of the week ahead


Matt Jones

Welcome to "The Long & Short of the Week Ahead", a production of Eurizon SLJ Capital that takes a look at the macro-economic themes of the week ahead and has been recorded for professional investors.

My name is Matt Jones, Head of Distribution for Eurizon SLJ Capital, and I'm joined by Neil Staines, Senior Portfolio Manager.

Welcome back, Neil. Good to have you here with us again.

Neil Staines

Thanks very much, Matt, great to be here.

Matt Jones

So as we end October with Halloween and look into the week ahead, a lot of action from central banks over the over the coming week. So Neil, tell us, is it going to be trick or treat from the central banks as we look into the next week?

Neil Staines

Wonderful, yes, thanks Matt. You're right; as we approach Halloween, you could say that markets have been spooked by inflation. Amid or against the extension of inflation concerns that were the dominant feature of October, markets have started to challenge the reaction functions of the world's central banks. Last week, we talked of conflict and divergence, but as far as inflation and central bank direction, it's important to note our view that the magnitude of possible rate hikes between central banks is very different. But as far as inflation and central bank direction is concerned, the week ahead is more aligned as DM [developed market] central banks dominate our attention.

First up is the RBA [Reserve Bank of Australia]. Like most DM central banks, the previous meeting took place amid a calmer backdrop for inflation concerns and sensitivity of markets to the threat of dislodged long term inflation expectations that have now forced central banks to act sooner and more aggressively. For example, inflation break evens were very well behaved throughout the summer in the US until the end of September, before they've surged in October. That's a good example. At the October RBA meeting, there was a clear message; rates and the three year yield curve control target both left unchanged at 0.1%, with the narrative highlighting that the Delta outbreak has interrupted the recovery, that the economy was expected to bounce back as restrictions ease, but that wage and price pressures remain subdued. They even restated that the condition for rate rises will not be met before 2024, consistent with their three year yield control curve target. On the 19th, the minutes emphasised the RBA as committed to highly supportive monetary conditions, stressing that underlying inflation was more moderate than other economies, and this week we saw the quarterly inflation where the core measure just edged into the RBA's target band of 2-3% at just 2.1%, driven by potentially anomalous housing costs, although wage inflation remains very subdued at just 1.7%. Now, amid this inflation print, the Aussie swap curve is now pricing somewhere around 100 basis points of rate hikes in 2022 and a further 100 in 2023 - clearly in direct conflict with the RBA's yield curve control messaging. If we reconcile that against the April 2024 bond, we've got a very big gap indeed, that's the target or the anchor for the yield curve control. Tuesday will be a very complicated communication challenge for the RBA. Do they push back against market pricing? Reiterate commitment to yield curve control target at 0.1%? Perhaps even outline a rationale or measures to keep the curve consistent with that, and if so, will the market believe them? We saw issues with the market pushing back against the rhetoric of the ECB [European Central Bank] this week. If they don't, then there are significant implications for tightening of financial conditions through rates and through Aussie on the currency basis on an economy that is still largely closed.

On Thursday, the communication challenge for the Bank of England is no less intricate. Market pricing of Bank of England rate hikes has moderated somewhat from the aggressive front end repricing following the hawkish comments from both Governor Bailey and Chief Economist Huw Pill over recent weeks. To some extent, that's due to a more dovish commentary from members Tenreyro and Mann highlighting the likelihood of dissent, at least in the November/December meetings, and thus reducing the prospect of multiple hikes at either the November meeting or split between November and December, but also due to the potential implications for growth of tightening monetary conditions abruptly at such a nascent stage in the economic recovery. Indeed the ECB pointed out just this week the negative implications on medium term growth purely from inflation itself. This week's budget was positive in terms of long term rhetoric or potential for the UK economy and its mildly expansionary relative to previous forecasts, much of this due to OBR upward revisions. Announced previous tax hikes also paved the way for big spending, but it does little really to boost domestic demand in the short term, although it does offer some counter to the cost of living squeeze, particularly at the low end. In my personal view the Bank of England should wait until February when the situation on furlough, potentially some areas of supply chain disruption, are perhaps clearer, not to mention the covid uncertainty over the winter. However, Bailey was clear to emphasise the primacy of the inflation target in the Bank of England mandate and on current long end inflation expectations pricing, the MPC [Monetary Policy Committee] may well get votes for the hike in November. I'd be surprised to see the 40 basis points that are priced into the curve already, but it's going to be a close call, a difficult decision and fascinating viewing.

Finally, we're back to the US for the October employment report and the all important Fed meeting for November. Now at the September FOMC, Powell was clear to state that the US was all but there in terms of attainment of substantial further progress. In terms of unemployment, at least; we've been there for a while in terms of inflation. Despite the disappointing September payroll data, it is clear that November is the intended announcement date for the tapering of asset purchases. If anything, the shift in inflation pressure or expectations that we've seen dominate October leaves US monetary policy even looser. We've argued that relative to pre-crisis levels, US monetary policy is very accommodative and inflation just exacerbates this view. A strong employment report - and there was some indication of improvement from the weekly claims data, and I'd wager that the Fed will have this indication prior to their meeting on Wednesday - this will only accentuate the Fed hawkishness more, in our opinion. Now, markets calmly expect $15 billion per month of tapering from the Fed and relatively modest rate hike expectations are priced in, certainly relative to the pre-covid levels, while at the same time, accelerating rate hike expectations elsewhere. We see in Russia, Australia, Brazil and Canada and even Poland over recent days as prime examples of that. As we've seen with the ECB and the RBA and even perhaps the Bank of England, it's likely that central banks are becoming happier with a greater degree of risk premium in the front end rate curves against such an uncertain inflation environment. But perhaps it's time for a further repricing of US rates on a healthier balance of inflation and growth. Either way, the November FOMC will be a key focus and likely a key watershed.

Matt Jones

Thank you, Neil. Some key points to be on the lookout for for next week. In the meantime, as we look at the weekend, I think there's some big hitting fixtures: cricket, but also international rugby. What are your thoughts?

Neil Staines

Yes, absolutely. It's possible that in the football this weekend, it's an extension of the nightmare for either Spurs or Manchester United, as they both face each other after disappointing losses last week. We've no Formula One as the drivers head to Mexico for next weekend. We do, however, have the return of international rugby. Wales vs New Zealand, Scotland vs Tonga will be fascinating clashes with England having to wait until next weekend. But for me, it's really again all about the World Cup T20. We have Australia vs England should be a fascinating affair, great battle ahead of this winter's Ashes, albeit in a very different format. And we also have India vs New Zealand in a must win game for India after a loss to Pakistan with the other big guns Pakistan, Sri Lanka and South Africa all in action either side of the weekend. It really does look like another fantastic weekend for the T20, and if that's not enough, we have snippets from COP26, I'm sure, over the weekend and of course, Halloween.

Matt Jones

Thank you, Neil. I'll certainly be keeping an eye on the cricket this weekend. Well, thank you once again for joining us, and we look very much to catching up with you again next week.

Neil Staines

It's a pleasure. Likewise.

Matt Jones

Thank you for joining us for "The Long and Short of the Week Ahead". Further insights are available on our website eurizonsljcapital.com/insights. We look forward to you joining us again next week for more insights into macro-economic events and "The Long and Short of the Week Ahead".


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Views accurate as at the time of publication. Opinions expressed by the authors are their own and do not necessarily reflect those of Eurizon SLJ Capital Limited, Eurizon Capital SGR or the Intesa Sanpaolo Group.
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