In-Depth Research: Quick Roadmap Central Bank Forecast/Rationale - February 2023
M/T Quick Roadmap – Fundamental MMKT/CB Roadmap and Rationale
February 2023
US FEDERAL RESERVE
The February 1 December FOMC meeting saw the pace of tightening slowed to 25bps. Inflation has slowed, but January's CPI details still show broad based inflationary pressures at a pace well above the Fed's 2.0% target. January's employment report showed an unexpected sharp acceleration, though average hourly earnings data did not add to inflationary concerns.
The combination of a still very tight labor market and still too high inflation suggests the Fed still has work to do. We expect the Fed to deliver two more 25bps tightenings, in March and May, which would take the rate to 5.00-5.25%, consistent with the peak rate seen in the December FOMC dots. However December's dots had an upside skew and a pause from May will require clear signs of both the labor market and inflation losing momentum.
The resilience of the labor market is supportive for consumer spending, but the outlook for investment appears to be weakening and a dangerous stand-off over the debt limit which is likely to come to a head in the summer poses downside risks to the economic outlook. This may help deliver a pause in rates, but Fed officials have been clear that rates will need to remain at their peak for some time and we expect rates to end 2023 at 5.0-5.25%.
We expect easing to start in early 2024, with 50bps in both Q1 and Q2. However, in the second half of 2024, we expect the economy to be seeing renewed momentum after a period of weakness, with signs of inflation stabilizing a little above the 2% target. That will keep the pace of easing cautious, with only 25bps of easing seen both in Q3 and Q4. We expect rates to end 2024 at 3.5-3.75%, well above the 2.5% the Fed sees as neutral. Expected difficulty in returning inflation to target has us projecting only 50bps of easing in 2025. Quantitative tightening will be continuing in the background.
David Sloan
EUROPEAN CENTRAL BANK
As expected and widely flagged, the ECB hiked all its rates by another 50 bp hike, earlier this month thus taking the ever-more important deposit rate to 2.5%, ie a 300 bp cumulative hike in the last eight months.Also in line with expectations the ECB adhered to its hawkish policy guidance unveiled in December, actually initiating its latest statement by stressing that the Council will 'stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive'.As a result, the ECB still expects to raise rates by another 50 bp at the March 22 Council meeting but was more explicit this time around in suggesting that it will then evaluate the subsequent path of its monetary policy, this qualification hardly chiming with an assertion of steady paced of further hiking. In addition, it is questionable whether this outlook squares with the ECB assertion that future policy rate decisions will 'continue' to be data-dependent and follow a meeting-by-meeting approach.But ECB communication has long been confusing as an element on the Council seem to think too!
Nonetheless, the guidance is strong enough that a further 50bp hike has to be pencilled in for the March meeting, especially as the updated ECB staff forecasts may even be more upbeat on activity, however, misplaced such an outlook may be.It would ignore that this partly reflects a better inflation backdrop; that any 'resilience' in the economy is partly an aberration; and that downside risks are clear emanating from the recent evidence pointing to a fall in both the supply and demand for credit according the latest Bank Lending Survey.As a result, delivering a further 50 bp-plus of extra policy restriction, will probably mean a clearer inflation undershoot in 2-3 years.This is especially so amid what has been the steepest rise in interest rates on record. For now we have pencilled in a 50bp hike for March but would consider it to be a policy error.
Otherwise, and as foreshadowed in December, the ECB detailed how it will pare back the APP, in order to obtain the average monthly decline of € 15 bn per from the beginning of March until the end of June 2023, and the subsequent pace of portfolio reduction will be determined over time. Not surprisingly, partial reinvestments will be conducted broadly in line with existing practice, so that reinvestment amounts will be allocated proportionally to the share of redemptions across each constituent programme.
Thus we continue to think the ECB is being too aggressive in its policy thinking not only because it is too complacent about EZ growth and that the somewhat moderate recession will still deplete spending power enough to sap currently solid company pricing power.This ECB optimism also conflicts with the worrying signs in the latest BLS which implies that the increase in the cost of credit is being compounded by an ever-clearer decrease in the supply of credit, all indicative of a clear tightening in overall financial conditions.The BLS also hints that the ECB should pay more attention to its own models which suggest that the 300 bp-plus rise in bond yields will have a more severe impact than its central assumption currently allow.
