There are three potential inflection points. The first is a
pause from the Fed; if nothing else, Powell signaled it was too early to think
about it. The second is for the Bank of Japan to change monetary policy.
Governor Kuroda has signaled that it is not time. Conventional wisdom is there
will not be a change until Kuroda's term ends next April. However, we note that
the surveys suggest economists and BOJ inflation forecasts for next year have
converged. The third potential development can alter the investment climate if
China fundamentally changes the way it is resisting Covid. Reports are playing
up this possibility, and it emerged as a significant factor ahead of the
weekend as metals and oil soared while the dollar gave back a chunk of its
post-FOMC gains. However, while there do seem to be a few adjustments, we are skeptical
of claims that Beijing is about to jettison its zero-Covid policy. Indeed,
if there are no developments over the weekend, confirming a shift, risk
appetites seem vulnerable to a reversal.
The US October CPI is the most critical
data point in the week ahead. Fed officials are unlikely to have known the number before they
met last week. But they knew at least as much as the Street, and a strong
month-over-month gain in both the headline and core rate is likely. The base
effect also may point to a small decline in the year-over-year rates.
The median forecast in Bloomberg's survey
calls for a 0.6% increase in last month's CPI and a 0.5% increase in the core
measure. Given the
base effect and rounding, the year-over-year headline rate may be 7.9%-8.0%. The core rate, which reached a cyclical high of 6.6% in September, could match
that or slip to 6.5%.
The November CPI will be reported the day
before the FOMC meets again on December 14. In November 2021, headline CPI
rose by 0.7% and the core by 0.5%. The median forecast in Bloomberg's survey sees
headline CPI finishing the year at 7.3% and falling to 3% at the end of 2023. In
PCE deflator terms, the median forecast put it at 5.6% at the end of this year
and 2.6% at the end of next year. In the September Summary of Economic
Projections, the median Fed forecast was for a 5.4% PCE deflator at the end of
2022 and 2.8% at the end of 2023.
There are two main ways to ascertain
inflation expectations: surveys simply ask people, and market-based measures,
comparing financial instruments. The Fed conducts its own survey. The results of the next two
surveys will be published on November 14 and December 12. The September survey
showed the one-year expectation eased to 5.4% from 5.7%. The three-year
expectation edged up to 2.9% from 2.8%. The five-year consumer expectation also
drifted to 2.2% from 2.0%.
The University of Michigan's consumer
inflation expectations survey was singled out as a factor that spurred the Fed
to accelerate its hikes in June. Leave aside the fact that Chair Powell cited a preliminary report
that was revised lower in the final reading. Last month's final reading put the
one-year expectation at 5.0% (4.7% in September) and a 5.4% peak in March and
April. The anticipation for the next 5-10 years edged up to 2.9% from 2.7%. A
peak of 3.1% was seen in January and again in June. It is notable that despite
the Fed's actions, this long-term inflation expectation has been flat since the
end of last year. The preliminary November estimate is due out on November 11,
when the bond market is closed for Veterans Day.
The market-based measures of inflation
expectations are derived from comparing conventional yields with
inflation-protected securities. The two-year breakeven finished last year near 3.20%. It peaked
shortly after the Fed's first hike in March, almost at 5.0%. It recorded the
low for the year in early October, around 1.90%. For the past two weeks, it has
been in roughly a quarter-point range below 3%. The 10-year breakeven began the
year near 2.60% and peaked in late April at around 3.07%. The low was set in
late September, slightly below 2.10%. It recovered in October to reach 2.60%. It
is hovering a little above 2.50% now.
However, inflation expectations have not
proven to be very accurate in forecasting future inflation. The surveys seem heavily influenced by
gasoline prices. The market-based measures may be poorer still. At the end of
2020, after a Covid vaccine was announced, the five-year breakeven was slightly
below 2%. The supply and demand of inflation-linked securities and their
relative attractiveness can drive, separate from, a pure expression
of inflation expectations.
Two other high-frequency data points do
not draw much market attention but are arguably important, especially in the
current context. The
first is consumer credit. Figures for September will be released on November 7.
It is expected to rise by a little more than August's $32.2 bln increase.
Revolving credit rose $17.2 bln, the third highest ever. This is a key way
households make ends meet when wages are not keeping up with inflation. To put
this figure in perspective, consider that Americans' revolving credit (think
credit cards and home equity loans) has risen by $112 bln through August. In
the Jan-Aug period last year, the figure was closer to a little more than $26
bln and slightly less than $30 bln in the first eight months of 2019.
Non-revolving credit, primarily auto and
student loans, rose by $15.1 bln in September. Non-revolving debt has also
increased. In the
first eight months of the year, non-revolving credit has risen by $137.1 bln.
In the same period last year, it was almost $120.6 bln. In the Jan-Aug 2019
period, non-revolving debt grew by about $95.5 bln.
The other report, the US monthly federal
deficit, gets little attention from the market. With the focus on monetary policy, the
dramatic tightening of fiscal policy is rarely discussed. Consider that the US
has recorded an average monthly shortfall of almost $111 bln in the first nine
months of the year. In the first nine months of 2021, the average monthly
deficit was more than twice that at nearly $245 bln. The US deficit is expected
to fall from 10.8% of GDP in 2021 to 4.3%. That said, weaker growth means less
revenue and greater counter-cyclical spending.
