Sterling Shines as BOE Surprises

December 16, 2021
  • Fed delivered a hawkish decision; Chair Powell was suitably hawkish in his press conference; November retail sales data were disappointing; regional Fed manufacturing surveys for December continue rolling out; Mexico is expected to hike rates 25 bp to 5.25%
  • ECB decision is due out shortly; eurozone reported weak preliminary December PMI readings; BOE started the tightening cycle with a 15 bp hike to 0.25%; U.K. reported weak preliminary December PMI readings; SNB kept policy steady; Norges Bank hiked rates 25 bp to 0.50%; Turkey cut rates 100 bp to 14.0%, as expected
  • BOJ meeting began today and ends tomorrow with a decision; Japan reported solid November trade data; Australia reported strong November jobs data; RBA Governor Lowe sounded more hawkish; Indonesia kept rates steady at 3.5%; Philippines kept rates steady at 2.0%; Taiwan kept rates steady at 1.125%

The dollar remains soft in the wake of the FOMC decision. After trading just below 97.0 yesterday, DXY closed lower and is trading even lower today 96.30. The euro is heavy and trading near $1.13 while sterling is outperforming and trading near $1.3360 after the BOE surprise (see below). USD/JPY has finally broken above 114 for the first time since November 26. The dollar is clearly suffering from some “buy the rumor, sell the fact” price action right now. Looking ahead, we believe the underlying trend for a stronger dollar remains intact.

AMERICAS

The Fed delivered a hawkish decision. As widely expected, the Fed doubled its pace of tapering a mere month after starting it to $30 bln per month ($20 bln UST and $10 bln MBS). If sustained, QE will end by March. Updated Dot Plots and macro forecasts support a more hawkish stance. The Dot Plots saw the median policy rate for end-2022 shift to 0.875% (three hikes) from 0.375% (one hike) currently, while the median for end-2023 shifted to 1.625% (six total hikes) from 1.125% (four) previously and the median for end-2024 shifted to 2.125% (eight total hikes) from 1.875% (seven) previously. Core PCE forecasts were revised higher and unemployment forecasts were revised lower. There were no significant revisions to the growth forecasts.

Chair Powell was suitably hawkish in his press conference. He said the Fed continues to see rapid growth and rapid progress towards full employment. Powell said it’s unclear how long labor shortages will persist but added that wage growth hasn’t been a major contributor to inflation yet. Of course, he said the recent rise in virus numbers and the spread of omicron pose risks. Of note, Powell acknowledged that the balance sheet debate is already under way but that no decisions have been made. He noted that “We looked back at what happened in the last cycle and people thought that was interesting and informative. But to one degree or another people noted that this is just a different situation and those differences should inform the decisions we make about the balance sheet this time.”

Let’s take a look back at that episode. Recall the Fed announced tapering in December 2013 and ended it in October 2014. The first rate hike was in December 2015, the second was in December 2016, and there were three more in 2017. It wasn't until the fourth hike in June 2017 that the Fed started balance sheet reduction. Yet we know already that the Fed is in an accelerated mode. Tapering will be over in four months, with liftoff seen shortly thereafter. In which case the market should start thinking about balance sheet reduction starting in early 2023. Of course, this is all data-dependent and subject to change, but the Fed has sent a clear signal to the markets that the removal of accommodation likely be much quicker than the previous experience.

Market pricing has adjusted but only to an extent. Fed Funds futures have fully priced in liftoff in Q2, with small odds of more than one hike. Follow-up hikes in Q3 and Q4 fully priced in. Swaps market sees the Fed Funds rate peaking at 1.5% by end-2023 and staying there through end-2024, while Fed Funds futures sees it near 1.75% by end-2024. If inflation were to return just a tad above the 2% target in 2024 as forecast, this would imply a negative real policy rate at the end of a Fed tightening cycle, which is something unheard of. It seems to us that the risks to the terminal Fed Funds rate are tilted to the upside from current market expectations. This is reminiscent of the 2015-2019 tightening cycle, where the Fed was typically more hawkish than the market throughout.

November retail sales data were disappointing. Headline sales rose 0.3% m/m vs. 0.8% and a revised 1.8% (was 1.7%) in October, while sales ex-autos rose 0.3% m/m vs. 0.9% expected and a revised 1.8% (was 1.7%) in October. The so-called control group used for GDP calculations came in at -0.1% m/m vs. 0.7 expected and a revised 1.8% (was 1.6%) in October. Recall that this data series measures sales in nominal terms and so the readings were particularly surprising given headline CPI rose 0.8% m/m in November. That said, we do not think the data moved the needle much on Fed policy.

