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.
Jason Daw:
Welcome to this edition of Macro Minutes called When. I'm Jason Daw, your host for today's call, which we are recording at 9:00 AM Eastern time on April 2nd. The question on everybody's mind is when central banks are going to start cutting rates?
Over the past month, market pricing has progressively gravitated from a near certainty that the BOC and the Fed would cut by June, to now under a 50% chance. In the UK, the pricing for a June cut is higher than a month ago, but less than two weeks ago. While for the ECB, the market has been resolute in pricing a June start date.
On today's call, I'm joined by Blake and Peter to discuss the nuances for each central bank and their monetary policy decisions and also Lori to tell us what this all means for the equity market.
I'm going to kick off the discussion today with the discussion on the nuances for Canada ahead of the April 10th meeting and divide the discussion into three parts. First, pre-GDP, second post-GDP, and third, post the business outlook survey. So to remind our listeners, our base case view for a long time has been for the Bank of Canada to start cutting rates in June. So we don't expect any change on April the 10th, but before the GDP report last week, we did think the odds for a June cut were pretty high, say 75% chance given that we've had two favorable CPI prints and a weak growth backdrop. But the combination of the stronger than expected January GDP report coupled with a firm flash estimate for February shows Q1 GDP tracking now at 3.5%. And this is a marked departure from the near zero growth over the prior three quarters. And if that was realized, it would be the strongest print since the second quarter of 2022. So that in itself has reduced the chances of a June cut to probably 60% chance in our opinion.
And then yesterday, we got the quarterly business and consumer outlook surveys. These are two things the BOC has cited in their policy minutes that they're watching to determine when the cut, specifically corporate pricing behavior and inflation expectations. These indicators in the quarterly surveys broadly moved in the right direction, but only marginally. So the odds of a June cut increased slightly to maybe say 65%, but there is a lot of wood to chop between now and the June meeting. We get two CPI reports the February GDP report and the full Q1 GDP report. Given the uncertainty the Bank of Canada is unlikely to become more dovish at the April 10th meeting. And as we've said many times before, the risks are for the Bank of Canada to start later than our June forecast.
And finally, before turning it over to the next speaker, I wanted to briefly talk about one of my favorite topics that is linked to monetary policy, namely the shape of the curve. A few weeks ago I wrote about why the yield curve could be inverted at the end of this easing cycle. It's never happened before, but it could happen this time. And I think specifically if the Bank of Canada only delivers the 200 basis points of rate cuts that are priced into the forward market, a material steepening is unlikely. And this would be consistent with a soft landing, a moderate cutting cycle that we've seen in Canada before and that we've also seen in the US. So on a carry adjusted basis, flatters seem to make more sense to me here.
Now over to Blake to tell us about US macro and policy after we got the Waller and Powell comments last week that suggested later cuts than what we've penciled in so far.
Blake:
Yeah, thanks Jason. And it's been a very eventful return from the long weekend. We've seen over the last two days the biggest sell off since the January CPI beat that has taken tens through a 435 level that they tried and failed to break both in February and March. We've got 2024 cut pricing at new highs with about 2.5 cuts this year versus our call in the Fed SEP media and at three cuts. But I would say compared to that January CPI sell off, the fundamental catalyst for this one is a lot less clear.
As you mentioned, we had Powell speech over the weekend. I think it leaned a bit hawkish similar to Waller. But in both of those speeches, I didn't really see the cautious and patient themes that they were hitting as necessarily precluding a cut in June or the SEP median path of three cuts this year.
Both of them left that door open to seeing confirmation in the next few CPI prints of which we will have three of before that June meeting. Both of them left that door open to the inflation data performing better and then still getting to those cuts by June. So that cautious tone, talking about being patient, I didn't really see that as necessarily different than what we've been hearing from them in recent weeks. If you could really point to one bear sheet, it was probably the ISM Manufacturing print we had yesterday. The headline index unexpectedly jumped into expansion area territory and the prices paid reading was the highest we've had since July 22.
Interesting though, much of the sell selloff actually came before that release. I think the ISM print yesterday surely playing a role in the continuation of that move today. And keep in mind we'll get a look at the services side of ISM on Wednesday, but expectations are for that to remain solidly in expansionary territory.
So really don't see that theme reversing the other data highlight we're going to have this week. Obviously at a P on Friday, our economics team's calling for 213,000, which is pretty close to what we see as consensus right now.
Prior to the last two days, I probably would've said that the risk around that NFP print or skewed to the downside. Powell took a bit of a bite out of any beat at the FOMC press conference. He suggested that weak labor market data could accelerate cuts, but the hot labor data wouldn't necessarily push them back any further given that I would've leaned towards receiving the front end on a miss and fading any dip on a beat. But now with the momentum towards the sell off over the last two days and we've got momentum based accounts, CTAs getting involved, I could see an NFP beat now adding to the fire of that sell off and really wouldn't want to be long going into it.
