Four Drivers in the Week Ahead

After the US and UK holidays on Monday, there are four highlights in the week ahead. First, the Reserve Bank of Australia's meeting will receive more attention after the Reserve Bank of New Zealand signaled the likelihood of a rate hike in the second half of next year. Second, the G7 finance ministers may agree to endorse a proposal for a minimum corporate tax rate of 15% and an additional tax on the largest 100 companies (so that areas in which they sell can collect taxes).  

Central banks say that their policy path is data-dependent, but this is coded language.  Officials at the Fed and ECB say price pressures are transitory, which means that it will look past near-term increases.  Yet, the ECB's Panetta seemed to link the increased bond purchases to sustained inflation pressures.  That means the June 1 preliminary estimate of the eurozone's May CPI will likely garner more attention than otherwise would have been the case.  When Fed officials like  Vice Chair Clarida talk about the importance of economic data, they probably have employment on their minds, not inflation.  After the big miss with the April jobs report, the May reading on June 4 will be riveting.  

RBA Meeting:   The Australian economy is around six times larger than the New Zealand economy.  Its terms of trade are dramatically different.  The Reserve Bank of New Zealand's reintroduction of its cash rate path outlook, with the first rate hike penciled in for H2 22, has no real material bearing on the Reserve Bank of Australia's meeting on June  1.  It is similar, though different than the ECB's Lagarde and the Fed's Powell batting away questions about if the Bank of Canada assessment that its economic slack will be absorbed in the second half of next year and that it would reduce its bond-buying says anything about the conduct of their respective monetary policies. 

Even those who think that the RBNZ is a sort of tell are not expecting much from this week's RBA meeting.  The July 6 meeting is more important.  First, the term funding facility is set to end on June 30.  Second, officials have already indicated that it will decide in July whether to target the November 2024 yield under the RBA's yield-curve control strategy, rolling out from the current April 2024 issue. The central bank will also decide then whether to have another round of asset purchases when the current A$200 bln operation is completed at the end of September.   

Like the Federal Reserve, the Reserve Bank of Australia has emphasized labor market developments in its reaction function.  Employment data has not been clean for a couple of months.  The JobSeeker income support program ended in March, and the holidays (Easter and school holiday) may have exaggerated the job loss in April (-30.6k, well below the median forecast in the Bloomberg survey for a gain of 20k).  The May report (due June 17 in Canberra) is expected to bounce back smartly.  Despite the disappointment, judging from survey data, anticipating lower unemployment in the coming quarters than previously.  

G7 Finance Ministers:  It has been a while since the G7 finance ministers meeting was truly a highlight. It may have acted in concert as the pandemic first struck, but it was not coordinated, and it was the Fed's swap line with several foreign central banks that provided that key international support.  With the combination of the increased importance of the G20 (partly reflecting the rise of China and India), the attitude of the Trump administration, and the salience of domestic challenges, the G7 has morphed into a caucus within the larger group.  

The coordination function is key now.  The issue is corporate tax reform.  It has been debated for several years and was stymied, in good measure, due to US intransigence.  However, this has changed, and, as the old saw has it, the convert sings loudest in the choir.  The Biden administration has jumped to the front of the queue it had been trailing.  Although the OECD had been talking about a 12.5% minimum corporate tax rate for a few years, Biden initially suggested 20%.  Facing strong pushback, the US Treasury compromised and proposed a 15% floor.   If it does not get the endorsement of the G7 finance ministers or if it is diluted to be less definitive, hopes for the G7 heads of state summit in mid-June will diminish.  It would also be seen as a setback for Biden's domestic agenda, which seeks to lift the corporate tax schedule to 28% from 21% (though some estimates put the effective tax rate at closer to 16% in 2019). 

Ireland is not part of the G7 or G20, but it still is a significant stakeholder.  Its 12.5% corporate tax rate attracts a large number of technology and pharmaceutical companies to book profits. The UK has also pushed back, less forcefully, perhaps, and some press accounts suggest its position may be wavering.  The issue is the digital tax that several countries are at different stages of implementing  Because it appears to single out US companies, Washington has demurred.  And more; the US has threatened to retaliate.  The compromise is to broaden the base to include other companies that sell many products online internationally.  The goal is to recognize countries' right to tax where the sales are made rather than where the company books the profit.  Fitting into the populist moment, the Biden administration has recast it to be a tax on the largest 100 companies.   Many countries seem more enthusiastic about this than a minimum corporate tax rate.  