Regional Fed manufacturing surveys for December continue rolling out. Philly and Kansas City Feds both report today. The former is expected at 29.6 vs. 39.0 in November and the latter is expected at 25 vs. 24 in November. Yesterday, Empire survey came in at 31.9 vs. 25.0 expected and 30.9 in November. Markit preliminary December PMI readings and November IP will also be reported today. Manufacturing PMI is expected at 58.5 vs. 58.3 in November, while services PMI is expected at 58.8 vs. 58.0 in November. If so, the composite should rise from 57.2 in November. IP is expected at 0.6% m/m vs. 1.6% in October.  Weekly jobless claims and November housing starts (3.0% m/m expected) and building permits (0.4% m/m expected) will also be reported. Initial claims are expected at 200k vs. 184k the previous week, while continuing claims are expected at 1.943 mln vs. 1.992 mln the previous week. We note that another reading for initial claims close to 200k would bring the 4-week moving average back to 2018 and 2019 levels, when the U.S. was last at full employment.

Banco de Mexico is expected to hike rates 25 bp to 5.25%. However, a few analysts look for a 50 bp move. November CPI rose 7.37% y/y, the highest since January 2001 and further above the 2-4% target range. Swaps market is pricing in a peak policy rate of 7.25% by end-2022 and remaining there through 2023. The bank will have a new Governor on January 1 as Victoria Rodriguez was confirmed last week by the Senate 78-21, with 10 abstentions. Rodriguez takes the helm at a difficult time for policymaking and she will under the microscope. While we are withholding judgment now, her choice by AMLO was controversial given her lack of monetary policymaking experience.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank decision is due out shortly. Madame Lagarde has flagged this meeting for a decision on extending QE beyond March, when PEPP is set to expire. It’s clear from the public comments that policymakers are looking to boost bond-buying with its long-standing APP to make up for the end of PEPP. Net purchases under PEPP have been around EUR15 bln per week recently, or roughly EUR60 bln per month. With APP currently running at around EUR20 bln per month, we think it is likely that the ECB will announce a modest tapering process by increasing APP to EUR50-60 bln per month once PEPP ends. We also know from public comments that many policymakers are against an open-ended timeframe and so the ECB will likely put an expiry date on when APP would return to its regular EUR20 bln monthly pace. Unlike the Fed, the ECB is in no hurry to hike rates and so we expect a 12-month period of elevated APP that is gradually tapered after perhaps six months.

Eurozone reported weak preliminary December PMI readings. Headline manufacturing PMI came in at 58.0 vs. 57.8 expected and 58.4 in November, but services PMI came in at 53.3 vs. 54.3 expected and 55.9 in November and the composite came in at 53.4 vs. 54.4 expected and 55.4 in November. German and French composite PMIs fell to 50.0 and 55.6, respectively. Germany is tipping close to recession and as the virus numbers worsen in Europe, we see greater downside risks to the outlook for Q4 and Q1.

The Bank of England started the tightening cycle with a 15 bp hike to 0.25%. Once again, the BOE has defied market expectations as WIRP suggested a 25% chance of a hike today. New forecasts were revealed at the November meeting and won’t be updated until February 3. Given such heightened uncertainty, we thought it made perfect sense for the BOE to remain on hold today, but the bank clearly thought otherwise. The vote was 8-1 and the bank said it would review omicron developments in February. Of note, WIRP is pricing in another hike at the next meeting while swaps market is pricing in a policy rate of 1.0% by end-2022 and a terminal rate of 1.50% by end-2023.

The U.K. reported weak preliminary December PMI readings. Manufacturing PMI came in as expected at 57.6 vs. 58.1 in November, but services PMI fell to 53.2 vs. 57.0 expected and 58.5 in November and composite fell to 53.2 vs. 56.3 expected and 57.6 in November. This is reflecting the recent spike in virus numbers and is another reason for the BOE to remain cautious.

All eyes are also on the by-election today in North Shropshire. While typically a safe Tory seat, all bets are off as the party’s standing has plummeted. Bookmakers now favor the Liberal Democrats to win the seat vacated by Owen Paterson over ethics. Elsewhere, Johnson fended off a rebellion within his own party, as nearly 100 Tory lawmakers voted against new Covid measures. Those measures eventually passed 369-126 with Labour support but talk of a leadership challenge is growing as Johnson continues to stumble in the polls.

The Swiss National Bank kept policy steady, as expected. The SNB still characterized the franc as “highly valued” and pledged to continue FX interventions as necessary. There were modest upward revisions to the inflation forecasts, while the growth forecast for this year was kept steady. However, the forecast inflation trajectory continues to signal liftoff won’t be seen until 2024 at the earliest. Of note, forecasts for 2024 will be added at the March meeting and likely to push liftoff out another year.

Norges Bank hiked rates 25 bp to 0.50%, as expected. Governor Olsen said “There is considerable uncertainty about the evolution of the pandemic. But if economic developments evolve broadly in line with the projections, the policy rate will most likely be raised in March.” New macro forecasts and an updated rate path were released. While the growth and inflation forecasts were raised substantially, the expected rate path was surprisingly little changed. Swaps market is pricing in a terminal rate of 1.25% for the policy rate by end-2023. This strikes us as too timid given the tightening path that the bank has set out in its projections.

