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“What a beautiful noise coming up from the street“

Neil Diamond, Beautiful Noise

Last week, we discussed the main events in the global macroeconomic space across fiscal (the UK Budget), monetary (the ECB meeting) and an update on the growth / inflation trade off in the US (the February employment report, or NFP).

With regard to the UK Budget, we made the point that, what effectively amounted to some minor election sweeteners (with the additional spending peaking at around thirteen billion pounds this fiscal year), were of secondary importance for the UK growth trajectory (and likely by extension the government's popularity - if that is not an oxymoron at this stage). Instead, the most significant impact on the UK economy going forward is likely to be a function of disinflation and the MPC reaction function to lower prices. In that regard, we suggested, it was more important for the Chancellor to maintain the fiscal rule and not make any significant waves in the gilt market. It could clearly be argued that the Chancellor achieved this objective of having minimal impact - the rest is likely down to domestic demand and the Bank of England.

Secondly, we discussed the ECB and their decision to leave the deposit rate unchanged at 4.00%. Again, it was the inference or rhetoric from the ECB that was more important than their action, as Lagarde guided market expectations for the start of the rate cutting cycle to the June meeting with the pointed statement “we will know a little more in April, and a lot more in June” - despite the dovish trajectory of the forecast revisions and the market bias.

From our perspective, however, it is the growth / inflation tradeoff that remains the critical piece of the current macro puzzle. While last week, the narrative from Powell (and backed up by recent rhetoric from wider Fedspeakers) was “not far”: the Fed are not far from the level of conviction needed to begin dialling back the level of restrictiveness of monetary policy. The market continues to need corroboration from the data to re-engage in the monetary normalisation trade (especially at the front end, where the pullback at the start of the year likely hurt many participants). Indeed, last week’s data revealed weakness in factory orders (Jan), ISM services (Feb) - especially in relation to prices and employment - activity moderation, and even the February employment report into the close of this week (where despite the higher than expected headline jobs gain, we saw significant revisions to the January print and a jump in the unemployment rate, indicating further weakness in the household survey relative to the establishment survey. All of these indicators continued to highlight the trend of growth moderation. More importantly, they have also continued to validate our interpretation of the macro backdrop.

This week was much more sedate from the perspective of the data calendar. While the growth data continued to highlight a trajectory of moderation, with retail sales rebounding less than expected from a (downwardly revised) fall in January, the inflation data continued to be noisy.

The CPI print ticked up at the headline level to 3.2% y/y and fell slightly less than expected on a core basis (3.8% y/y) in February. Some analysts argued that while the February data disappointed, the composition remained disinflationary, with the important ‘non-housing services’ dropping back sharply from the ‘January bounce’ and OER also falling back into line with the recent trend. There are still many who view the recent noise in inflation as validation of their assessment of sticky inflation and/or higher for longer rates. However, Core PCE (the Fed’s preferred, or most policy relevant measure of inflation) continues to be better behaved and trace a smoother disinflationary path.

Indeed, later in the week we got the release of the PPI which again had its fair share of noise. While the print highlighted continued strength in core goods and services, much like the CPI print, the components that map directly into the PCE calculation (important for the FOMC next week) were marginally biased weaker. However, the noise in inflation, even against some signs of growth moderation, are not enough to bring the first rate cut in the US forward… at least while growth moderation remains contained)

While this week has been relatively quiet from a data perspective, next week is a lot more noisy. Noise that is predominantly focussed on the array of DM central bank meetings. The Reserve Bank of Australia and the Swiss National Bank are likely to be less of a focus, with the RBA likely holding rates steady as they continue to assess the tradeoff between immigration fuelled inflation and growth moderation. The Swiss National Bank is more of a focus, with many commentators expecting the undershoot in Swiss inflation top result in a (perhaps significant) near term rate cutting cycle. However, next week may still be a little early in this regard.

First up next week will be the Bank of Japan, where expectations have grown for a simultaneous removal of both the Negative Interest Rate Policy (NIRP) and the Yield Curve Control (YCC). There has been a raft of headlines from local news agency Jiji this week in this regard, and commentary from a number of BoJ members (pre blackout) suggesting that the decision to normalise policy will be made with specific reference to, or analysis of the recent wage bargaining rounds. We have also made the point that the BoJ were likely to make the move away from maximalist easing policies when the global policy direction turned dovish - at the very least to offer some protection against a disorderly rise in the yield curve. Recent rhetoric around the likely imminence of the hawkish policy move and little reaction in bond yields suggests the BoJ may have achieved this goal.

In the UK, we get the Bank of England meeting next week. Having last week argued that the fiscal event was of secondary importance to the growth (and even political) backdrop relative to inflation and the monetary trajectory, there have been some significant developments in that regard. The labour market data this week came in the soft side, as rebalancing of the demand and supply of labour continues and job openings decline, nudging the unemployment rate higher. Furthermore, expectations for the March inflation print is for a further sharp deceleration, setting what we see as dovish backdrop for the MPC. At the Feb 1st meeting, the MPC voted 1:6:2 (6 votes for the Governors proposition - unchanged rates, 2 dissents favouring a 25bp rate hike, and 1 dissent in favour of a 25bp rate cut). Our view is that next week’s meeting will bring a vote of 8:1 (with the singular dissent being in favour of a cut). This would be further dovish iteration from the BoE and open up the prospects for an earlier start to the rate cutting cycle in the UK - especially if, as we suspect, the growth backdrop turns out to be weaker than the current headline data suggests.

The biggest focus for markets next week, however, will undoubtedly be the FOMC. Unlike the Bank of England meeting, the FOMC meeting brings with it updated Summary Economic Projections (SEP’s) and new ‘dots’ - the Fed governor projections for interest rates over the three year forecast horizon.

The US data for 2024 so far has been noisy. Labour market data has continued to demonstrate a rebalancing of supply and demand (with immigration a notable contributor - likely also driving equilibrium jobs growth higher), keeping wage inflation on a moderating trajectory. On the growth front, the retail sales data this week has driven further downward revisions to the Q1 GDP tracking (Atlanta Fed Nowcast was revised down to 2.3% q/q annualised from a high above 4% in initial estimates). Inflation has also been on a continuing disinflationary path, albeit a noisy and complex one (with conflicting signals from some subcomponents).

Ultimately, we remain of the view that disinflation and growth moderation will continue to be the dominant macro force for financial markets for coming quarters. With interest rates “well into restrictive territory” [Powell] this continues to argue in favour of a path of rate cuts in the US. Markets will watch very closely at the updated ‘dots’ (we would expect the median dot to remain indicative of three rate cuts in 2024). The inflation and unemployment projections in the SEP’s will also be of critical importance for the policy evolution and for market expectations.

Lastly, while the ECB meeting is now an almost distant memory, it is perhaps the ECB pricing that may have the biggest surprise next week - at least relative to expectations. So far, the ECB rhetoric combined with the Fed ‘delay’, has kept ECB pricing quite orderly and centred on a June start and somewhere in the region of four cuts through 2024. Next Tuesday a conference in Frankfurt will bring commentary from the three (arguably) main voices at the Governing Council: Lagarde, Lane and Schnabel. Any change in messaging, however unlikely we see it as being, would have a disproportionate impact in the volatility space.

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