EMU May CPI:  The ECB has one mandate:  price stability, which it presently defines as close to but below 2%.  Many expect this could be tweaked to simply 2% later this year, but the significance may be difficult to articulate.  ECB President Lagarde has sketched out many reasons why officials are inclined to look through the near-term gains in measured inflation.  They largely have to do with base effect, changing the weights of the basket of goods and services used, alterations to the seasonal sales, and tax adjustments like the end of the temporary reduction in the German VAT. 

Europe seems to be a few months behind the US in the vaccine rollout, fiscal stimulus, and price pressures.  The base effect in the US, for example, will peak with the May report.  Last June and July, headline CPI rose by 0.5%, making year-over-year comparison not as challenging.  That may lower the anxiety over inflation.  On the other hand, measured eurozone inflation is likely to surge in July and August when headline CPI fell by 0.4% in both months in 2020.  

A 0.2% rise in May's EMU CPI would lift the year-over-year rate to 1.9%, the highest since the inflation scare in H2 2018.  Around half of this emanates from food and energy.  Excluding them, May's core rate is expected to tick up to 0.9% from 0.7%.  Some try reductio absurdum to argue that if one excludes the items that show rising prices, inflation disappears.  The truth of the matter is that as a heuristic device it is useful because 1) over time, the headline rate appears to converge to the core rate, not the other way around, and 2) food and energy prices are (often?) subject with supply shocks and not a reflection of monetary policy.  EMU's 12-month moving average core rate was stable at 1.0%-1.1% from September 2017 and August 2020.  

Last week, a notable development was the attempt to link the stronger bond-buying under PEPP to inflation by the ECB's Panetta.  It is not clear that this will ultimately prove to be a decisive argument.  The increased buying announced at the March meeting was not linked to inflation or inflation expectations at the time.  Recall that yields appeared to have been dragged higher by the sharp rise in US rates as the vaccine rollout accelerated and additional fiscal stimulus (after the $900 bln package at the end of 2020) was provided.  Europe yields have risen, and premia over Germany have risen.  Most of it took place in April.  

US May Employment Report:  In the mid-to-late 1980s, the US trade report seemed to be the most anticipated high-frequency data point, replacing money supply.  However, since probably the early 1990s, the national employment report takes the honor.  The disappointment with the 266k increase in April nonfarm payrolls shocked policymakers and investors.  Economists who had forecasted a million jobs, and there was a projection for two million, have been chastened.    In the survey for the May establishment survey, only three of the 56 respondents look for a 900k or more increase.   At the same time, there may be a tendency to overcorrect, and some the low estimate is 335k.  The median and average converge around 650k.  

Millions of jobs begin and end every month.  The nonfarm payroll report is the net change.  It is by all accounts among the most difficult numbers to predict.  There are few useful and timely inputs. Weekly initial jobless claims have marginal.  Between survey weeks, the four-week moving average of weekly initial state jobless claims fell by around 150k.   It had fallen by 100k previously.   The preliminary PMI was strong, led by labor-intensive service business activity in the hard-hit leisure and travel sectors.  

The market reacted dramatically to last month's disappointment.  The 10-year yield plunged from around 1.58% to almost 1.46%, a two-month low, but within a few hours had fully recovered.  The other observation is that yields have tended to rise into the month-end.  This was the case in Q1.  However, the 10-year yield was trending higher, and the rise into the end of the month meant little, but it is happening in Q2 even as yields drifted lower.  Of course,  initial conditions matter, and the market reaction is often driven by short-term market positioning. Still, perhaps the takeaway from last month's experience is that one month's number will not change the Fed's stance.  Moreover, in the few weeks since that underwhelming jobs report, which was followed by disappointing retail sales, housing starts, and durable goods orders, there has been an increase in the number of Fed officials referring a discussion of tapering in the coming months.   Just like the knee-jerk rally in Treasury prices was faded, so too a sell-off on a stronger report will likely be bought.    

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