The Week Ahead: Four Central Banks and the US Jobs Report
• The Federal Reserve will announce it will begin slowing its bond purchases. A faster than expected pace would bring forward the first anticipated hike. Dropping the characterization of inflation as transitory would also add to the hawkish read.
• Most Bank of England officials have been encouraging the market to price in rate hikes and it has, but with softer than expected CPI and five consecutive monthly declines in retail sales, it may choose instead to stop its bond purchases first.
• The Reserve Bank of Australia appears to have clumsily abandoned its yield-curve control and this has destabilized its debt market. Between the policy meeting and the monetary policy statement, it needs to re-build its credibility.
• Norway’s Norges Bank has begun its tightening cycle and is most likely going to continue with another hike. • US jobs growth is expected to have accelerated in October after the disappointment in September. While there is headline risk, the policy implications are minimal.
The Bank of England and the Federal Reserve meetings are the highlights of the week ahead. Usually, the US jobs report is the main feature of the beginning of a new month’s high-frequency data cycle. However, the FOMC meeting two days earlier may take away some of its significance, even if it still possesses some headline risk.
Two other major central banks meet in the first week of November. The Reserve Bank of Australia meets early on November 2 in Wellington. At its last meeting, it confirmed the reduction of its bond purchases but extended them until mid-February 2022. Governor Lowe may push against market expectations for a rate hike next year (~85 bp of tightening is priced into the swaps market in 12-months). He has argued that a rate hike is not justified until inflation is back into the 2%-3% range on a sustained basis, which the central bank does not anticipate before 2024.
Economists surveyed by Bloomberg suspect that inflation in Australia peaked in Q2 at a 3.8% year-over-year rate and to be back below 2% in Q2 and Q3 22, though barely. Last week, Australia reported that its headline inflation slowed to 3.0% in Q3 from 3.8% year-over-year in Q2. However, the underlying measures (trimmed mean and weighted median) rose above 2% for the first time in five years. So a rate hike next year or early Q1 23 may be more reasonable than Lowe’s protestation suggest.
The Reserve Bank’s commitment to its yield-curve control policy targets the April 2024 bond yield at 10 bp has been challenged by the market. After making a bid to defend it on October 22 for the first time since February (A$1 bln), the RBA seems to have abandoned its position without as much as an official word. This contributed to the dramatic jump in Australian interest rates last week. This probably could have been handled better, and Lowe will have a lot of explaining to do at the meeting and in the Monetary Policy Statement to regain the market’s confidence.
Norway’s central bank, Norges Bank, was the first high income to lift rates in this cycle. It put the key rate at 25 bp in September after being at zero since May 2020. It will most likely lift it another 25 bp on November 4. The economy is doing fine, and inflation is not only picking up, but it will likely accelerate into the end of the year.
This is partly the economy recovering and the supply chain disruptions, but it is also the base effect. Consider that Norway’s CPI was practically flat in Q4 20, and the underlying measure fell by 0.4%. Norway joined a select group of high-income countries, including the US, Canada, and Germany, who have reported inflation above 4.0%. The swaps market appears to be discounting a couple of follow-up hikes in the first half of next year.
In October, the krone rose 3.6% against the dollar and was only bested by the Antipodean currencies among the majors. The gains were sufficient to put it positive on the year (~1.6%). It was down almost two percent through Q3 this year before its performance this month. Many see the krone as a petro-currency, but the government tries to insulate the economy from the vagaries of the oil market. Still, with the dramatic increase in oil prices as the market prices in more tightening, it is difficult to disentangle the influences. Still, something did change over the past month. The correlation on a rolling 30-day basis on the changes in oil and the changes in the dollar (vs. Nokkie) was positive in Q3 but turned inverse here in October (higher oil weaker dollar vs. NOK).
The Bank of England meets the same day as Norges Bank. While a Norwegian rate hike is as done of a deal as these things get, the Bank of England call is more complicated. First, several BOE officials, including the leadership, have been particularly hawkish in their rhetoric, but at the same time, still seem to believe that the price pressures are mostly related to the re-opening and supply-side disruptions. Second, the BOE is still engaged in QE, and although Governor Bailey has said that the MPC is prepared to raise rates before QE is finished, the contradictory impulses are greeted with a degree of skepticism. Third, if the BOE moves, the magnitude of the move is also debated. The last cut delivered in March 2020 was 15 bp, even though the traditional quantum of the 25 bp and multiples thereof.
Despite the numerous considerations, the market has responded to the verbal signals and its perception of the BOE’s reaction function. The swaps market appears to be pricing in 45 bp of tightening over the next three months and about 80 bp in the next six months. Or consider that when the BOE met in September, the implied yield of the December 2021 short-sterling (three-month interest rate contract) was about 13 bp. It surged to almost 62 bp on October 18 before pulling back, perhaps the softer data (CPI, CBI orders and optimism, and retail sales) and finished last week at 47 bp.
