Fed signals ongoing rate hikes to deliver tight policy stance; curve-flattening signals scepticism that soft-landing will be achieved
As expected, yesterday the Fed raised its target range for the fed funds rate for the first time in four years and by 25bps to 0.25-0.50%, with only one FOMC member (St Louis Fed President James Bullard) voting for 50bps. Most notably, with Jay Powell making clear in his press conference that the Committee’s tolerance of high inflation has now reached its limit, so that it is now “acutely aware of the need to return the economy to price stability”, the FOMC’s statement noted that it “anticipates that ongoing increases in the target range will be appropriate”. Indeed, the “dot plot” of Committee member expectations for the FFR finally caught up with market pricing for the remainder of this year, and also signalled additional hikes next year to push monetary policy into a tight stance. Additionally, Powell said that the FOMC had made “excellent progress” in developing its plans for quantitative tightening, suggesting that its intentions for shrinking the Fed’s balance sheet should be announced after the May meeting enabling roll-off to begin in June at the latest.
In particular, matching the market-implied path for this year ahead of the policy announcement, the “dot plot” suggests that the median member of the FOMC now expects rates to rise in every one of the six remaining policy meetings this year, so that the FFR ends 2022 at 1.875%. It also signals an expectation of a further three hikes in 2023, that would push the FFR above the FOMC’s assessment of the longer-run equilibrium level (2.4%) by the end of next year and throughout 2024. The Committee’s economic projections suggest that will be enough to steer inflation back to its target, but not before 2025. And they also imply that the policy tightening will help to engineer a gentle soft-landing for the economy, with GDP growth expected to moderate steadily to (a still above-potential) 2.8% by the end of this year and further to 2.0% by 2024, and the unemployment rate expected to remain steady at about 3½% over the coming few years.
Of course, whether more tightening will be required to tame inflation (a couple of FOMC members think that the FFR will need to rise above 3½% next year), and/or whether the Fed’s policy stance will get inflation smoothly back to target without engineering a recession or a material increase in unemployment, very much remains to be seen. The significant further flattening of the UST yield curve following the Fed’s announcement – with minimal difference yields from 3 to 10 years – suggests markets are unsurprisingly sceptical. The initial assessment of yesterday’s Fed announcements from Daiwa America’s Mike Moran can be read here.
BoE likely to raise Bank Rate by 25bps and signal further modest tightening ahead
Just like the FOMC yesterday, the BoE’s MPC is set to tighten policy today, although this will represent its third successive rate hike. February’s decision was a close one, with four MPC members out of nine having preferred a hike of 50bps. But the MPC signalled only that “further modest tightening in monetary policy is likely to be appropriate in the coming months”. Since then, GDP has come in well above the BoE’s expectations and inflation has surprised significantly on the upside, with the near-term price outlook having worsened markedly due to the war in Ukraine. So, a 50bp hike can’t be ruled out today.
However, the MPC will also be mindful that high inflation is eroding real disposable incomes, which this year look set to decline the most in more than 40 years. Consumer confidence deteriorated markedly even before Russia’s invasion, further suggesting that the outlook for domestic demand has weakened. And in the absence of the announcement of some extra fiscal support next week, the probability of a recession sometime this year is non-negligible – indeed a contraction in economic output in Q2 now looks a decent bet. Recent market turbulence could also make some MPC members wary about tightening policy aggressively. So, while MPC members have remained largely tight-lipped since the Russian invasion, we expect the majority to want to avoid a marked shift in its policy stance and – as is currently priced by the markets – vote for a hike in Bank Rate of 25bps to 0.75%.
ECB Board members to repeat hawkish signals about the policy outlook
After last week’s hawkish ECB announcements, President Lagarde, Chief Economist Lane and influential Executive Board Member Schnabel will speak publicly at the ECB Watchers’ conference today, while Dutch National Bank Governor Knot is also due to speak today. While Lagarde, Schnabel and Knot are likely to remain hawkish, Lane’s comments might give an indication of how much resistance the doves might make to (currently signalled) moves in the second half of the year to end net asset purchases and perhaps also raise rates.
Japanese machine orders fall in January, but still point to modest capex growth for now
Data-wise, the weakness in Japan’s machinery orders numbers at the start of the year, reported overnight, was not overly surprising. Having risen in each of the previous four months and by a cumulative 8.8%, private sector core orders – which exclude the more volatile items like shipping and electric power companies and provide a more accurate gauge of private sector capex – fell 2%M/M in January. This still left orders some 5½% above the pre-pandemic level and up 5.1% compared with a year earlier. The weakness in January was, however, broad based, with orders placed by manufacturers down for the first month in three and by 4.8%M/M, with sizeable declines in the electrical machinery, autos, ICT equipment and non-ferrous metals subsectors, while non-manufacturing orders were down 1.9%M/M, to be still more than 7% lower than the February 2020 level. Despite the fall in January, core orders were still a touch firmer than the Q4 average (0.8%) suggesting some modest growth in private sector capex over the coming quarter, although the increase in business uncertainty since the start of the year might put some investment plans on ice for the time being. In terms of public investment, despite PM Kishida’s stimulus, government orders fell a disappointing 13.6%M/M in January to be roughly 16½% lower than the Q4 average.
Euro area final inflation data for February at risk of upwards revision
The most notable new data in the euro area will be the final euro area inflation figures for February. The preliminary release reported a leap of 0.7ppt in the headline HICP rate to 5.8%Y/Y and an increase of 0.4ppt in the core rate to 2.7%Y/Y. But following last week’s upwards revision to Spain’s HICP inflation (by 0.1ppt to 7.6%Y/Y), today’s French HICP also came in 0.1ppt above the flash estimate at 4.2%Y/Y. And so, in the absence of a sizeable downwards revision to tomorrow’s equivalent Italian numbers, there seems a good chance that the euro area aggregate inflation rate will be nudged higher still in February. With the detail likely to reveal broader-based pressures, the trimmed mean CPI is likely to rise further from January’s series-high 3.7%Y/Y.
Euro area car sales remain in reverse as supply constraints persist
According to the European Automobile Manufacturers’ Association (ACEA), euro area passenger car registrations were down 6.9%Y/Y in February despite the extremely low base a year ago as manufacturers continued to struggle in the face of persisting supply shortages. Indeed, just 617.5k units were sold last month, the weakest result for a February since records began, and more than a quarter lower than the pre-pandemic level. The performance by member state was mixed, with double-digit year-on-year losses in Italy (-22.6%) and France (-13.0%) contrasting with modest growth in Spain (6.6%) and Germany (3.2%). Of course, the near-term outlook for the autos sector has been further clouded by Russia’s invasion of Ukraine, with bigger risks to supply of a range of inputs in car production, from wire cable harnesses to palladium for catalytic converters, and nickel ore to semiconductors. And various German car manufacturers, including Volkswagen, BMW and Mercedes, have already cut output over recent weeks.
US industrial production and housing data should be consistent with growth in February
A busy day for new economic data from the US will bring February reports on industrial production, housing starts and building permits, as well as the March Philly Fed survey results and weekly jobless claims. Daiwa America’s Mike Moran expects a rebound in single-family housing starts in February after back-to-back declines pushed activity in that component significantly lower at the start of the year, while multi-family starts should remain firm. Mike also expects solid growth in manufacturing and mining activity, but utility output to fall back after a surge in January, so that overall IP rises about 0.4%M/M.