Turkish central bank cut rates 100 bp to 14.0%, as expected. It noted that “The Committee decided to complete the use of the limited room implied by transitory effects of supply-side factors and other factors beyond monetary policy’s control on price increases.” While this suggests the end of the easing cycle, the damage has been done. Was it really worth weakening the lira by nearly 50% just to cut rates 500 bp since September? The costs of this misguided easing cycle far outweigh any potential benefits, with inflation set to move higher and higher in the coming months.

ASIA

The two-day Bank of Japan meeting began today and ends tomorrow with a decision. Some reports suggest the bank is considering an announcement that it will allow its emergency corporate lending programs to expire in March as scheduled. However, other reports suggest some policymakers would rather delay the announcement until the impact of omicron is better known, perhaps at the next meeting January 18. New macro forecasts will be released then as well, perhaps offering a better opportunity to tweak policy. This week, it should be steady as she goes for the BOJ.

Japan reported solid November trade data. Exports rose 20.5% y/y vs. 21.0% expected and 9.4% in October, while imports rose 43.8% y/y vs. 40.0% expected and 26.7% in October. Preliminary December PMI readings were also reported. Manufacturing PMI came in at 54.2 vs. 54.5 in November, services PMI came in at 51.1 vs. 53.0 in November, and the composite PMI came in at 51.8 vs. 53.3 in November.

Australia reported strong November jobs data. A whopping 366.1k gain was posted vs. 200k expected and a revised -56.0k (was -46.3k) in October, which led the unemployment rate down to 4.6% vs. 5.0% expected and 5.2% in October. The recovery in jobs is to be expected after lockdowns ended this fall but the RBA has flagged an unemployment rate near 4% as the likely trigger for higher wage pressures. We are still above that and so we do not think the RBA will be in any rush to tighten. Preliminary December PMI readings were also reported. Manufacturing PMI came in at 57.4 vs. 59.2 in November, services PMI came in at 55.1 vs. 55.7 in November, and the composite PMI came in at 54.9 vs. 55.7 in November.

RBA Governor Lowe sounded more hawkish. While we thought that it would announce another round of tapering at the February review, comments from Governor Lowe overnight suggest that bank may end to QE altogether. He noted “We were very much influenced by the actions of other central banks. At the margin if they stopped doing this then it increases the probability that we will stop as well. But if we think it’s the right thing to keep going we will.” It will be a close call and will depend on the data. As a result, swaps market is pricing in nearly 100 bp of tightening over the next 12 months from 75 bp at the start of the week. Next RBA meeting is February 1 and the RBA will likely have to adjust its forward guidance at the February meeting.

Bank Indonesia kept rates steady at 3.5%, as expected. Governor Warjiyo stressed “Don’t jump to the conclusion that if the Fed fund rate increases, then the BI rate will follow. That is not true.” He added that when it’s time to start a tightening cycle, the central bank will begin by gradually reducing liquidity and that rates “will be determined by our assessment of inflation and economic growth in 2022 until 2024.” November CPI rose 1.75% y/y, the highest since June 2020 but still below the 2-4% target range. Rates are unlikely to go lower due to the likely negative impact on the rupiah, but a rate hike is completely unnecessary right now. Bloomberg consensus sees steady rates through H1 22, with some odds of a hike seen in Q3 22 and another one in Q1 23.

Philippine central bank kept rates steady at 2.0%, as expected. The 2021 and 2022 inflation forecasts were each raised a tick to 4.4% and 3.4%, respectively, while 2023 was kept steady at 3.2%. Governor Diokno said that growth appears to be “on firmer ground,” which was a bit more upbeat than his November assessment that it was “gaining solid ground.” Still, Diokno reiterated the need to maintain accommodation over the next few quarters to make sure the recovery is sustained. November CPI rose 4.2% y/y, the lowest since July and moving closer to the 2-4% target range. Rates are also in a sweet spot right now, with falling inflation allowing the bank to maintain its current policy stance. Bloomberg consensus sees steady rates through H1 22, with some odds of a hike seen in Q3 22 and another one in Q1 23.

Taiwan central bank kept rates steady at 1.125%, as expected. However, Governor Yang Chin-long warned “Monetary policy is moderately loose now, but it will definitely move toward tightening next year.” He added that the bank decided to stay on hold now because the economy is not overheating and there are uncertainties in the outlook. November CPI rose 2.84% y/y, the highest since February 203. However, the central bank does not have an explicit inflation target and so the central bank can be cautious and maintain its accommodative policy for the time being. Bloomberg consensus sees steady rates through H1 22, with some odds of a 12.5 bp hike seen in Q4 22.

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