Macroeconomics: The Day Ahead for 2 February

Today is primarily about the ECB and BoE following on from the Fed, though there will be a barrage of earnings, headlined by Alphabet, Amazon and Apple, while the data schedule is very light, with German Trade to digest ahead of US Challenger Layoffs, weekly jobless claims and Factory Orders. In addition to those three tech behemoths, there are results from JD.com, Marubeni, Mitsubishi UFJ, Mizuho and Sony in Asia to digest, with Europe featuring Banco Santander, BT, Deutsche Bank, ING, Nordea and OMV, while North America also has earnings from ConocoPhillips, Eli Lilly, Estee Lauder, Ford Motor, Gilead Sciences, Hershey, Merck & Co, Qualcomm, Rogers Communications, Starbucks and US Steel. Govt bond supply takes the form of multi maturity sales in France and Spain. There is also unusually, a busy run of SNB speakers.

** U.S.A. – FOMC meeting **

The Fed rate hike was as expected, and the accompanying statement pointed strongly to at least two further rate hikes, with the replacement of the “pace” of further rate hikes, with “extent” being nothing more than an adjustment to reflect that it has, as Powell said, covered a lot of ground, and is back at a “normal” 25 bps pace. Both the statement and Powell stressed that inflation remains too high, while acknowledging that it has slowed, but also that the labour market remains ‘extremely tight’. There was a good deal more confidence expressed about engineering a soft landing, but it was Powell’s acknowledgement of a nascent ‘disinflationary’ trend, and a relatively sanguine view about the easing in financial conditions, attributing it to a difference of opinion between the Fed and markets, adding ‘we will have to see” (which one is right), and the hint of a possible pause after another hike in March (given that Powell mentioned the Fed could go back to alternate meeting rate hikes), which appeared to prompt the sharp push lower in 2-yr yields, and the accompanying bounce in risk assets. The fact is that Powell & Co will rightly view the difference between a 4.75%/5.0% and 5.0%/5.25% Fed Funds target being moot, given that the cumulative tightening would be 475 bps or 500 bps, therefore this is a battle which they are not interested in fighting, and rather save their energy for ensuring markets understand the no rate cuts in 2023 message that they have given consistently, and if they do too much, then they can always beat a retreat if needed. The problem remains that the curve, which saw a somewhat surprising parallel yield shift lower has all the good news already discounted, and if tomorrow’s labour data proves robust like JOLTS Job Openings, rather than soft as per the ADP, then markets will probably need to reprice on rates, perhaps sharply. Tangentially and as a prima facie example of lack of market liquidity, the US’ 6-month Sovereign CDS has now spiked to the same level as 2011 debt ceiling debacle, which is no way a reflection of the level of relative market concerns about the current debt ceiling stand-off, but rather very poor price formation due to lack of market depth.

** Eurozone – ECB rate decision **

By contrast to the Fed, the ECB has been emphatic about ‘staying the course’ on hiking rates, though markets while discounting a further 50 bps rate hike this week (Depo 2.50%, Refi 3.0%), had been veering towards a 25 bps rate hike in March, despite all but a few doves signalling 50 bps at both meetings. The week’s CPI and GDP readings in effect only strengthen the case for a very a hawkish tone from the ECB, given that the larger than expected fall in headline CPI was all about the impact of energy subsidy adjustments, and the absence of the German reading imparts some risk of an upward adjustment to the final reading. But more important was the unchanged but higher than expected core CPI at 5.2% y/y, and above all the rise in core ex-Energy & Fresh Food measure edging up 0.1 ppt to a fresh high of 7.0% y/y. The better than expected Q4 GDP (even if distorted by the Irish data) also confirms that recession risks in the Eurozone have eased, per se also blunting the cause of the doves. Lagarde will likely suggest that the growth outlook has improved, but what the focus will be said about wages, which are clearly becoming more of a concern, with even the very dovish Panetta conceding that a wage price spiral must be prevented, as well as the view on energy price falls. Should the statement see little change to this section “In particular, the Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target”, this would underline their hawkish narrative, especially if they were to add ‘at the next several meetings’. The other focal point will be on the impending start of balance sheet reduction (QT), and on any further details on timing and implementation, and above all on any discussion about how this might interact in policy implementation terms with rate policy, i.e. the extent to which QT might mitigate some of the upside pressure on rates. The risks are skewed to markets being unpleasantly surprised by ECB hawkishness.

** U.K. – BoE rate decision ** 

The BoE is seen as having little choice in having to hike rates by 50 bps to 4.0% following the only gradual drop in headline CPI and stubborn core inflation, as well as the uptick in Average Weekly Earnings (even if, as previously noted, adverse base effects are clearly playing a role). That said, a few forecasters have wound back forecasts for this meeting to 25 bps, and a good number in both camps are expecting the BoE to signal a pause. But the key questions are on a) the voting, after Dhingra and Tenreyro voted for no change in December, while Mann voted for +75 bps, underlining deep divisions on the MPC, and b) the extent to which GDP forecasts are revised higher, as well as longer term CPI forecasts, given that market rate expectations have been wound back quite sharply since November’s Monetary Policy report, and are now even entertaining the prospect of a rate cut by year end. It will also be interesting to see if Hunt’s tight fiscal policy stance is seen as mitigating the need for an aggressive rate policy. It is possible that the already quite ambiguous signal on future rate moves becomes even more vague, though an outright pause signal would probably have to be couched in terms which emphasize that the risk would still be for higher rates if needed, and not opening the door to ‘pivot’ chatter. Given the divisions on the BoE’s MPC and high level of uncertainty around the policy outlook and UK economy, it may well be that GBP FX market reaction to the BoE decision proves to be rather more volatile than EUR to the ECB decision.