Anecdotally, we've had conversations with a number of real money accounts noting buying interest in this 430 to 450 range in tens. But given the speed with which we've moved through that, the lack of clear fundamental catalyst, I think those buying targets are probably movable go posts. We'll be keeping a close eye on cash flows coming in to see if there is any buying on this dip, but my guess is that some of that is going to be relatively light. And to that point, I think the no landing higher for longer higher term premium narrative still seems to be dominating over soft landing and hard landing tail risks. In conversations we've had in recent weeks, that august, October 23 selloff has been invoked in many of those conversations. So something that's really at the forefront of people's mind.
And like I said, even though we've had anecdotal comments from real money that they would be buyers in this 430, 450 range, I think with that sell off last year in the back of people's minds it's a little bit harder to get there.
If we do see all these things line up. If we get strong ISM services see a strong NFP, we continue to sell off. I do think the next level is in that 450, 460 range that people are really looking at. I do think it's going to be difficult for 450 to become a new four for rates for us to really move into that 450 to five type of range that we saw last year unless the march inflation data starts coming in hot. Because remember from the Feds' perspective, inflation data I think is still really the key metric here.
That is not something we are currently expecting. And overall I think most of the markets seem to be pretty comfortable that January inflation print was a one-off, which is really what the Fed's been saying in their communications as well.
If that is the case, if March inflation data confirms that return towards that late '23 inflation trend, I think it's very hard to see us pricing any closer to two cuts than we are right now. Anything closer to two cuts really starts to look like pretty attractive tail insurance with eight months still left in the year for this reason, I'm probably leaning a bit towards steepeners here just given that any further sell off from here, that momentum is most likely to hit beyond the belly if you have that fed pricing hitting a bit of a ceiling.
Overall, I think outright directional curve positioning seems fairly light as well other than long held structural longs and steepeners at real money. But I think those are going to be very difficult to shake out. I think the focus right now in the market is still on finding carry opportunities, selling ball, et cetera, more than outright positioning for a duration or the curve.
Jason:
Okay, thanks a lot Blake. Now over to Peter to tell us if the lay of the land is different for the ECB or Bank of England.
Peter:
Thank you Jason. I would like to start with the ECB and would like to pick up in the name of the call for today, When. I think for the ECB it seems to be the clearest answer. Because a lot of the ECB speakers have outright mentioned June as the decisive meeting.
So we have a meeting next week, but I don't think there's going to be any fireworks here. I'll speak a bit more about that. But let's just zoom in on the June meeting. That is priced for near certainty. We have about 25 basis points priced that is most likely what they're going to deliver. Even the most ardent hawks have indicated June. So that seems to be what the market is correctly pricing in our view as well. We think that's when the ECB will start.
But in my mind the next question that's probably going to be asked is, what comes thereafter? What is the speed and what is the target? The latter is probably one that they don't really know. And because they don't know that, we think that the speed at which they will go it's subsequently to June is probably going to be slower than what the market is anticipating. And here I also think that the latest inflation figures that we had are quite informative. So just today, we had the latest pan-European inflation flash estimate. It came in slightly better than what the market was expecting, but when you add it all together combined with the previous the February numbers, it is tracking slightly higher, particularly on the core number than what the ECB was last putting out in their forecasts. And that probably means that even though headline inflation is behaving, core inflation is probably still slightly higher than where they were expecting it and they have to acknowledge that.
And in my mind what that probably means is yes, they will live up to their promise to cut in June, but we'll probably put the thought out there that the speed at which they will progress the rate cuts is going to be relatively modest. So we stand firm with our view that they will cut only three times this year where the market is pricing nearly 90 basis points. And we also think there is a decent chance that they will not get to the roughly 250 that the market is pricing.
Now let me quickly divert to the Bank of England and then I'll say something about the market before I wrap up. The Bank of England is not going to meet for a while, but the interesting thing here is that they have been late in converting to the rate cutting brethren across the Atlantic, across the English Channel.
And even though they haven't really fully endorsed the rate cuts as others have, the market is clearly also pricing that but slightly less. But what we had is a quite significant change in the voting pattern. The last two holdouts that previously were voting for hikes have fallen in line. And we do think that also the bank is on track to cut rates this year. And the question really is when, as the title suggests, for the Bank of England, I think it's probably the least certain here.
We forecast it will only go in August, but there is a possibility that they will go a little bit earlier. We have the next meeting in May where they will present new forecasts and it could be that they're preparing the ground for an even earlier cut maybe in June. We still think that August is much more likely, but clearly what they're saying will be carrying a lot of weight as regards to question of when.
And then finally on the market, Blake was mentioning that in the US we've now broken higher. In Europe, that hasn't really happened. 250 has been the line in the sand for 10 year bonds. We haven't really broken through there. 410 has been the case for 10 year gilts. We're still a smidge below that, but we do think that there is a decent chance that will break out in our markets as well. And for choice, what we hear from our clients is that the market is positioned slightly on the long side and we do think that the risk in the near term is probably to slightly higher yields, particularly against the backdrop of what I've been saying that the market is particularly in Europe pricing a little bit too speedy rate cuts for our liking.
