. Central bank speakers have been roaring back some of the more dovish rhetoric that we've seen and heard at the end of 23 and the fully expected on supply wave seems to have fully left some footprints into the market. Nevertheless, 10 bonds deals have now risen 25 through 30 basis points depending on where you look and equity markets have also given back some of the gains to make some sense of why these moves came about. I'm once again joined by a full suite of RBC experts and I'm sure we will all benefit from their insights. We'll start with Blake Gwinn talk about the US and the treasury market, followed by Gordon Scott who's going to fill it in on some of the recent data releases coming out of Europe. Jason Daw will tell us what the story is in Canada and our special guest today, Andrea Marcheggiano, will walk us through the early days of the credit market and particularly how the strong primary market pipeline has been digested. And with that I'll hand it over to Blake.
Blake Gwinn:
So I kind of wanted to do two things with my time today. One is just kind of level set, give a brief overview of some of the updates you were just mentioning given that it's been a decent gap since the last one of these calls that we've recorded. And then second, talk briefly about the Fed's quantitative tightening program or qt, just given that that has jumped back into the narrative over the last week. So first on kind of what we're seeing in markets right now after the So-called pivot at the FMC meeting in mid-December tens broke below 4% grow lower into year end markets started to pull forward the timing of the start of the cutting cycle. Of course, this move was happening against a backdrop of very low liquidity holiday trading conditions, so it's easy to kind of dismiss it a and sure enough, as markets came back in after the year turn started to hit reset, we saw yields pop back above 4% and they seem to be holding in a fairly tight range around that level, at least to start this week, markets have seemed to largely wave away a lot of the post FMC comments from fed officials that at least in our of view, haven't really been indicating any type of urgency around getting the cutting cycle started.
Even if the conversation about starting that cutting cycle has started, pricing for a March cut has come off a bit since just after the December FMC, but we're still showing greater than a 50% probability and 2024 year end showing more than five total cuts compared to the three that are shown in the median fed SP dot. I think when we look at the data that's happened over that time, we'd characterize recent data as pretty consistent with our call for soft landing. We've had evidence of further cooling and inflation labor market data has been holding in despite a continued reduction in tightness. We'll get another read on inflation later this week with a release of December CPI we're looking for a month over month core print just a hair below consensus. We have a high 0.2% month over month versus Bloomberg consensus is looking at a 0.3%, so a bit softer there than consensus.
Overall, nothing we've seen though over the last month either in the Fed speak I was discussing or the data has really materially shifted the views that we outlined in our 2024 year ahead late last year. And if anything, the modest shift in fed rhetorics the December FOMC, I think really serve to even out the bounce of risks around our call for a gradual adjustment minded cutting cycle kicking off in June. As I mentioned, we haven't really seen any signs of urgency where we would expect the Fed was trying to set up a march cut. Like I said, I think they've started that discussion process, but nothing they've said thus far I think really serves as a deliberate attempt to get the market's pricing in that March cut. So we haven't really pulled forward our cut from June, but I do think the odds of an earlier start are about now even with those of a later start relative to that June call.
Similarly with rates, I think yields may be able to hold onto relatively tight ranges into the January FMC where markets of the Fed likely going to have to start moving after that point more decisively in one direction or the other for the March meeting. But until then, I think we can hold and chop within these relatively tight ranges. Turning to the second thing I wanted to discuss, I think interestingly this last week has seen the market conversation focus more on the fed's balance sheet policy than rate policy for the first time in a very long time. qt, the quantitative tightening process received some airtime in the December minutes that were released last week and that was followed by a pretty detailed speech on the topic from Dallas Fed President, Lori Logan over the weekend. Both of those things start to really get markets discussing this topic a lot over the last few sessions.
After nearly a year with QT running largely on autopilot meeting, it got very little attention from either the Fed or markets. I think these mentions in both the minutes and by Lori Logan over the weekend represent a shift towards increased vigilance as the Fed is now trying to figure out how they're going to run down the program and when they might initiate that process and end the balance sheet rundown, the conversation as it arrived triggered a pretty large rise in swap spreads as well as markets started to contemplate the impacts of an earlier end QT on treasury supply and funding markets, very similar to the view that I outlined just a second ago with rates. I think the shift that we've seen in market expectations around QT over the last few sessions actually is bringing the market more in line with our prior view than the other way around.
