Between a rock and a hard place

View from the Trading Desk:

Despite looming global recession fears, the Federal Reserve and the Bank of England are likely to unveil mammoth 75 basis point hikes this week in the face of soaring inflationary pressure. The latest annual CPI data that was released out of the US came in above market expectations at 8.1%. Meanwhile, UK inflation currently sits in the double digits. Both central banks are conscious of the fact that they need to be seen acting aggressively to combat rising consumer prices. 

Commodity prices have eased over the last few months, but it will take time for the disinflationary pressure to work its way to prices for the man on the street. Moreover, declining commodity prices reflect softening global demand, as recessionary fears dent business investment. However, not all commodities are exhibiting a downward trend. OPEC's decision to cut its production of oil by two million barrels a day is unlikely to help moderate consumer prices, particularly heading into winter. Furthermore, Russia has abandoned its UN-backed agreement with Kyiv that facilitates the free movement of wheat from Ukraine, hinting that supply isn't normalizing anytime soon. 

Bottom line: Will central banks continue to tighten economic policy knowing the economic cost of tightening too far? What is clear is that central banks have an inflation credibility issue, so they must be seen not only acting, but achieving results. With the lag of commodity price normalization and a still unresolved energy crisis, the central banks' job doesn't appear to be done, and they may not be dissuaded by recessionary concerns. Markets disagree, though, and several central banks have weighed in with them; the Reserve Bank of Australia has already delivered smaller-than-expected hikes. What more must we see before a change of heart takes place at the Fed and BoE?

 

The week ahead

GBP 

The Bloomberg Pound Index is up 2% over the last week as markets price out the Liz Truss premium on UK financial assets and prepare for a fiscally stable premiership under Rishi Sunak. The outlook still remains bleak for the UK and Sterling; however, the Bank of England is looking set to hike interest rates by 0.75% this Thursday, potentially reaching the highest level since 2008 at 3%. Mortgage rates are sitting at their most substantial levels since the 2008 Global Financial Crisis, with forecasts for a housing market downturn beginning to emerge. Lloyds Banking Group estimates an 8% decline in property prices next year, with the worst-case outcome being as much as 18%. 

  • The Nationwide House Price Index MoM for October will be published on Tuesday; analysts expect a -0.3% print. 
  • The British Retail Consortium Shop Price Index YoY is scheduled for release on Wednesday, and a 5.5% reading for October is projected. 
  • Thursday, Bank of England policymakers will meet and provide their latest interest rate decision; a 75 basis point rate hike is market consensus. 
  • Monetary Policy Committee members Catherine Mann and Huw Pill are due to speak this Thursday and Friday. 

EUR

The Euro has opened softer this morning as economic downturn fears rise following a hotter-than-expected CPI print for the Eurozone of 10.7%. Spain and France are already experiencing economic slowdowns, with tourism demand weakening heading into the winter as consumers look to reign in spending. This puts the European Central Bank in a more precarious position ahead of its meeting in December, with a real concern that continued aggressive interest rate hikes could exacerbate the seemingly inevitable downturn. Elsewhere, wheat prices surged on Monday morning as Russia suspended its agreement to maintain grain exports from Ukraine, further exacerbating the food price spiral. 

  • This morning, Eurozone flash CPI, and Core CPI YoY for October came in at 10.7% and 5.0%, respectively.  
  • Eurozone preliminary GDP QoQ data for the third quarter of 2022 printed at 0.2% versus estimates of 0.1%. 
  • German Factory Orders MoM are forecast to decline yet again in September by 0.5% versus a 2.4% decline in August. 
  • European Central Bank President Christine Lagarde will be speaking on Thursday and Friday this week. 

USD

Dollar strength has returned today ahead of the Federal Reserve meeting on Wednesday. Murmurings of a Fed pivot are making the rounds in markets, with some strategists of the belief that the current set of economic data warrants a pause in further monetary tightening. A 75 basis point hike is fully priced in; however, any dovish language from the central bank could be enough to spark a turnaround in terminal rate pricing. However, with consumer cash reserves staying relatively strong, the argument for a continuation of a hawkish rhetoric is a fair one, with the threat of persistently high inflation still very much real. 

  • ISM Manufacturing and Services PMIs are scheduled for release this week. Manufacturing is expected to come in at 50.0, while Services are forecast at 55.1. 
  • JOLTS Job Openings for September are anticipated to decline to 9.75M versus 10.05M in August. 
  • The Federal Reserve will meet on Wednesday to publish changes to the Federal Funds Rate; a 75 basis point interest rate hike is widely anticipated. 
  • US Non-Farm Payrolls for October are due on Friday with a 190K reading the consensus. 

 

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