The euro, trading around its lowest level in two
years, may initially tick higher if Macron is re-elected president. Yet it should not be exaggerated. Le Pen
never ran ahead in the polls, but the proximity spooked some market
participants. One of the key reasons the race was tight was that Le Pen
tapped into a concern with broad appeal and may strike a responsive chord
elsewhere. Between the rising cost of living from inflation and higher
taxes (in many countries), households are squeezed. This potent political
issue taps into a vein of anger and frustration that arguably were simmering
below the surface.
However, Europe is more exposed to the stagflationary
forces emerging in the post-Covid period and from the war in Ukraine. The IMF's updated World Economic Outlook recognizes
this and cut its forecast for eurozone growth this year to 2.8% from
3.9%. This is now in line with the market's forecast (the median forecast
in Bloomberg's survey is 2.9%). However, this may still seem a bit elevated unless
the war ends quickly. In addition, another energy shock may be around the
corner. The stand-off between Russia's payment scheme now that it cannot spend
the euros due to the sanctions and Europe's reluctance to play ball will likely
come to a head in the coming weeks. The eurozone will publish its first
estimate of Q1 GDP on April 29. It is expected to have risen by 0.3%
quarter-over-quarter.
German growth will be reported an hour before the
eurozone estimate. Remember,
Europe's largest economy contracted by 0.3% before the war
began. It may have eked out 0.2% growth in the first three months of
2022. The French economy continues to fare better than Germany. It will
report its GDP figures a few hours before Germany. After growing by 0.7%
in Q4 21, Q1 22 activity appears to have slowed to around half that pace.
Italy reports its Q1 22 GDP estimate that will be released at
the same time as Germany. For
the second consecutive quarter, Italy appears to have outperformed
Germany. While Germany contracted in Q4 21, the Italian economy expanded
by 0.6%. In Q1 22, it may have contracted by 0.3%, according to the
median forecast in Bloomberg’s survey. The Bank of Italy warned of a
deeper contraction. Specifically, earlier this month, the Director-General
of the central bank cautioned that Italy's economy may have contracted by 0.55
in Q1. Signorini cited two drivers: the surge in Covid cases during the
few several weeks of the quarter and the jump in energy prices.
To round out the top four largest eurozone economies,
Spain may surprise many observers by likely being the best performer. The Spanish economy probably expanded by around 0.6%
in Q1 22 after a 2.2% bump in Q4 22. Spain is among the least dependent EMU
members on Russian energy. After shaving its growth forecast one
percentage point to 4.8%, this year, the IMF has Spain growing faster than
China (4.4%).
At the same time that the eurozone's Q1 GDP report
will be published, Eurostat will also announce its preliminary estimate of the
region's CPI. German and
Spanish national figures the day before will help solidify forecasts.
French figures are due a few hours before the aggregate figure. Italy
offers no lead time whatsoever. Its estimate is made at the same time as
the eurozone as a whole. Given Covid-related distortions, there may not
be much that can be said about it with confidence.
However, two things seem likely. First, March's 2.4% surge (month-over-month) is
unlikely to be repeated. Energy prices were a key driver and appeared to
account for a little more than half of the monthly rise. After the Dutch
wholesale benchmark for natural gas jumped more than 24% in March, it has
nearly fully retraced it in April. Wholesale costs are passed on to
consumers with variable lags, making it difficult to estimate when it
hits. Also, several countries have cut taxes on energy purchases to
relieve the squeeze on households.
Second, last April's 0.6% increase is the bogey. If the Eurostat estimate comes above it, the
year-over-year pace will accelerate from March's 7.5%. The median
forecast in Bloomberg's survey is for a 0.5% month-over-month increase.
Higher input costs and supply chain disruptions could see the core rate
continue to accelerate. It rose 2.6% in 2021, and March's 2.9% is
unlikely to be the peak.
The Bank of Japan is in the proverbial hot seat. It meets on April 27-28. Forecasts will be
updated. It will likely boost this year's CPI forecast of zero made a few
months ago. It is also likely to reduce its growth projections. Previously,
the BOJ's forecast stood at 2.8%. The IMF cut its forecast to 2.3% from
3.2%. The BOJ will probably boost its inflation forecast from 1.1% in
January to something closer to 1.7%. However, Governor Kuroda will likely
reiterate that the price pressures coming from food and energy and the
statistical quirk with the mobile phone charges are not the kinds of things
that make for sustain inflation.
The yen has been on a historic depreciation course
that has seen it depreciate by 10.5% this year, with more than half of which
has taken place here in April. The
divergence of monetary policy is the key driver, and the rise of roughly 140 bp
increase in the US 10-year yield can be explained by the nearly 200 bp increase
in the anticipated increase in the Fed funds rate this year.
Many observers believe that if the BOJ were to abandon
the 10-year cap of 0.25%, the yen would strengthen. We are less sanguine. The key, we think,
is the divergence of monetary policy, not the cap on the 10-year bond.
Japan's 30-year bond yield is not capped, and pays 1%. The US premium on
this tenor briefly exceeded 200 bp last week for the first time in nearly three
years. The IMF has suggested that the BOJ target the five-year yield,
which is around three basis points, but not now during the challenge of the
existing 10-year cap. After selling off for a record 13 consecutive
sessions and extending the losses into a 14th session (reaching JPY129.40), the
yen bounced strongly after the BOJ defended the 10-year cap.
On April 28, the US reports Q1 22 GDP. As recently as early March, the Atlanta Fed's GDP
tracker warned that the economy may be contracting. However, last week's
update now sees it at 1.3% at an annualized rate. That is slightly firmer
than the median forecast in Bloomberg's survey (1.1%). This would still
be well below the 6.9% pace in Q4 21, but that had been bolstered by a surge in
inventory accumulation. Consumption, which still drives the economy, is
expected to have strengthened from the 2.5% Q1 rate to 3.4% (median, Bloomberg
survey). Retail inventories and the March trade balance will be reported
days before the GDP estimate and may prompt last-minute tweaks to
forecasts.
The GDP deflator may have stabilized around 7%, but
the March PCE deflator, which the Fed targets, is likely to have accelerated
from 6.4% in February to near 6.7%. The median forecast in Bloomberg's survey looks for the core measure to
ease slightly to 5.3% (from 5.4%). The actual spending figures will have been
incorporated into the GDP estimate.
With inflation running the highest in a generation,
the important differences between CPI and the PCE deflator seem somewhat less
significant. The point is that
the market has become convinced that the Federal Reserve may have been slow to
respond, but it has begun what will be very aggressive. Outside of some
bolt-from-the-blue as it were, or a black swan, if you prefer, the Federal
Reserve will likely raise rates by 50 bp at each of the next three meetings
(May, June, and July). The market is almost sure that it will hike another half
a point at the September meeting too. The Fed funds futures strip now
implies a year-end rate of almost 3.0%
The hawkishness of the recent rhetoric from Fed
officials means that the tightening cycle will continue into next
year. Last month's Summary
of Economic Projections showed six of the 14 "dots" were above 2.75%
in 2023. Eight were above it in 2024. The swaps market now sees the
peak in Q2 23, moving toward 3.50%. One of the implications is that the
two-year note yielding less than 2.70% is still rich. It should be
expected to rise above 3%. Long-term yields are a different story.
We will see the appetite for 10- and 30-year bonds when yields rise above
3%. Arguably, there is value there, especially if core inflation is near
a peak. Food and energy are excluded from the core rate, not just because
they are volatile, but because over time the headline rate seems to
converge with the core rate, not the other way around.
Disclaimer
Reviewed by Marc Chandler
on
April 23, 2022
Rating:
