A strange reversal
View from the Trading Desk:
One need only scan news headlines from a few weeks ago to see the shift in tone and sentiment taking place on the subject of monetary policy. Until recently, markets have been signalling that central bankers have been behind the ball and too late in tightening policy to combat skyrocketing inflation. Symptoms of this inflationary trend—namely a supply-side issue stemming from Covid, and record-high commodity prices—can’t adequately be addressed using monetary policy tools. However, central bankers have taken note and have acted, except for the European Central Bank and Bank of Japan.
When asked about policy tools and how they’re expected to alleviate supply-side issues, central banks responded that they will tighten policy to reduce demand, and helping markets clear demand will help to balance the supply-demand disequilibrium. Now, that sounds like something directly out of a university economics textbook; in other words, there are too many people chasing too few goods/services, so reducing the number of people demanding those goods should help drive growth lower. For all intents and purposes, this was signalling what some economists call a ‘hard landing’ which involves driving the economy into recession to control the larger issue of inflation.
Bottom line: At first, this was taken with a grain of salt since the Federal Reserve’s estimate of the likelihood of recession was low. Recently, that’s changed. If you, dear reader, are on Linkedin, you may have seen plenty of Fed memes about a recession. Looking at today’s news headlines also shows the discussion has almost completely shifted from inflation-fighting to second-guessing the Fed for tightening too strongly and quantifying the economic fallout of a coming recession. The Fed’s track record for engineering a ‘soft landing’ is poor. The noise around the initial inflationary surge was so strong, and the Fed’s delay in normalising policy so delayed, that markets have a right to be concerned that the Fed will miss the right point to disembark the tightening train. Strictly from an incentive perspective, Fed policymakers will likely be inclined to prioritise inflation above economic growth and see through their hiking cycle rather than dialling back too soon and exposing themselves to criticism.
The week ahead
The Pound Index has fallen 0.8% over the last week as Sterling's weakness continues, with the British currency down 7.3% against the US Dollar in the second quarter of this year. The Resolution Foundation has called for more support for the poorest in society as disposable income growth stalls and the country faces rising price pressures. Wells Fargo expects rising prices to stunt consumer spending in the second half of 2022, leading to Gross Domestic Product contractions in Q1 and Q2 of 2023. Bank of England interest rates could reach 2.75% by December, with as many as seven rate hikes forecast in the next year. UK Sovereign yields climbed this morning while UK stocks rose.
- The Bank of England will release its latest Financial Stability Report alongside the Financial Policy Committee meeting minutes tomorrow at 10:30AM.
- Bank of England Governor Andrew Bailey is due to speak tomorrow at 11:00AM.
- The UK Construction Purchasing Managers' Index for June is forecast to read 55.0, following a 56.4 print in May.
- Several Monetary Policy Committee members will be speaking towards the end of the week, with BoE Chief Economist Huw Pill speaking at the Qatar Conference this Wednesday.
The Euro to US Dollar exchange rate has fallen over 1% this past week as the US currency staged a rebound. Madis Muller, a European Central Bank policymaker, supports a 25 basis-point rate hike in July followed by a half-point rise in September, with colleague Bostjan Vasle expecting a continuation of rate hikes after that. The ECB will try to avoid a debt crisis in weaker Eurozone economies by reinvesting the proceeds of maturing debt into countries like Italy. This aims to prevent borrowing costs from spiking, ensuring an orderly normalisation of monetary policy. Elsewhere, Ukraine's troops have fallen back from the city of Lysychansk as Vladimir Putin tightens his grip on the Luhansk region in Ukraine. Equity shares climbed this morning in European markets, with chemicals and healthcare leading the gains.
- French Industrial Production m/m for May is expected to read 0.2% versus -0.1%% in April.
- The latest EU Economic Forecasts will be released on Wednesday, providing the updated projections of member states for the next two years.
- German Industrial Production m/m looks set to expand in May at 0.4% compared with 0.7% one month prior.
- European Central Bank President Christine Lagarde will be speaking at the Economic Meetings in Aix-en-Provence, France, this Friday.
The Greenback is back in favour this week, with the US Dollar Index moving back above the $105 handle. There will be another bout of US jobs data released this week which should highlight the strength of the labour market. This may give the Federal Reserve the impetus to hike another 75 basis points in its next meeting at the end of this month to try and avoid a rally in wages, putting further pressure on prices. US President Joe Biden is facing calls from senators to repeal Chinese trade tariffs as the administration look for ways to soften the impact of surging inflation on consumers. US equity futures were pointing lower today, with the S&P 500 down 30 basis points in pre-market trade.
- The ISM Services PMI for June will be released on Wednesday; analysts expect a 54.0 print versus 55.9 in May.
- Federal Open Market Committee (FOMC) meeting minutes for the June 15th meeting will be published at 7:00PM this Wednesday.
- ADP Non-Farm Employment Change is forecast to climb 200K in June, up from the 128K print in May.
- US Non-Farm Payrolls for June are anticipated to be weaker with a 273K reading compared with 390K employees added in May.
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