November flash PMIs would be the main focus for the coming week if it were a more normal period. But these are not normal times, and growth prospects are not the main driver of the investment climate. Much of this quarter’s growth is built into the pie. The world’s three largest economies, the United States, China and Japan, are expected to accelerate for various reasons in the fourth quarter compared to the third quarter. Europe is the weak sister, and growth in the eurozone and the UK could slow down sequentially.
The fiscal and monetary rebound induced by last year’s global shutdown has reached its peak. However, there is still sufficient support to keep growth in most high and middle income countries above trend for a few more quarters. Restocking will also help support growth in the first half of next year. And then things will get interesting. The Fed will likely start removing some monetary accommodations rather than tapering them in just as economic growth slows, below 3% on a sustained basis. In the swap market, the UK is raising the base rate by 100bp over the next 12 months as the economy is expected to gradually slow down. In addition, given the varying time frames for the impact of monetary policy on the real economy, central banks will join governments in pursuing a pro-cyclical path.
Given the market’s sensitivity to inflation, the October US PCE deflator could be the most important data point in the coming days. Remember that the Fed targets the global deflator (average over an indefinite period of 2%), not the deflator. In October 2020, the global deflator was unchanged. It remained unchanged in November. This suggests some powerful base effects that will speed up the pace of the headlines. The median forecast (Bloomberg survey) was for the October PCE deflator to rise 0.7%. That would likely increase the rate year over year to just over 5%. Assuming the PCE deflator rises from its 2021 average (January-September) by 0.4% now, that would suggest a pace closer to 5.5% when the November data is released.
Fed officials often quote the key rate. The base rate excludes food and energy, not because they are volatile, but because over time the overall rate converges with the base rate, not the other way around. The base effect here is similar to the overall rate. In October 2020, the core PCE deflator increased 0.01% and in November it remained stable. The median forecast (Bloomberg survey) expects an increase of 0.4%. This will take the year-over-year pace slightly above 4.0%. Until September, it grew by an average of 0.36% per month. If he does so this month, the year-over-year rate will accelerate to 4.4-4.5%.
Two important elements of the Federal Reserve’s reaction function have come to light. The first was in the FOMC statement, and the second in President Powell’s remarks after the meeting. Powell said:
“Given the unprecedented nature of the disruption associated with the pandemic and the reopening of the economy, we remain alert to risks and will ensure that our policy is well positioned to address the plausible economic set of outcomes. ”
Essentially, Powell says the Federal Reserve needs to guarantee the maximum degree of flexibility because of the higher degree of uncertainty.
By announcing the tapering, it specified the tapering in November and December at a rate of 15 billion dollars per month. The statement added that “the Committee considers that similar reductions in the pace of net asset purchases are likely to be appropriate each month, but is ready to adjust the pace of purchases if changes in the economic outlook warrant.” The key question is whether there has been a change in the economic outlook.
Powell acknowledged that growth is likely to accelerate this quarter. The strength of the United States October,,, and point in that direction. The Atlanta Fed’s GDPNow forecasts growth of nearly 8.2% (Nov 17), while economists are closer to 5%.
The acceleration of growth alone probably wouldn’t have moved the needle. However, the surge in inflation and the base effect indicating the likelihood of further increases broaden the range of “plausible outcomes”. This is especially true given that some studies suggest that price pressures are spreading, not just intensifying.
Even though the September dot plot (summary of economic projections) showed that half of Fed officials did not believe a hike next year would be necessary, the Fed must have the flexibility to raise rates sooner. Currently, it is crippled by the pace of tapering, which means the Fed cannot currently raise rates until mid-year. In order to give itself the flexibility to raise rates sooner, the Fed will need to step up the pace of tapering. The famous hawk-hawk Fed chairman of St. Loius argued for the cut to be completed by the end of the first quarter. To achieve this after the November and December tapering, the Fed will need to double its pace to $ 30 billion per month in Q1-22 to complete the operation.
Effective Fed funds (weighted average) have been stable at eight basis points since early September. Fed funds futures advance the likelihood of a rate hike in Q2-22. It is not fully discounted, but the market recognizes the increased risk. The implied returns of the May and June contracts are 18.5bp and 24bp respectively.
The divergence of monetary policies is an important factor. Consider that next month, as the Fed ramps up its tapering, the ECB provides “terms” for its bond buying program after the emergency pandemic buying program ends next March. There are different ways to capture the divergence. One of the tracks is the Eurodollar-Euribor spread of December 2022, which rose above 120bp for the first time since March 2020. Another way is to look at the two-year rate differential. It went from around 90bp before the September FOMC meeting to an average of around 125bp last week.
The exchange rate is more sensitive to the US rate. The correlation over the last 60 days of the change in the exchange rate and the yield is close to 0.55. The correlation with the two-year yield is 0.35. Often times, the yen is viewed as a safe haven currency, meaning that as stocks rise, the yen should weaken and vice versa. From February to early August, the 60-day correlation between the change in the exchange rate and the change in the price was the opposite. With the rise of the US index, the dollar weakened against the yen. Since then the correlation has turned positive, with stocks rising and the yen weaker, but not statistically significant (less than 0.1).
Three high-income central banks will meet in the coming week: (November 22), (November 24) and (November 25). Last week, the rise hit its best level against the US dollar since 1996. October was lower than expected, rising 0.1% instead of 0.4% according to economists’ forecasts ( Bloomberg median). The drop to 2.3% against 2.5%, the first drop of the year. Although the key rate is at 10bp, the central bank will hold its own.
The Swedish Riksbank is also in no rush to adjust its monetary policy. Monthly GDP impressions for the July-September period warn of a contraction when third-quarter GDP is released at the end of the month. is high, but the underlying base measure, which takes into account fixed mortgage rates and excludes food and energy, stood at 1.8% in October. The has depreciated against the Norwegian krone as its central bank has started and will likely continue the normalization process with another hike next month. However, from late August to early this month, the krone appreciated about 4.7% against the. These gains have been reduced since the US CPI boosted the greenback’s larger gains.
The Reserve Bank of New Zealand is likely to move again. It raised official rates by 25bp in October and should match that now, although some see the upside by a 50bp move. Price pressures are increasing faster than expected and the labor market has tightened. At 3.4%, it is well below the level of 4.0% observed at the end of 2019 and is at its lowest level in 14 years. The economy contracted sharply (-6.5% quarter over quarter) as another lockdown moment, but the economy appears to be recovering quickly and sharply.
It rose nearly 4% in October but is struggling this month. It’s down 2.4% so far. If he could, he would invoke extenuating circumstances. First, it made the most of its micro-universe of other currencies that often trade like it (and Scandis). Second, aggressive rate hikes have been anticipated in the swap market for some time. The market has valued just over 100bp over the next six months and another 100bp + over the next six months.