Jason:
Okay, very insightful. Peter. Last up is Lori to tell us what this all means for the equity market.
Lori:
All right, so thanks for having me on today Jason. And for those of you who don't know me, I'm Lori Calvasina, Head of US equity Strategy at RBC.
And last week before the long weekend we did do some spring-cleaning on our S&P 500 forecast. So what I wanted to do today is just run you through some of the highlights and really put it in the context of some of the comments that Blake made in particular.
So three big things you need to know. The first big thing we did raise our year-end 2024 S&P 500 price target just 5300 up from 5150. This is our second revision. We have five models that we use to arrive at our forecast. Those of you who know me know I'm all about the math and the median outcome of those models is 5291. The range of outcomes is 5075 to over 5400. And I would say that latter number is really our case if our base case ends up being too conservative.
Now, generally speaking, we do consider this price target to be a compass. We're trying to guesstimate where the S&P is going to be on December 31st, but we don't really think of it as a precision tool like a GPS. We do think the strong move observed in the S&P 500 so far this year has been deserved and a rational case can be made for some additional upside from here. But some of our work is also suggesting that gains are going to be tougher to come by from here and the stock market frankly just needs to take a bit of a breather.
I don't consider myself to be overly bearish like some of my peers in the strategy world, and I do see more upside risk than downside risk to our call. I'm not saying the market can't go higher than our target, but I'm just not seeing it in our data right now. And so what you need to think about is just more information would be needed to get more bullish than where we are today.
So the second big thing you need to know, when we go through our models, we see some conflicting cross currents for stocks and that's just an unfortunate reality of where we are right now. The sentiment work that we run is the most cautious AAII net bulls are at one standard deviation above the long-term average. That's typically accompanied by a flat market over the next three months and muted over the next 12. And CFTC equity futures positioning data on the buy side is also well above the early 2018 and early 2020 highs. So that CFTC work is actually a bit more scary to put it simply.
I do think it's interesting to note in light of [inaudible 00:15:43] comments that AAII is right around levels that we saw in place last August when yields started to move up and equity started to sell off. That equity sell off didn't really stop until after we got the peak in 10 year yields. I also see the election as an ongoing source of uncertainty for the equity market. We tend to see below trend gains of about seven and a half percent in a presidential election year. And normally we do get a sell off that's pretty significant at some point in the first half of the year because of that uncertainty. We haven't seen it yet, but I'm wondering if that may change soon. Biden is starting to move up in some swing state polls and we are seeing a pickup for Biden in the betting markets. And that really runs counter to the assumption that I've seen for most non-US clients for Republican [inaudible 00:16:23] this fall.
Our most constructive model is actually our earnings yield gap model. The S&P 500 tends to do just fine when you've got a flat earnings yield gap of about 12.8% on a 12-month forward basis. And we did see that condition throughout the 1990s, so I'm actually not overly worried there. The most improved and now bullish model is actually our GDP test. The S&P 500 tends to be up about 12% when GDP runs in real terms between two and 4%. And right now the consensus is tracking around 2.1. That's a very big change from where we were last August when consensus forecasts were still about 0.6%, and even where we were to start the year when the consensus was looking for 1.3. And that's all very important because zero to 2% GDP is really economic purgatory for the stock market. Stocks tend to be quite weak in those kinds of backdrops. So that's one thing that is very, very different from last August and the start of the year.
And I'll wrap up by just talking about my valuation model and then a quick blurb on earnings. On valuation. Our model is projecting a trailing PE at year-end based on regression analysis between the S&P average PE going back to the sixties and factors including fed funds, 10 year yields and PCE. If we model in current consensus assumptions, which frankly I worry are a little bit stale, we come up with a trailing PE of 22.3 times or close to 5300 the S&P using my earnings forecast 237. You get the 5400 consensus [inaudible 00:17:46].
But there is one very important I wanted to highlight where we model in no rate cuts 10-year yields around 4.3%, which at the time I penned the piece was the recent high and sticky inflation with PCE at 4Q of 2023 levels. That points to a PE of around 20.9 times in an S&P 500 in the 4950 to 5100 range depending on whether you use my earnings or consensus forecast.
So as we think about what could pull markets down from here, and I listen to the risks that Blake and Jason have highlighted to the Fed views, I do think it's important to keep in mind where the S&P deserves to be if we just simply take out.
The improvement in the interest rate environment that's been modeled in so far. And then I'll just lastly leave you with a quick thought on earnings. Earnings do start late next week for financials. In the S&P 500, we tweaked our number up to 237 from 234, but we are still well below the consensus of 243 on a bottom up basis. The big difference between my number and consensus is I'm modeling in flat margins, and the Street is baking in some pretty hefty expansion. We'll end up seeing who's right.
Jason:
Okay, thank you everybody for joining today and thank you to our listeners for tuning into this edition of Macro Minutes. Monetary policy expectations has been a key driver of bond yields and the shape of the curve and central bank expectations are going to remain fluid this year. So please reach out to your sales representative or to us directly for further insights.
Speaker 5:
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