Divergence Update: Global Monetary Policy Cycles

(from my colleagues Dr. Win Thin and Ilan Solot)

The global investment environment continues to be driven largely by divergences in central bank policies. This holds true not just across Developed Markets, but Emerging Markets as well.  We thought it would be helpful to summarize our expectations of central bank policies going forward.

December is shaping up to be one of the most important months for monetary policy in the last few years.  So far, it's spelling out dollar strength. The Fed is backing up its intention to hike this year, the ECB is considering easing, while the BOJ could defy expectations for further easing.  Further afield, most other central banks have an easing bias.

DEVELOPED MARKETS

The FOMC next meets on December 16.  Barring a significant surprise on the data front, a rate hike by the Fed then is very much in play.  At the October meeting, the FOMC played down the risks emanating from abroad, while recent comments by Yellen have reinforced the view that the Fed is prepared to follow-through with its intention to hike rates this year.  The US rates market seems to be taking this to heart, as the 2-year yield has risen to 0.85%, a new high for this year and matching the February 2011 highs.  Some argue against a December hike on technical grounds, given the proximity to the end of the year.  However, the Fed has taken action in the month of December.  It hiked rates in December 2004 and December 2005, for example, and it cut rates in December 2001 and December 1995.

The European Central Bank next meets on December 3.  Hopes are running high for more monetary stimulus to be announced after Draghi planted the seeds of expectations in his press conference following the last ECB meeting.  Although the odds of the bank taking action are high, we caution against getting too confident about it.  First, it is not clear that a consensus has been forged.  Second, the recent economic data suggests that, on balance, the expansion continues apace.  Core inflation is running at 1.0% year-over-year, which, while soft, is not signaling a deflationary spiral.  In short, the economic outlook does not seem consistent with the sense of urgency that Draghi seemed to express at the October ECB meeting.  

The Bank of Japan next meets on November 19.  It left policy on hold last week, which disappointed many who had anticipated an expansion of its asset purchase plan.  Contrary to what some refer to as a "technical” definition, officials do not appear to regard what Japan is experiencing as a recession.  Still, continued weakness in Q4 and the risk that headline inflation continues to soften will likely keep speculation running high for addition monetary easing either late this year or early next.  While Governor Kuroda offered assurances that further easing will be delivered if necessary, we think markets may be overestimating the odds of it happening imminently.  

The Bank of England next meets on December 10.  Earlier today, the BOE kept the key rate at 0.5% with an 8-1 vote.  The bank expects inflation to stay below 1% into H2 2016, which many interpreted as dovish.  The bank also trimmed its 2016 GDP forecast to 2.5% from 2.6%, and highlighted downside risks from EM.  The BOE is still widely expected to be the second major central bank to hike rates after the Federal Reserve.  This anticipation has helped sterling outperform most other major currencies on the divergence hypothesis.  However, the perceived gap between the Fed's move and the BOE's move can be several months and therein lays sterling's vulnerability.  

The Norges Bank next meets on December 17.  The central bank kept rates steady at 0.75% today, as expected, but some saw Governor Olsen’s comments as relatively less dovish.  In particular, he said the bank didn’t discuss a rate cut today.  The statement highlighted the effects of the fall in oil prices, but it also noted that, “the krone exchange rate has been weaker than projected, and a more expansionary fiscal policy will contribute to fuelling demand for goods and services.”  On balance, we think that the bank will retain its dovish bias and a cut in the next few meetings is certainly on the table.

The Riksbank next meets on December 15.  Deflationary risks persist and the Riksbank is still in easing mode, having extended its bond purchase program at the October meeting.  Many are still looking for further stimulus ahead, and believe that a rate cut will eventually be seen.  

The Bank of Canada next meets on December 2.  The unexpected election of a Liberal majority government changes the policy mix in Canada.  Fiscal policy will shift from a small surplus to a small deficit.   This may take some pressure off monetary policy, though with the economy recovering after the difficult first half, the Bank of Canada’s mini-easing cycle was likely over even before the electoral outcome.  For now, we see steady rates.

The Reserve Bank of Australia next meets on December 1.  It left rates steady at 2.0% earlier this week, but some forecasters had expected a 25 bp cut.  Governor Stevens left the door open for further easing in recent comments, but also noted that “prospects for an improvement in economic conditions had firmed a little.” The next meeting will likely be a close call.  Right now, about a third of the analysts polled look for a 25 bp cut.  Strong domestic credit growth may have bought the RBA some time, but further softness in the data would likely push it into cutting rates again.  

The Reserve bank of New Zealand next meets on December 10.  Markets widely expect it to cut rates by 25 bp to 2.50% then.  Recent data support this view.  The Q3 employment report was on the soft side, with the unemployment rate holding at 6.0% only because of the drop in participation rate.  There was also a terrible milk auction earlier this week, along with a wider than expected September trade balance, which doesn’t help the outlook.