The US holds midterm elections on November
8. The entire House
of Representatives, a third of the Senate, and 36 governor races are to be
decided. While of greater importance domestically and for the partisans, the
impact on the capital markets will likely be subdued. The main thrust of monetary
and fiscal policies is unlikely to change based on the results. Moreover,
despite some noises to the contrary, key parts of foreign policy appear to
enjoy bipartisan support, including support for Ukraine, confronting and
decoupling from China, a show of restraint in the face of North Korean missile
tests, and unconvinced to rejoin the nuclear treaty with Iran.
Outside the US, there are three sets of reports that likely will draw will likely first is from China. First, China's trade surplus is
expected to have jumped to nearly $96 bln in October from almost $85 bln in
September. The record was reached in July, slightly less than $102 bln. China's
trade surplus has swelled this year. China reported a $645 bln trade surplus in
the first three quarters of the year. Last year's Jan-Sept period, its trade
surplus was about $426 bln. In the same period in 2019, China's trade surplus
was around $295 bln. While it is indeed large, trade is swamped by capital
flows. The latest BIS survey estimates that the daily turnover
of the yuan is about $525 bln. The US dollar is stronger this year despite the
$675 bln deficit through September vs. $556 bln in the same year-ago period; we
need to be careful about extrapolating from trade balances to exchange rates.
China will report October PPI and CPI on
November 8. These two data points will be notable. China's PPI has fallen since it peaked at
13.5% in October 2021. It slowed to 0.9% year-over-year in September and likely
went negative in October. It would be the first such print since the end of
2020. China's CPI rose to 2.8% in September. That was the highest since April
2020. The median forecast in Bloomberg's survey sees it slowing to 2.4% in
October, a five-month low. There is scope for additional measures to support the
economy. However, they might be lost in the shuffle without some lifting of the
zero-Covid policy. It does seem to be adjusting but not retracting. Lockdowns
and restrictions seem to be more limited in geographic scope to be more
targeted to neighborhoods and quieter, without large announcements.
Second, Japan reports September labor
earnings and household consumption. These reports, coupled with the current account figures,
are the last essential data points ahead of the preliminary estimate of Q3 GDP
on November 15. It looks like consumption slowed after rising by 1.2% in Q2. Net exports also appear to have been a drag (-0.3% vs. 0.1% in Q2). However,
contributions were likely made by stronger business spending and less of a drag
from inventories.
The correlation between US rates and the
yen's exchange rate has loosened. The correlation of change in the exchange rate and the 10-year
Treasury yield on a rolling 60-day basis has fallen to its lowest level since
Q1 21, a little below 0.35. It had been hovering above 0.60 earlier this year.
The correlation with changes in the two-year US yield has also slipped recently
to around 0.43 from closer to 0.58 a month ago. Real and feared intervention
may have injected a new dynamic into the mix.
The third set of data is from the UK. It reports Q3 GDP and details for
September. Recall that the economy unexpectedly contracted in August.
Economists expect the economy likely contracted by 0.2% for the entire quarter.
They expect it to be the first of four quarterly contractions. When
the Bank of England hiked the base rate by 75 bp last week, it updated its
forecasts and warned of a 0.5% decline in output in Q3. It also sees inflation
peaking this year at 10.9% rather than 13%, as previously projected.
The precise details may not be as
important as the reaction function of the new Tory government. The budget statement is now scheduled for
November 17. That will allow the Office for Budget Responsibility to use
dramatically lower interest rates to assess the government's plans. What does
seem to be clear is that the new government will be one of austerity, the
restoration of tax hikes that Sunak had planned as Chancellor, which Truss
eschewed.
A recession, for which the Bank of England
offered an advanced warning, will not stand in the way of tighter monetary
policy. After last
week's 75 bp hike that brought the base rate to 3.0%, the swaps market looks
for at least another 50 bp hike at the mid-December meeting. The Bank of
England said that the market had looked for the terminal rate near 5.25% next
year, but that seems a bit dated. The last time the swaps curve saw
the terminal rate above 5.25% was October 21. The terminal rate is seen between
4.50% and 4.75%. Moreover, the BOE has begun selling securities it bought during
QE. It began with GBP750 mln of short-term notes that were in high demand
(over-subscribed more than three times. Like several other countries are
experiencing, including the US and Germany, there is a scarcity of short-end
instruments that are often used in repo transactions. It might not be that easy
going forward, especially as maturities (duration) lengthen.
Separate from the high-frequency data, two
emerging market central bank meetings catch the eye. Poland's central bank meets on November 9,
and Mexico's meets the following day. Poland began its normalization efforts
last October and hiked its reference rate relatively aggressively to 6.75% in
September. It defied expectations and left policy steady in October. The market
accepts that the central bank has a pregnant pause, but swaps appear to be
pricing around 75 bp of hikes over the next year. The preliminary estimate put
October CPI stood at 17.9%, and the core rate was above 10.5% in September.
While the zloty is off around 15.5%
against the dollar, the Mexican peso is one of a few currencies that have
appreciated against the dollar greenback this year. The central bank began hiking rates in
June 2021. Its overnight target rate bottomed at 4.0%. Poland's low was 0.10%.
Mexico's overnight rate now stands at 9.25%, which is expected to match the
Fed's 75 bp hike. Its October CPI will be reported the day before Banxico
meets. Headline CPI has begun leveling off around 8.7% (August and September).
The core rate made new cyclical highs near 8.3% in September. The swaps market
sees a terminal rate in Mexico of around 10.75%.
Disclaimer
Reviewed by Marc Chandler
on
November 05, 2022
Rating:
