“How many times must a man look up, before he can see the sky?“
Bob Dylan, Blowin’ In The Wind
Last week, we discussed the increasing signs of rebalancing of supply and demand and how this is likely increasingly consistent with our view that ‘disinflation will be notable through 2023 in its significance and persistence - the exact opposite of the prevalent analyst consensus of ‘sticky, persistent inflation’. Further, we argued that continued significant improvements in the global supply chain backdrop will also likely generate an increasingly disinflationary supply/demand dynamic.
We argued that the (likely anomalous) jump in the ADP private job gains for June induced a capitulate sell off in US Treasuries and thus a spike high in yields across the curve that we viewed (and continue to view) as an important peak and is in our view likely to presage a persistent duration bid in DM more generally.
Lastly, we discussed the downside surprise to the June CPI, with a drop of half a percent in the core measure to just 4.8%. “To put this into perspective, this is broadly consistent with a core PCE of around 4.0% - a whisker away from the updated year end core PCE projection in the SEP’s of 3.9%” - arguing that further downside surprises in inflation will not only continue to question the dominant ‘sticky’ inflation narrative, butnarrative but will also undermine the case for the monetary tightening implied by the dots.
This week, against a quiet macro data calendar, we look ahead to the events of next week. While equities will come under intense scrutiny with around 50% of S&P companies reporting quarterly earnings, the macro focus will be on monetary policy and the, likely historically significant, DM Central Bank meetings - Bank of Japan, ECB, and the Federal Reserve.
The action kicks off with the FOMC decision on Wednesday, likely by far the most wide reaching and consequential decision (and commentary) of the week. With 24bps priced into the front end of the US curve and a blackout window denying an opportunity to push back against current market expectations, it is unlikely that the Fed do not deliver. However, the devil, as they say, will be in the detail. From our perspective the July hike has the potential to be the ultimate ‘dovish hike - one in which the Fed do not give a clear directional bias, for the first time in this tightening cycle, even if they provide data dependent guidance or conditionality. However, it is possible that the explicit announcement of an end to the policy cycle comes alongside the new Summary of Economic projections in September.
The language in the statement and the commentary in the press conference will be closely scrutinised for discussion in relation to the likelihood of future action and the persistence or amendments to the sentence stating that the Fed will “determine the extent of policy tightening that may be appropriate to return inflation to target” - especially given the recent downside miss to inflation in June. From our perspective, given our long-held view that inflation will continue to falter as supply and demand normalisation continues, we see little obvious need for the 25bp hike at the July meeting - let alone beyond.
Thus, from our, and the market, perspective the discussion around the ‘pace’ of policy action will also be key to the future policy path. 12 out of 18 FOMC members anticipated the need for (at least) one further hike beyond July in the June ‘dots’ (within the Summary of Economic Projections SEP’s). A slower pace will allow time for the data to demonstrate a clearer disinflation and sub-trend growth - in our view the case for adding to the policy restriction, when inflation is clearly slowing (from both supply and demand) and growth is already running below equilibrium is a weak argument, ultimately risking a much sharper demand hit, implying a need for rates to be cut faster in the future.
Next up, the ECB. The ECB policy decision in the aftermath of the Fed’s next week, with the market again fully pricing a 25bp hike in the policy rate, for the ECB taking it to 3.75% will also be material in shaping market expectations and positioning. The key focus for the market will likely be the signalling from both statement and press conference across the ECB’s three guidance pillars: “the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission."
The growth narrative will also be important, as will the prospect of QT in the context of the Governing Council’s view on the transmission mechanism. The most recent staff projections saw inflation above target at the forecast horizon, with rates at 3.75% and with the June core CPI revised a touch higher to 5.5% (and likely to remain at similar levels through July and August), it is unlikely from our perspective that the ECB remove the hawkish bias from the statement and press conference - even if there is no specific guidance for September.
The Bank of Japan concludes this week’s DM policy focus, but with by far the least likelihood of policy action. The BoJ have been increasingly direct over recent weeks in relation to the underlying view of the BoJ that the current (modest by the standards of DM peers) above trend core inflation is transient and that they are still not confident of attaining their price goal “stably”. Thus, they are said to see little need to act on YCC for now.
While the actual policy actions of the Fed, ECB and BoJ likely offer no surprises, the commentaries will be very keenly watched and for us the Fed in particular has the potential to be a very significant meeting indeed in terms of the progression of monetary policy for the cycle. In this context we maintain our view that inflation will fall faster than some think, while economic growth remains resilient. The implications for equities (positive), bond yields (negative), and the dollar (negative) are, to us, clear. To paraphrase the great Bob Dylan, how many times must the Fed look up before they can see the sky?
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FOMC Statement, 14 June 2023: https://www.federalreserve.gov/newsevents/pressreleases/monetary20230614a.htm
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