EMERGING MARKETS

LATIN AMERICA

The next policy meeting for Brazil is on November 25.  No change is expected by analysts.  COPOM kept rates steady last month at 14.25%, and the minutes suggest that further tightening is unlikely (for now).  However, market pricing now suggests a 25 bp hike to 14.5% at that meeting, followed by two more 50 bp hikes in Q1 2016 (January 20 and March 2) that would take the SELIC rate to 15.5%.  That's very aggressive, and is almost certainly due more to risk aversion pushing up the local yield curve than to expectations for actual hikes.  IPCA rose 9.77% y/y in mid-October, well above the 3-7% target range and still rising.

The next policy meeting for Chile is on November 12.  No change is expected by analysts.  CPI rose 4.6% y/y in September, and is expected to fall to 3.9% in October.  If so, it would be the first time since March 2014 that inflation is within the 2-4% target rate.  The last move by the central bank was a 25 bp hike to 3.25% in October that started the tightening cycle, but we know that no hike was also discussed.  With the economy sluggish and inflation falling, the tightening cycle is not expected to be an aggressive one.

The next policy meeting for Colombia is on November 27.  The last move was a bigger than expected 50 bp hike to 5.25% in October, after starting the tightening cycle with a 25 bp hike in September.  Inflation was 5.35% y/y in September, and is expected to rise to 5.6% y/y in October.  If so, it would be another new cycle high and further above the 2-4% target range.  Indeed, inflation has been above the target range since January 2015.  

Banco de Mexico next meets on December 17.  At its policy meeting last week, the central bank kept rates steady at 3% but warned of pass-through risks from the weak peso.  Mexico stands out as a regional exception in terms of inflation risks.  Inflation is below the 3% target, and is currently at an all-time low just below 2.5% and still falling.  Banco de Mexico warned at the beginning of this year that it would likely hike rates pre-emptively.  That has not come to pass, but we do see some risk that Mexico hikes rates immediately after the Fed does.  

The next policy meeting for Peru is on November 12.  No change is expected by analysts.  The last move was a 25 bp hike to 3.5% in September that started the tightening cycle.  Inflation was 3.66% y/y in September, still above the 1-3% target range.  However, it has fallen from the 4% y/y peak in August and disinflation should continue.  The economy remains sluggish and so an aggressive tightening cycle seems unlikely.  

EMEA

The next policy meeting for Czech Republic is on December 16.  Today, it left policy steady but altered its forward guidance slightly.  It now sees current policies maintained until “around” the end of 2016.  Previously, it said until “at least” H2 2016.  Deflation risks continue, with CPI coming in at only 0.4% y/y in September.  If the data turn down again, we would not rule out an adjustment to the floor itself, rather than just the forward guidance.

The next policy meeting for Hungary is on November 17.  No change is expected, and it has kept rates at 1.35% since the last 15 bp cut in July.  However, the bank has been getting more dovish.  The bank recently moved the horizon for steady rates out to the end of 2017.  Central bank Vice President Nagy later said it could hold rates steady into 2019.  He then said earlier this week that the bank will ease policy further with “non-conventional” tools rather than rate cuts.  Deflation risks continue, with CPI coming in at -0.4% y/y in September.

The next policy meeting for Israel is on November 23.  Steady rates are expected.  Furthermore, the risks of a dovish surprise appear to have fallen after Governor Flug last meeting downplayed the need for more easing.  The last move was a 15 bp cut to 0.10% in February.  CPI contracted -0.5% y/y in September, and is well below the 1-3% target range.  The economy remains weak, but for now, it seems the weak shekel will be the main source of stimulus for now. 

The next policy meeting for Poland is on December 2.  No change is expected, and it has kept rates at 1.5% since the last 50 bp cut in March.  While the bank is on hold for now, it will likely get more dovish next year when virtually the entire MPC will be replaced as their terms expire in Q1.  The incoming Law and Justice government has already expressed a desire to stack the MPC with a more growth-oriented staff, so further easing seems likely in 2016.

The next policy meeting for Russia is on December 11.  The central bank has kept rates steady at 11.0% since the last 50 bp cut in July.  CPI inflation has decelerated two straight months, but remains too high at 15.6% y/y in October.  We think steady policy is the right decision in light of rising inflation and the weak ruble.  The central bank suggested at its last meeting that easing could be seen in 2016 if the inflation trajectory improves as it expects.  

The South African Reserve Bank next meets on November 19.  It is the only notable hawkish central bank in this region, but it has been wavering of late.  With the economy still weak, we think the SARB will find it hard to continue its tightening cycle after restarting it with a 25 bp hike to 6% back in July.  Analysts are looking for a continuation of the tightening cycle, roughly at a pace of 25 bp per quarter.  This strikes us as too aggressive, and we believe that political realities (unemployment above 25%) and social unrest will prevent this scenario from unfolding.  Fiscal policy is also being tightened, putting more headwinds on the economy.

