It’s been another eventful week with focus on the timing of the ‘central bank pivot’, UK budget mess, a large OPEC production cut and rising tensions in the Ukraine war. Especially the possible pivot of central banks towards a slower pace of rate hike have been in focus and drove a decent rally in global bonds as well as equities in the middle of the week. It got more fuel with the dovish surprise by Reserve Bank of Australia reducing the hiking rates 25bp rather than the 50bp seen in the previous four meetings and which analysts were looking for again this week. The Polish central bank also surprised by refraining from lifting rates after being on a steady path of tightening monetary policy over the past year taking the policy rate to 6.75% from the starting point of 0.1%.
Will the Fed follow in the footsteps soon? We believe it is still too early, although there are some signs that the labour market is softening with job openings in August showing the biggest decline in a long time (non-farm payrolls arrived after deadline). However, with core inflation still elevated and the labour market overall still tight despite the moderate loosening, we believe it is too early for the Fed to allow an easing of financial conditions, which would immediately follow a more dovish signal from them. This week showed that any hint that a pivot is here, triggers a rally in both bonds and equity markets and also lifts commodity prices. For this reason, we think the Fed will have to strike a fairly hawkish tone until it is convinced that inflation pressures are indeed easing on a sustained basis. The same goes for the ECB, which struggles with inflation at 10% now and concerns about a price-wage spiral. Policy makers also seem increasingly eager to ease fiscal policy to cushion the hit to consumers, which adds to the burden for central banks. A prime example was the new British governments’ fiscal easing but also Germany’s up to EUR200bn package to cushion the economic hit shows politicians feel a rising pressure to respond to the crisis. However, as the recession becomes more visible, we believe inflation pressures will come down as unemployment begins to rise amid interest rates moving into restrictive territory. This will eventually make both the Fed and the ECB stop hiking and then the market will likely start to price in more cuts in late 2023 and 2024. Key data to watch for gauging when the pivot is here will be labour market as well as core inflation data.
Goods price inflation pressures are easing in the US as oil and metal prices are lower, freight rates are almost back to pre-pandemic levels and inventories are rising. But in Europe the rising costs from electricity and gas prices keep inflation pressures high. OPEC+ didn’t show much willingness to help on easing inflation as they decided to cut production by two million barrels to counterweight a decline in demand. While in practice it will only amount to one million barrels it will, all else equal, delay a decline in inflation back to 2%.
Economic data was a mixed bag. ISM manufacturing for September was weaker than expected with the new orders index dropping to a low 47.1 from 51.3 but ISM service fell less than expected to a still robust 57.7 from 57.9. Euro retail sales (volumes) for August dropped 0.3% m/m adding to a decline of 0.4% in July. But while consumer spending is clearly weakening it could have been worse given the massive hit to real wage growth.
In the coming week, the key data release will be US CPI for September. It surprised to the upside again last month and has proved very sticky despite the easing pressures on goods. IMF will publish new forecasts and it will be interesting to see how much they revise down growth and what they see on the inflation front.