Andrew Wroblewski
BANK OF JAPAN
BoJ Stay Put before Ueda
Bottom line: The Mar. 9 Bank of Japan (BoJ) meeting will state their commitment of ultra-loose monetary policy as usual in forward guidance to avoid stirring the pot before Kuroda steps down. The BoJ would be unlikely make any changes to monetary policy before Ueda succeeds. The BOJ's changes in the 10yr JGB cap on Dec. 20 has created uncertainty over policy for 2023 in Japan and the amendment in fund-supply operation on the Jan. 17-18 seems to signal BoJ's commitment in upholding the ultra-loose monetary policy. However, it is more of a signalling effect than a lasting impact for the efficiency of the JGB market. With Ueda's succession in April and his data dependent tilt, we could see more changes to the YCC in June.
Figure 1: BOJ Deposit Rate and 10yr Yields (%)
Source: Datastream/Continuum Economics
The BoJ meeting on 17-18 Jan. was closely watched after the surprise “tweak” in YCC at the December meeting. Some market participants were expecting more cues of an early exit from current ultra-loose policy and they were left disappointed. Instead, the BoJ surprised the market with an amendment to their fund-supply market operation, allowing them to lend to financial institutions. Despite such operation has more signalling effect than increasing the functionality of JGB market, it is the opposite of what certain market participants are anticipating. It looks like the BoJ is trying to reinstate credibility by demonstrating their commitment to ultra-loose monetary policy.
The signal from BoJ was well received by market participants. 10yr JGB yield retreated from the upper band of 0.5% to 0.38% on Jan 24. The act has relieved the pressure from BoJ since the past rounds of extra unscheduled bond purchase operation across the curve have been fruitless to keeping a lid on the rising yield. Kuroda reinstated his commitment to current monetary policy and pledged further easing if necessary, by saying Japan has not reached sustainable inflation despite core inflation touching 3%. And he clearly stated he has no intention to hike rates nor head into the tightening path. However, since Ueda was nominated as BoJ's next governor, 10yr JGB yield quickly returned to sub 0.5%. Most believe the Japanese Government has appointed Ueda to lead the normalization of BoJ's monetary policy.
Despite being a BoJ board member from 1998 to 2005, Ueda has mostly been an academic for the past decade and there is little clue of his dovish/hawkish bias. He has openly voiced out his thoughts on the ineffectiveness of YCC in monetary policy. Yet, his close contact has also mentioned he is a data dependent person. The National Core CPI is 3% y/y and Labor Cash Earning jumping to 4.8% y/y are signalling the transition of “unsustainable inflation” to “sustainable inflation” in the BoJ's eye. Yet, Q4 GDP has significantly missed at 0.6% and built a dilemma for tightening. Given the current low growth and relatively high but temporarily high inflation, hiking the deposit rate rate does not seem to be the best option. Further changes to YCC would be a more logical step toward normalization.Even so, a tactical tweak to the deposit rate from -0.1% to zero is possible to end ZIRP, under Ueda.
Looking forward, we are forecasting two options for BoJ's next step of reducing ultra easy policy. An abandoning of the 10yr yield cap could cause a surge in 10yr JGB yields and potentially a long-term rise all the way to the 1.0-2.0% range that existed in the 2000-08 period, so the main option and our central forecast would be a further adjustment to 0.75% from 0.50%. The Kuroda era after 2013 but before QE with YCC has seen 10yr yields above 0.50% when the BOJ were undertaking JGB purchases. However, this would likely require a persistence of inflation pressures in 2023, which is unlikely looking at wage trends and a detailed breakdown of CPI. That being said, core inflation touching 3% with little signs of slowing down would be concerning for the BoJ in the coming months. Elsewhere, headline inflation is signalling moderation, which would reinforce our forecast of inflation peaking in Q1 2023.
A 2nd alternative is that the BOJ increase the deposit rate from -0.1% to zero or +0.1% to end ZIRP but as a one-off adjustment. The BOJ will remember that previous it has tried to move away from ultra-low interest rates, with the last phase being in 2006 with a gradual shift from zero to +0.5%, which was then largely reversed with the global recession after the 2008 global financial crisis and then the key policy rate was +0.1% (Figure 1). The BOJ could feel that the global tightening cycle provides an opportunity in H1 2023 to adjust the deposit rate and end ZIRP, without starting a 2006 style tightening cycle. This is an uncertain call at this juncture and this will mean that the April and June meetings need to be watchedclosely.Inthe Mar. 9 meeting, the BoJ will likely stay put on its monetary policy and keep the forward guidance unchanged before Ueda's succession. We are then forecasting Ueda to provide forward guidance as soon as June to signal changes in YCC, as wage inflation could filter in to promote a sustainable inflation cycle.