The next policy meeting for Turkey is on November 24.  Steady rates are expected, and the last move was a 25 bp cut to 7.5% in February.  Inflation has started decelerating, falling to 7.58% y/y in October.  It may move back within the 3-7% target range in the coming months.  With political uncertainty lower after the November 1 elections, the bank may come under pressure to resume rate cuts.  Indeed, press reports suggest the AKP is considering a change to the central bank’s structure to give it a growth mandate, rather than an inflation one.  

ASIA

With China data still softening, the PBOC is likely to continue its easing cycle.  The last move was a 25 bp cut in its policy rates and 50 bp cut in reserve requirements in October.  CPI rose to 1.6% y/y in September, down from 2.0% in August, which was the highest level this year.  Still, inflation is not the main variable in the PBOC’s reaction function.  With the growth outlook still uncertain, we expect further easing by a combination of policy rate cuts and reserve requirement cuts.

The next policy meeting for India is on December 1.  Price pressures remain low, with CPI rising 4.4% y/y in September, near the middle of the 2-6% target range.  WPI contracted -4.5% y/y, pointing to no pipeline pressures. Governor Rajan, however, is also very much focused on banking reform and legal issues pertaining to the independence of the central bank.  Rajan has also made it clear that it fiscal discipline is an important element in the reaction function of the RBI.  So the easing cycle will be gradual.  The last move was a 50 bp cut in its policy rates in September. Also of note, regional elections are ongoing in India and a strong result for ruling BJP would help ensure that reforms would continue moving and fiscal outlook under check.

The next policy meeting for Indonesia is on November 17.  Bank Indonesia faces a quandary.  Like the rest of the region, the economy is slowing.  However, inflation here is too high to allow for easing near-term, especially with the rupiah weakening steadily.  As such, the bank is likely to say on hold for now.  CPI rose 6.25% y/y in October, the lowest since November 2014 but still above the 3-5% target range.  Easing in 2016 is possible if disinflation continues.  The bank is primarily focused in currency stability at the moment and is debating new money market instruments to deal with excess funds.  However, it has taken some macroprudential steps to boost lending.  The last rate move was a 25 bp cut to 7.5% in February.

The next policy meeting for Korea is on November 12.  Although core CPI remains elevated at 2.1% y/y, headline is running at a relatively benign 0.9% y/y in October, and is below the 2.5-3.5% target range.  We suspect the bank will prefer to see the reaction from the first Fed hike before pulling the trigger.  Effects of fiscal stimulus will also be gauged by the BOK before it acts again.  The last move was a 25 bp cut to 1.5% in June.

The next policy meeting for Malaysia is on January 21.  It just kept rates steady today, but the tone of the statement seemed to be more dovish than in the past.  It noted that "Downside risks to growth remain high.  The performance of the Malaysian economy continues to be affected by the weak external environment" and it added that private consumption is expected to moderate.  We think it will lean more dovish and perhaps ease in 2016 if the slowdown continues.  The weak ringgit is a constraint on cutting rates near-term.  The last move was a 25 bp hike to 3.25% in July 2014.  

The next policy meeting for the Philippines is on November 12.  Data has come in on the firm side recently, despite the external headwinds.  A lot of the country’s economic performance will hinge on President Aquino’s fiscal plans and implementation of infrastructure expenditures.  Inflation remains very subdued at 0.4% y/y in October, well below the 2-4% target range.  However, upside risks are present due to the El Nino effect and its pass-through.  Monetary policy seems to be roughly in balance at the moment.  The last move was a 25 bp hike in its policy rates in September 2014.  

The next semi-annual policy meeting for the Monetary Authority of Singapore is in April 2016.  Singapore is experiencing deeper deflation risks.  CPI fell -0.6% y/y in September, and is the eleventh straight month of deflation.  Even core is too low at 0.6% y/y.  The MAS does not have an explicit inflation target, but should be concerned that deflation risks remain strong.  The economy is slowing, and we think the MAS will ease policy at its April meeting by adjusting its S$NEER trading band again.  No date has been set yet.  The MAS reduced the rate of S$NEER appreciation at the October meeting, which was more timid than many expected.  MAS had been on hold since the last emergency intra-meeting easing move back in January.

The next quarterly policy meeting for Taiwan is in late December.  Another rate cut is expected then after the 12.5 bp cut to 1.75% at the September 24 meeting started the easing cycle.  Data have come in very soft since the September meeting, with imports, exports, IP, sales, and GDP all showing further weakness.  CPI rose 0.3% y/y in both September and October, but deflation risks remain in place.  Of course, the slowdown in China is the key variable here.

The next policy meeting for Thailand is November 4.  No change is expected.  It seems as if the bank is leaving further stimulus in the hands of the government and also to the weaker baht.  Despite headline CPI falling -0.8% y/y in October (the tenth straight month of deflation), the central bank will probably want to see how the fiscal measures impact the broader economy (and possibly wait for the Fed to move) before committing to further action.  The last move was a 25 bp cut to 1.5% in April.    

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