We've long expected QT program to end around June, 2024, which was a lot earlier than I think most forecasters out there. L ls equal. The earlier QT ends, the less replacement issuance treasury will have to do and the more positive it's for spreads. Also, I think aside from the supply impacts, if the Fed is going to be more sensitive to funding markets and really proactive to avoid any September, 2019 type of repo blowout, that's also likely net positive for spreads. So we've written two pieces over the last week to go into this topic in much more depth. Given the limited time here, I would urge all of you to check those pieces out for our more in-depth comments.
Peter Schraffik:
Thank you, Blake. Very interesting and detailed. As always, let's move over to Europe and I'll give the floor to Gordon.
Gordon Scott:
Since the new year, we've had a number of data points which have pointed to a stabilization in the Euro area economy. This started with the bank lending data published last week. This showed quite a large increase in Euro area bank lending in November, the three month over pace of bank lending rising to its highest level since November, 2022. While half of this increase was driven by lending to other financial corporations, we've also seen an uptick in lending to both households and businesses and with both on a three month over three month basis back in positive territory. This improvement in loan growth is particularly notable as both we and the ECB had expected weak loan growth to drag on investment spending in 2024. Indeed, we'd thought that the main area of upside support to growth next year and would come from consumption, but nonetheless, the potential improvement in bank lending and hence investment represents a potential source of upside risk to R and the ECBs growth projections.
We've also seen as well an improvement and indeed stabilization in the survey data. This started with the PMI release where we saw quite a large upward revision to the December estimate, this unwound and reversed and the decline seen between the November release and the December flash estimate of an turning bat picture on its head. We also saw an improvement as well in the Euro area economic sentiment indicator and which measures business and consumer confidence. This saw a large jump in December with the improvement broad based across sectors. We've now seen three consecutive months of improvement in the Euro area economic sentiment indicator with services in particular, particularly firm having risen back to its highest level since April. Lastly, I would highlight the Euro area labor markets data that we got this week. This showed unemployment falling to 6.4%. Its lowest level on record, thus the Euro area labor market continues to remain resilient.
Putting all this together, where does that leave us? We still think that growth is likely to have been relatively weak in Q4, we're looking for a 0.1% Q over Q contraction. That being said, the data is now providing clear signs that the momentum and activity has started to turn and indeed that we're seeing a stabilization this should provide and the ECB with scope to continue its patient approach to watch and monitor and the developments in underlying inflation.
Peter Schraffik:
Thank you, Gordon. That's very, very insightful and I guess gives us a bit of a glimmer of hope. Let's go back to North America and Jason, what are we seeing in Canada?
Jason Daw:
So there's three topics related to Canada that I want to touch on, and these are related to both your introductory comments on bond yields and Blake's on the Fed and qt. So the first is Bank Canada policy. So we don't have a big disagreement at the moment with the directional shift that's happened in market pricing over the past two months. So if you recall that back in October, the market was only pricing around 50 basis points of cuts in 2024 and now it's closer to a hundred, 125 and we think for a long time now that the bank would cut a hundred basis points this year. But the biggest pushback we have with market pricing is not the direction of magnitude, but rather the timing. So March has adjusted back closer to reality in our opinion, but April seems a bit too early from our lens for the bank to cut rates unless the data deteriorates more than what our current forecast assumes.
So our base case is the first move happening in June. The second topic I wanted to touch on is bond yields. Now these have been closely linked to two factors over the past few years. One is market expectations for the peak in the policy cycle, and the second is rate cut pricing one year forward. And when you look at it from that standpoint, from a valuation perspective, twos and fives, they look a little bit rich. Tens and thirties, a little bit cheap based on this methodology. Nothing dramatic but still some deviations versus rate cut pricing in general. But I do think that the onus is still now on the data to be consistently weak to justify the current rate cut pricing and the bond yield levels that we're seeing. And it does seem like the path least resistance is for the more recent selloff in the past couple of weeks.