BANK OF ENGLAND
That the Bank of England (BoE) hiked by 50 bp this month, in what was the tenth successive policy move and which took Bank Rate to a 14-year 4% was not anything like a surprise.Also as expected there were two dissents in favor of no action.But the key aspect was the important change in tone and rhetoric.Previous Monetary Policy Statements had pointed fairly emphatically to more hiking ahead unless there were clear downside surprises compared to BoE expectations.This time around the MPC policy hints are conditional, concluding that 'If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required', also no longer talking about possible acting forcefully.In addition the updated projections even based on rates staying at 4%continue to see inflation back under target in Q2 next year and then remaining so, albeit with the BoE keen to stress this outlook is biased with upside risks.The BoE still sees a recession, albeit shorter and shallower with a 0.5% drop this year and a 0.25% fall 2024, this generating excess supply even given the gloomier assertion the BoE has made about potential growth not to under 1%. Moreover in recent weeks there have been more sign of an easing incost and price pressures, not least a marked fall in core CPI inflation. Against this outlook, while a further, possible hike of 25 bp is possible at the March MPC meeting, we instead think stable policy is more likely an that the next move May be a rate cut probably in late Q1 next year.
Indeed, we still feel that policy is now at or very close to a peak given the recession, the fall in wholesale energy prices and the likely slump in bank credit supply.Notably, the reduction in bank credit availability seen in the latest credit conditions survey, has serous possible implications for the economy.Also on the monetary side, and something the that the MPC minutes did make a token acknowledgement of is the money supply backdrop, albeit refusing to link the marked softening in the growth of M4 of late having possibly important connotations for inflation.
Andrew Wroblewski
SWISS NATIONAL BANK
Another, but more moderate hike, was duly delivered by the SNB in December, with a largely as-expected 50 bp increase to 1.0%, the third move since June Dec 15.Echoing the assessment made in September, the Board said 'it that cannot be ruled out that additional rises in the SNB policy rate will be necessary'.This does not mean that further hikes are in the pipeline but perhaps markets will be perturbed by the fact that somewhat puzzlingly, the SNB also raised it medium-term inflation outlook a notch, now envisaging a small overshoot of the 2% target three years hence, albeit after a prolonged undershoot.We regard this as overly pessimistic and, even though inflation has risen it is no higher than SNB has been predicting, we think another hike will occur next month. We l think that policy may then pause after what will have been a cumulative 225 bp amount of tightening
Indeed, the SNB continued a policy normalization but has not signalled that the hiking cycle is at an end: given the modest inflation overshoot it envisages three year hence, it is leaving scope, and possibly rationale, for at least one more hike.But the rationale behind the inflation outlook pick-up is hard to fathom fully, it at all.Domestically, it already seems that inflation may have peaked to a degree.Meanwhile, the 'stronger inflationary pressure from abroad' rationale the SNB assessment pointed to seems even more puzzling as global demand and supply pressures actually seem to be abating amid worries about global growth.The other rationale the SNB advertises, namely that 'price increases are spreading across the various categories of goods and services in the consumer price index, also seems inconsistent with recent data, not least the SNB's own underlying CPI barometers, including the trimmed mean measure which is both no longer rising and still well below the 2% target.
As for risks, while the SNB's 0.5% GDP projection for this year is understandable and in line with consensus thinking, most would regard that such an outlook to be dominated by downside risks.That projected growth rate is also less than half the economy's potential rate and with the likelihood thatthis will create a modest negative output gap that will extend into 2024 even if (as we think) growth then recovers.
Regardless, while the SNB may have confidence that its formal remit of controlling inflation is in reach, but that it has failed to address, let alone puncture, what may be excessive property price gains.However, given the manner in which house prices have been falling in some neighboring economies, the SNB will be careful what it wishes for.
Andrew Wroblewski
BANK OF CANADA
The Bank of Canada tightened by 25bps to 4.50% as expected on January 25 but sprung a surprise in stating it expects to hold the rate at that level if economic developments are broadly in line with its expectations. We expect the rate to be held at this level through 2023, though the BoC still has a marginal bias to tightening, stating that they are prepared to raise the rate further if needed to return inflation to the 2% target. Governor Tiff Macklem at the subsequent press conference said it is far too early to be talking about easing.