The risk seems to be that BOE has painted itself into a bit of a corner. If it does not take action after the hawkish commentary and Bailey’s talk of what the BOE must do, sterling seems vulnerable to weakening on disappointment. On the other hand, if the BOE hikes while at the same time as it continues to buy Gilts, the contradictory impulses may be confusing. It could reduce the bond-buying quicker, but it was expected to end this year in any event. Following Chancellor Sunak’s budget presentation last week, the Office of Budget Responsibility says the projected debt issuance in FY2021-22 is almost GBP58 bln (vs. GBP33 bln expected). Gilts rallied strongly, with the 10-year yield dropping 13 bp to fall below 100 bp for the first time this month. It ended up dropping 10 bp last week to 1.02%.
One way to square the circle is for the BOE to stop its bond-buying entirely and keep dangling the need to remove some monetary accommodation for a bit longer. That seems prudent as well, given the rising covid cases and the recent string of disappointing data, including the fifth consecutive monthly decline in retail sales. The unexpected downtick in inflation also buys officials time so soon after the furlough program ended.
Turning to the Federal Reserve, there seems little doubt that it will announce that it will gradually begin reducing its bond purchases. This is hardly a surprise. The Chair has well signaled, and it seems fair to say that a taper tantrum has been avoided. Since at least the spring, surveys found a majority expected tapering to begin late this year. Admittedly, there has been a re-pricing of central bank policy, but it is more like a wager, in a way, on central banks responding to the elevated price pressures.
Chair Powell has been clear about the sequence: Finish the bond purchases before raising rates. He indicated that the tapering would be complete around the middle of the year. The market continues to aggressively price in Fed tightening next year. In fact, in recent weeks, the market has moved to price in a strong likelihood of a hike next June or July, which is almost immediately after the bond-buying ends (Fed fund futures). Since the April FOMC meeting, the FOMC statement recognized inflation was elevated but largely reflecting transitory factors. If the Fed were to change its characterization of inflation, it would likely be seen as a validation of the backing up of US short-term rates. The most aggressive thing the Fed could do, though, is to announce a more rapid pace of tapering, bringing forward the hike expectations.
A few hours before the FOMC meeting concludes, the US Treasury will announce the details of its quarterly funding needs. Officials have already indicated that the Treasury anticipates reducing the amount of notes and bonds it needs to sell. That means as the Fed starts to buy fewer bonds, the Treasury will be issuing less. There will be some exceptions. For example, the Treasury has been increasing the size of the Treasury Inflation-Protected Securities (TIPS) in the last three months and may continue. There also seems to be interest from the debt managers to gradually increase the average weighted duration, which means the shorter end and the belly of the curve may see a more considerable adjustment than the long end. That said, 20-year bond auctions have often been weakly received, and it is possible that the Treasury would pare back its offering. Last week, for the first time, the 30-year yield traded through the 20-year, which likely speaks to the lack of a clear, consistent constituency for the tenor.
That brings us to the jobs report on November 5, two days after the FOMC meeting concludes and the Treasury shows its ask. Non-farm payrolls are expected to rise by more than twice the disappointing 194k initially estimate for September. However, there seemed to have been a problem in assessing government employment, especially the seasonal adjustment for teachers. What this means is that private-sector employment has been more stable. In September, it rose by 317k, and the median forecast in Bloomberg’s survey expects 400k. We note that the Action Economics survey shows a softer median at 413k and 383k for the non-farm payroll change and the private-sector tally.
The unemployment rate fell to 4.8% in September from 5.2% in August. It is the lowest since March 2020. It may have slipped a bit further in October. Recall it was steady at 3.6% each month in Q4 19. However, the unemployment rate is impacted by the smaller workforce. The labor force participation rate has barely changed this year. It stood at 61.6% in September and 61.4% a year ago. Economists surveyed by Bloomberg see it at 61.8%. Although the dollar value of the goods and services the US produces is now above the pre-crisis peak, it is doing so with about five million fewer workers, including three million early retirees.
Lastly, overwhelmed by the disappointing September headline jobs figure, the average workweek rose 0.2 hours to 34.8 hours. It does not sound like much, 12 minutes, but given that there are 128 mln full-time employees, that turns out to be something on the magnitude of 735k full-time equivalents. It is also interesting to note that the workweek averaged 34.4 hours in 2019. This suggests how many businesses as a whole are coping with the perceived shortage of workers and reporting solid profits.
Bannockburn Global Forex