To extend a bit further before we can get another leg and lower, its throughout the year. The last topic I want to mention is funding pressures in Canada, which are elevated historically and especially high compared to what we're seeing in the US for some context. Cora has set well above the overnight rate for some time now and the Bank of Canada has started overnight repo operations to provide liquidity. Simon Deeley, my team, he's been ahead of the curve on the topic and I encourage anyone interested to reach out to him or read his publications, but in a nutshell, we're not surprised by recent funding pressures. We did think for a long time now that links balances could not get as low as what the Bank of Canada thought before QT needed to be abandoned. Previously. We did think that the bank would need to end QT start regular purchases and possibly term repos and Q2. Given the overnight repo operations they've been conducting and upcoming sizable maturities, the bank could announce an end to QT possibly as early as the next policy meeting on January the 24th. We think it's going to be difficult for them to continue with full passive QT through the large April 1st maturity schedule. For some context, 37 billion in bonds mature for which the Bank of Canada holds 23 billion of those. So that'll bring the links balances down quite significantly at that time. So therefore we expect an end to QT by early March at the latest.
Peter Schraffik:
Thank you. Jason. I think funding pressure is a good segue for our last speaker. Andrea, how's the credit market looking particularly against the backdrop of the early primary market activity? Thanks, Peter. Yeah, you mentioned at the start of the call the large recovery in rates into the end of last year well in European credits has enjoyed an even stronger recovery into the end of last year due to the compound effect of both rates and credit spreads tightening at the same time. To give an idea of the extent of the move we saww in credits, IR Maine, which is the major and most big indicator for credit sentiment in Europe, has traded an average of 75 basis points throughout 2023 reaching 90 basis points as recently as October before collapsing titer and closing the year inside 60 basis points, which is a level we haven't seen since January, 2022.
The end of the year rally provided a perfect condition for issuers to come to the market at the start of this year taking advantage of attractive funding levels. Historically, January has always been a period of very high supply, but the pace that we've seen so far is even stronger than what we normally see. Particular in credit denominated in Euros due to this heavy and concentrated amount of each ones spreads have seen a sharp retracement wider with I trucks bouncing back to 65 basis points and cash pairing even a lot worse, particularly in terms of spread versus swaps. Which brings me to an interesting point, which is Euro credited as a product is generally benchmark versus boons, but as we see boons underperform swaps, credit bonds also suffer. Hence due to the compound effect of both the swap spread tightening and heavy that we see that's left cash credit looking locally pretty attractive on a swap spread basis.
Taking a step back though, looking at things on a broader time horizon 65 base points on IRA is still the tightest level that we have seen in over two years when it averaged closer to 85 base points. Broader micro condition of course have improved as discussed over recent quarters with inflation coming down nicely and growth not being as bad as some feared. Hence we wouldn't expect credit to really reprise significantly wider from here, but equally, the current levels really don't leave much room or error. Fantastic. Thank you everyone. If I maybe conclude and summarize a little bit, I mean the data has been stabilizing as we heard from both Blake as well as Gordon and Jason. The market repricing that we've seen, we therefore think is justified, maybe even has a little bit further to run. We do question a little bit the timings in particular of the first rate cuts.
Peter Schraffik:
We heard that from Blake, we heard it from Gordon and we heard it from Jason. And even though we don't necessarily question in some cases the magnitude such as in Canada, the timing certainly looks a bit early what the market is pricing. And we would probably look for further correction here. Funding pressures remain a theme, particularly in the credit market as we just heard from Andrea. But overall in an environment where fixed income doesn't really seem to be falling out of bed, we wouldn't necessarily expect a significant underperformance going forward. So I think that sets us up nicely for the year. That gives us lots to get our heads around and we're pretty sure in the next edition that we're going to, we'll follow up with some of these themes. So with that, I hope everyone had a good start in 2024. Thank you for joining us today and to you're going to join us again in our next edition minutes.
Speaker 6:
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.