The statement recognized recent activity has exceeded expectations and still sees the economy as remaining in excess demand, but also saw growing evidence that restrictive policy is slowing activity. A strong employment report for January released in early February adds to the risk of another tightening, but we believe it is unlikely the BoC will move as soon as March having clearly signaled a pause, and that subsequent data will slow sufficiently to allow the BoC pause to continue. While the BoC revised up its GDP view for 2022, 2023 GDP was revised lower, to 0.5% Q4/Q4 from 1.0%. 2023 CPI was also revised marginally lower, to 2.6% Q4/Q4 from 2.8%, though 2024 is still seen at 2.0%, marking the return to target. The statement expected inflation to fall significantly this year and while core inflation remains near 5%, 3 month measures suggest the pace has peaked.
We expect the BoC to ease by 125bps in 2024, taking the rate to 3.25% at the end of the year, still above the 2-3% range the BoC sees as neutral. While inflation is now falling, a sustained return to 2.0% may prove difficult to achieve in a less globalized world.
David Sloan
NORGES BANK
As widely expected, the Norges Bank paused policy at it latest verdict last month, the first such pause since last May, this backed up by what was a very equivocal statement.Indeed this pause was flagged at the December meeting, when the Norges Bank suggested that another 25 bp hike will be made in the coming quarter, but most likely at the next scheduled meeting on Mar 23 when forecasts will also be updated in the Monetary Policy Report.
Regardless, existing projections still suggest that rates will then peak, with it notable that even given a continued projected overshoot of the inflation target, the Norges Bank existing projections sees policy easing starting in early 2024. But with a further CPI inflation surprise so far this year alongside stronger than expected GDP and labor market data the question is whether this outlook could change, possibly either encompassing even more hikes or delated easing.Indeed, it was debated in January, raising the policy rate at that meeting. But it was also then noted that there are prospects that energy prices will be lower than expected and global inflationary pressures appear to be easing.
On the margin, it is now likely that the Norges Bank will deliver that hike but that may still mean policy has either peaked already or is very near to doing so amid what seems to be a larger projected negative output gap and where downside risks from already slumping house prices may be the key factor in the next few months. Overall, the policy rate has been raised considerably over a short period of time, and monetary policy has started to have a tightening effect on the economy. This may suggest a more gradual approach to policy rate setting.
Andrew Wroblewski
RIKSBANK
Very much meeting market expectations, the Riksbank Board hiked its policy rate by 50 bp to 3.0% earlier this month, despite still suggesting that inflation would return to target and stay there in the latter part of its 2-3 year forecast horizon. Indeed, its updated forecasts suggest further hikes of at least 25 bp could arrive at the next meeting in April and then suggesting that policy will be on hold until at least end-2025.Notably, the Riksbank also highlighted that it will shrink its balance sheet at a faster pace, by selling government bonds (while retaining is holdings of non-government bonds|), something it suggests will contribute to higher risk-free market rates.However, the rate hike is still considered to be no more than probable and certainly does not encompass the alternative (more persistent inflation) scenario highlighted in the November Monetary Policy Report (MPR) in which the policy rate approached 5%!Indeed, aware of the risk of financial instability from where policy is presently, let alone if rates go much higher, given the marked and rising interest sensitivity of households specifically and the economy generally to short-term rate hikes, the Riksbank's intended manipulation of its balance sheet may be designed to push longer rates higher rather than shorter ones and with the hope that this pulls the currency back up.Regardless, amid clear downside economy and housing market risks, we think that it will take further upside inflation surprises in order to make the Riksbank hike any further and we think the opposite is likely for upcoming CPI data.Rate cutting is still possible from next year.
Market and credibility issues may be forcing the Riksbank into more monetary policy front-loading even though this carries risks.Instead. the Riksbank is courting financial stability risks that the Riksbank itself highlighted in its recent Financial Stability Report.Notably as household debt has been growing faster than income for a long time, households have become increasingly sensitive to rising interest rates as, unlike many other economies, Sweden has a larger share of the mortgage stock tied variable interest rates.
In any case, although possibly under pressure from new governor, Erik Thedéen, the Riksbank is now going to sell is modest holding off government bonds,We think this may be a partial substitute (as opposed to a complement) to more conventional tightening, designed to reduce the risk of higher short-term rates accentuating stability risks.
