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“So take a look at me now, oh there’s just an empty space“

Phil Collins, Against All Odds

Last week, we discussed the dominant ongoing theme: inflation, growth and monetary policy, essentially asking how best central bankers should gauge underlying aggregate demand in their respective economies such that they can correctly gauge the continuing threat to price stability relative to the current, and projected future tightness of financial conditions through the monetary channel. In short, what is the level of real rates needed to balance supply and demand, and are we there yet?

The complexity of this task comes not just due to the fact that monetary policy acts with the famous “long and variable lags”[Friedman]; nor the fact the hard data upon which policymakers rely on to inform them of the current economic dynamics are backward looking, delayed and/or often revised; nor due to the fact that the current dataset emanating from around the turn of the year are likely distorted by seasonal adjustments that have been (likely significantly) impacted by the covid lockdowns contaminating the annual comparisons for the past two years; but also due to the fact that real rates are as much a function of inflation as nominal rates.

We continue to believe that the underlying momentum (or perhaps most significantly, future strength) of the US consumer is significantly weaker than current market assessment - the divergence of which has increased since the (anomalous in our view) US data for January.

This week, markets leapt on commentary from the Chair of the Fed that the “Fed is prepared to speed up the pace of hikes if needed” and that the “latest economic data have been stronger than expected…” - though there was much less focus on his emphasis that “...this could revert in the data to come”. US rates markets continued their hawkish repricing, with the market now erring in favour of a reacceleration to a 50bp hike in March and a peak Fed Funds Rate of around 5.68%.

Perhaps in part, Fed’s Chair conscious decision to put a 50bp hike in March was related to the fact that some of the highly policy relevant data for the March meeting consideration (notably CPI) fall inside the ‘blackout window’, whereby a later intervention would not be possible; and also likely a function of the intent to avoid past mistakes (not 1970, but the 2021 ‘transitory’ language - which turned out to be premature, and abandoned).

Essentially, the Fed remain data dependent. However, market pricing is such that the data now likely needs to paint a very rosy picture simply to justify that pricing.

On that basis, today we will discuss briefly the evolutions of the monetary policy discussions elsewhere - namely Australia, Canada and Poland.

In Australia, as we also mentioned last week (where we suggested that the RBA were likely to adopt a more cautious monetary narrative), the situation has been confused by the data, where seasonality has thrown the RBA a curve ball. A higher-than-expected inflation print in January (for December) swung the RBA more hawkish, despite some sequential weakness in the employment data. A sharp drop in the inflation data for January has seen the RBA shift more dovish - or at the very least less hawkish - with Governor of the Reserve Bank of Australia stating clearly that the RBA are “closer to the point where appropriate to pause rate rises”.

In Canada, the ‘pause’ was announced in January. However, given the significant rate repricing in the US over recent months and the obvious economic and geographical similarities, markets would have been forgiven for being cautious about the potential for the Bank of Canada to recalibrate its hiking cycle. Ultimately, the Bank of Canada stuck with its pause, with the caveat that they are prepared to hike again if needed and removed the reference to excess demand in the statement. Interestingly the Bank also noted that while the economy stalled in Q4, it was not the headline GDP print that was the dominant concern, rather the Bank were focused on other factors, such as household spending, and weaker business investment, with productivity declining in recent quarters.

Indeed, in Poland this week, the Central Bank Governor Glapinski, reinforced the dovish inflation rhetoric, stating that “Polish inflation is to drop ‘very quickly’ to target… to slow more than expected in the projections”. Thailand, Taiwan and Korea have shown recent sequential weakness in inflation prints; and closer to home, the central forecast in the Bank of England’s inflation projections see just close to 2% this year and less than 0.50% at the forecast horizon.

Why is this relevant?

From our perspective, even with a modest adjustment for de-globalisation effects, as a function of pandemic and energy related resource deficiencies over recent years, it remains likely that the dominant inflation forces remain global, and thus correlated. Recent data in the US - data that we have serious doubts about in relation to both seasonality and representation (when so many alternative data streams give much more troubling trajectories for underlying domestic demand in the US) - have driven a wave of rate repricing and a huge shift in analyst bias towards higher rates. Just as a raft of central banks are starting to become more dovish.

Furthermore, we remain aligned to the view (that we have been discussing since late last year), that the risks to US domestic demand are non-linear, as excess savings are almost depleted and the peak impact of rate hikes, nominal price increases, and asset declines are yet to be felt fully.

For us, therefore, the bigger question is likely how quickly US rates will need to return to equilibrium (now likely around 300bps lower than current terminal rate pricing in the US), and not on whether the Fed will hike 25 or 50bps in March.

To paraphrase Phil Collins, markets should perhaps take a close look now at the empty spaces: the empty retail space, the emptying excess savings balances, the emptying support for inflation via supply channels and absolute price levels - if, as we expect, growth slowdown and continued disinflationary pressures become dominant then it is not ‘against all odds’ that terminal rates and even rate cuts are closer than markets currently suggest.

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