Macroeconomics: The Day Ahead for 4 May

The heavily anticipated US FOMC meeting will be front and centre of the day’s proceedings, even if the Ukraine war, China’s Covid-19 battle and India’s extreme weather are likely to cast a shadow, and holidays will continue to thin trading volumes, and thus only add to already high volatility risk. There is a busy run of data and surveys, headed by Services PMIs/ISM, with Australia’s Retail Sales, UK BRC Shop Prices and German Trade Balance to digest ahead of UK Consumer Credit and Mortgage Lending, US ADP Employment and Trade, but this is all likely to be little more than statistical roadkill. Brazil’s BCB also meets on rates, with a raft of further policy meetings tomorrow. Another busy run of corporate earnings has Equinor and Volkswagen in Europe, with Albemarle, Cheniere Energy, Chesapeake Energy, CVS Health, Marathon Oil, Moderna and Yum! Brands to be among the headline makers in the US, and EcoPetrol and Grupo Mexico topping the run from Latin America, with Germany unusually re-opening its 2031 Bund, by dint of local issuance rules.

In terms of the data and survey run, Services PMIs: the resilience in the Eurozone despite the Ukraine War, and some loss of momentum in the UK (though still robust), is likely to contrast with anecdotal evidence suggesting a potentially sharper than expected pick-up in the US Services ISM, as the sector continues to benefit from the general lifting of Covid-19 related restrictions, and above all noticeable in the leisure and travel sectors. This will contrast sharply with tomorrow’s China Caixin Services PMI that is expected to slip deeper into contraction territory (40.;0 vs .42.0) after already sliding heavily in March, mirroring the already published official NBS PMIs. As for the US ADP Employment report, for the first time in a very long time, the ADP report was broadly in line with the official labour data, and as ever the consensus forecasts for the two are little different, but the record over the past two years suggests that a) the ADP remains a very poor predictor of Payrolls, but b) quite well aligned with Employment measure of the Household survey. However with the FOMC meeting in focus, the ADP report will have to be a major outlier to have any impact, and an outlier would likely be swiftly dismissed as unreliable.

** U.S.A. – May FOMC meeting **

The Fed is expected to hike the Fed Funds Rate 50 bps to 0.75%/1.0%, and kick off its balance sheet reduction (QT), with $35 Bln per month initially, starting in the middle of May, and move quickly up to a $95 Bln/month pace by July.  But with markets pricing a roughly 50/50 chance of a 75 bps move at this week’s meeting and no dot plot or summary of projections, there will be questions at the press conference about the possibility of a 75 bps move in June, given that many Fed speakers have signalled a desire to get to a neutral rate of 2.50% as quickly as possible. But it is the QT programme which will get most attention. Initially it should be remembered that the current volume of Fed Reverse Repo Operations stood at a record $1.907 Trln as of Friday, and that this will serve to provide a significant buffer against the impact of QT for a while, and obviously underlines that banks have been  drowning in an ocean of ‘excess reserves’, though they are already falling quite sharply above all in latter half of April, when UST yields spiked. One can add that the US Treasury, which has seen a very sharp rebound in its balance at the Fed ($954 Bln) is well prepared for QT, and will still be able to reduce auction sizes somewhat further, but this is probably rather moot given a) it still has a borrowing requirement of $2.6 Trln for the current fiscal year, and b) US Treasury yields have sky rocketed, with the 10-yr up from an end year level of 1.51 to 2.94 on Friday. Equally important is that we are in a collateralized lending environment, so reduced auction sizes and the Fed running down its balance sheet passively (i.e. as Notes and Bonds mature) reduces the pool of collateral. With volatility in all asset classes, above all commodities, and the volume of margin calls and failed trades on the rise as a result, collateral is much in demand, but availability is becoming increasingly scarce (doubtless also underpinning the USD, well beyond any consideration of forward rate differential between USD and any or all of CNY, EUR & JPY). Thus with the war in Ukraine becoming ever more entrenched, and per se raising the risk of a shock due to Russia taking precipitous action, the chances of a money market seizure are also on the rise. The latter is rather more significant than what Powell may say about inflation, the labour market or the economy, above all due to still high levels of leverage, which in turn means that as much as markets are discounting ever more in the way of Fed tightening, there is a risk that Financial Conditions, which remain no higher than the most accommodative levels seen pre-pandemic (see chart), may tighten much more quickly than the Fed would like, and force it into yet another volte face on rates and QT.

** Brazil – BCB COPOM policy meeting **

– Brazil’s BCB is expected to hike rates a further 100 bps, with the IPCA-15 inflation measure rising from 10.8% y/y to 12.0%, slightly below forecast, but offering little room for the BCB to opt for a less aggressive hike. Market expectations for inflation were revised sharply higher in the BCB’s April survey (2022 seen at 7.65% y/y vs. a March forecast of 6.86%), though reports suggest Campos Neto did sound a more dovish note in comments he made during the IMF/World Bank meetings, and the BCB may yet signal that it will pause to evaluate the impact of 1,000 bps of rate hikes since the current cycle started just over a year ago.