It is clear that the Riksbank believes its credibility is being tarnished by not only persistently high inflation, but by the upside surprises it has had to contend with.Admittedly, these outcomes do not conflict with inflation succumbing to this weak economic outlook in due course, where a steep GDP decline and scaled back recovery was envisaged and still seems likely.As a result, a marked negative output gap exceeding 1% of GDP is still seen, even by 2025 when the economy is envisaged to be growing above potential and during which a 20%-plus slump in house prices will help hit consumer spending but also capex on more sustained basis.But this weakness comes with continuing downside risks both to overall activity and with possible spill-overs into financial stability.
Andrew Wroblewski
RESERVE BANK OF AUSTRALIA
RBA Dancing to the Music
Bottom line: The Reserve Bank of Australia's communications at the Mar. 7 meeting will provide forward guidance on their data dependency in further tightening after hiking the cash rate by 25bps to 3.6% at that meeting. The RBA will guide that despite inflation showing signs of moderation, it is still too high and would require further tightening to bring inflation back to target range. However, the shakeout in the housing market would not allow RBA to return to aggressive tightening without smashing the housing market and disrupt Australian economy & household. We forecast the cash rate to be 3.75-4% in H1 2023 depending on the coming CPI data with our central forecast currently at 3.75%.
Figure 1: RBA Policy Rate (%)
Source: Datastream
The RBA admitted Australian inflation is very high and will be above 2-3% for at least another year. The Q4 CPI is at 7.8% and is inches from the high end of RBA's forecast of 8% inflation by year end 2022. RBA is therefore dancing to the music by suggesting more rate hikes are necessary to control inflation instead of the previous slowing tightening rhetoric. Still, RBA would have a hard time to tighten further when the housing market is under pressure with home buyers struggling with mortgages increase. Additionally, inflationary pressure from demand could ease in 2023 when higher mortgage payment and lower real income limits private consumption. RBA Governor Lowe is seen playing both sides in his recent speeches as he stated the necessity of more tightening and uncertainty of terminal rates to fight inflation while floating the idea of rate cuts in 2024. Lowe made it clear that the RBA would like to take a more balanced approach towards further tightening as the effect of cumulative increase in cash rate is lagging.
The housing market is already turning and is dampening consumption activity for new households, as well as residential investment. Moreover, the surge in mortgage rates will also dent consumption, given that a large portion of variable-rate mortgages will quickly transmit RBA rate hikes into a squeeze on other spending. Finally, if the peak-to-trough decline in house prices is more than 15%, then it will start to dent wealth perceptions. All of this argues for the RBA to be cautious in its coming tightening steps.
The Australian labor market remains at historic levels but is starting to show signs of peaking. The unemployment rate is 0.3% higher than the historical low at 3.7%, which is still 1.6 ppt below pre-pandemic level. The participation rate is also 0.5 lower than previous high at 66.5%. However, full time jobs have decreased for the first time in months with part time jobs still growing. The slowing in employment growth with steadily high vacancies seems to suggest the labor tightness has reached a peak. The wage price index is still rising by 1% on a q/q basis and 3.1% on a y/y basis. It is expected to further increase in 2023 and would translate into more inflationary pressure.
Household spending was a key pillar in supporting the rebound in the Australian economy in 2022. RBA has recognized the pent-up demand being fully released with household saving ratio down to 6.9%, yet household spending remains solid on tight labour market and accelerating wage growth. These higher prices are partially buffered by increases in hours worked and wages gained, which will lend support to future household spending. International visitors will also be supporting spending in the Australian economy. However, the negative real wage would limit domestic spending in 2023 and likely dragged GDP growth. The RBA stated the uncertainty of consumer spending behaviour in a tightening cycle would be a key factor in deciding further rate moves, along with the uncertain global outlook.
The Australian economic growth is also expected to slow in 2023 after the revival of service industry after COVID restrictions are eased and is leaving little cushion for the RBA to hike without damaging the economy. Therefore, we see the RBA hiking by 25bps to 3.6% in March 2023. We project the terminal RBA cash rate at 3.75% by year end 2023 if CPI plays along our script of showing moderation in 2023. RBA communications at the Mar. 7 meeting will signal that the cash rate need to be more restrictive and the magnitude of which would be inflation dependent.
Cephas Kin Long Yung