Week Ahead: The First Look at US and EMU Q3 GDP and more Tapering by the Bank of Canada
• The rise in energy prices and official rhetoric has encouraged a dramatic rise in interest rate expectations in the US, UK, Canada, Australia, and New Zealand.
• Market psychology has shifted from judging central banks too patient to very aggressively pricing in hikes.
• The Atlanta Fed warns that Q3 US GDP may have nearly stagnated (0.5% annualized). Market forecasts have been shaved but may still be disappointing.
• Q3 EMU GDP is expected to have expanded by around 2% quarter-over-quarter.
• There are upside risks to the US September PCE deflator and EMU October CPI.
• The Bank of Japan will update its economic forecasts. The ECB will debate ahead of key decisions in December. The Bank of Canada will likely taper further and may push against ideas of an early rate hike.
The macro highlights for the week ahead fall into three categories. First are the preliminary estimates for Q3 GDP by the US and the EMU. Second, are the inflation reports by the same two. The US sees the September PCE deflator, which the Fed targets, while the eurozone releases the first estimate for October CPI. Third are the meetings of three G7 central banks, the BOJ, the ECB, and the Bank of Canada.
The broad backdrop includes softening PMI readings, the continued rise in oil prices, and a sharp backing up of interest rates. On the eve of last month’s FOMC meeting conclusion, the August 2022 Fed funds future contract implied an average effective rate of 11 bp. It is now yielding almost 32 bp, nearly completely discounting a 25 bp rate hike at the late July 2022 FOMC meeting as there is no meeting in August next year.
The nearly seven basis point decline in the 10-year US Treasury yield ahead of the weekend brought the yield increase to about 33 bp since the September FOMC meeting. However, this reflects a rise in inflation expectations primarily. The 10-year breakeven (the difference between the conventional 10-year bond yield and the 10-year Treasury inflationary-protected security) has also risen by about 33 bp over the same time.
Since the beginning of September, the implied yield of the December 2021 short-sterling interest rates futures contract has risen by a similar 34 bp, as the market anticipates the beginning of a tightening cycle this year, and that is after the yield has eased by nine basis points over the past four sessions. Pricing in the swaps market appears to have discounted nearly 100 bp of tightening over the next 12 months. The two-year Gilt yield has risen by slightly more than 45 bp since the start of last month to 66 bp. The US two-year yield has increased by nearly 25 bp to almost 45 bp.
August 30 was the last time the UK 10-year Gilt yield was under 60 bp. It has more than doubled since then to 1.22% before pulling back before the weekend. The 10-year breakeven has risen by about 55 bp during the same time. This suggests a larger rise in real rates than the US may be experiencing. Despite these interest rate developments, sterling has slipped slightly against the dollar since September 1. It is the only major country ahead of the US in this monetary cycle whose currency has not risen over this period.
Encouraged partly by the unexpected surge in Q3 price pressures, the market sees the Reserve Bank of New Zealand as the most aggressive high-income central bank over the next 12 months. The swaps market is pricing in 150 bp of interest rate hikes. Indeed, the market is discounting the risk of a move larger than 25 bp at the next RBNZ meeting (concludes first thing in Wellington on November 24). The implied yield of the December 2021 three-month T-bill futures jumped nearly 20 bp in reaction to the news that CPI accelerated to 4.9% year-over-year from 3.3% in Q2. The 10-year yield, which rose 25 bp the three weeks before the CPI, surged another 24.5 bp last week. The New Zealand dollar is leading the other dollar-bloc currencies with a 3.7% gain so far this month.
Of the three G7 central banks that meet next week, only Canada has experienced a sharp rise in short-term interest rates. Since the Bank of Canada’s meeting last month, the implied yield of the June 2022 Banker Acceptance futures (a three-month interest rate contract) rose more than 40 bp to nearly 1.09% bp by the end of last week. During the same time, the Canadian dollar rallied about 2.6%.
Strong September jobs data and a robust Bank of Canada business survey (outlook reached a record higher, and 87% of respondents expect inflation over 2%, the highest since 2005) boost confidence that the economy has exited the soft patch. Monthly GDP had contracted in three of the four months through July. In fact, the market has turned so aggressive that it is pricing in a hike before the central bank anticipated the output gap will close (middle of next year). The implied yield of the March 2022 BA futures has risen by around 20 bp to 79.5 bp. In the cash market, the yield of the three-month BA is about 45 bp. The swaps market is pricing almost 100 bp of tightening over the next 12 months.
The Bank of Canada will likely confirm its expectation that the output gap will close around the middle of next year. This assessment is consistent with a rate hike around then. However, the market appears to be leaning toward an earlier move. Perhaps, it has been encouraged by the subtle shift in Governor Macklem’s rhetoric about the transitory nature of the price pressures. He seems to be more cognizant that the elevated price pressures are likely to persist a bit longer than previously anticipated. This may be reflected in the central bank’s updated quarterly economic forecasts. Look for the central bank to slow its bond-buying to C$1 bln a week, half the current pace.
Bank of Japan officials will not dislike last week’s September CPI report that showed the headline rate rising above zero for the first time since August 2020. The core rate, which excludes fresh food and is the BOJ’s targeted measure, ticked up to 0.2%, its highest level since March 2020. Still, it is primarily a function of the surge in energy prices. Excluding both fresh food and energy, deflationary forces are still evident at -0.5%. Recall that the Q2 GDP price deflator stood at -1.1%, the strongest deflationary thrust in a decade.
There is little the BOJ apparently thinks it can do at this juncture. It has slowed its bond and equity purchases but is hesitant to call it tapering as it is not leading to an endpoint. It will update its forecasts. Previously, it saw inflation rising from 0.6% this year to 0.9% next year and 1.0% in 2023. Its GDP forecast anticipated growth to slow from 3.8% this year to 2.7% in 2022 and 1.3% in 2023.
The ECB meeting will conclude several hours after the BOJ meeting on October 28. As far as ECB meetings go, this is not a particularly important one. No new forecasts will be provided. No new initiatives will be launched. Instead, ECB President Lagarde may explain the different forces impacting prices and why on balance, it still appears that the inflation overshoot will prove transitory. We note that the annualized pace of CPI in Q3 was about 2.4%, half Q2’s annualized rate.
German and Spanish national October CPI estimates will be available while the ECB meets, and the following data aggregate estimate will be published. Given the base effect (0.2% increase in October 2020), the rise in energy prices, and the euro’s weakness, prudence dictates that the ECB assumes that price pressures have not peaked. The core rate, which excludes food and energy, stood at 1.9% in September and has not been above 2% since 2002.
Such data will steel the resolve of the hawks to limit the scope of further accommodation. It seems almost a given that the Pandemic Emergency Purchase Program will finish at the end of Q1 22. The big fight now is over QE afterward. The current Asset Purchase Program is modest (20 bln euros a month) and has various, even if, self-imposed restrictions. The ECB wants a facility that is more flexible in terms of eligible assets and time of purchases. The program now seems open-ended: “The Governing Council expects them to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.”
The swaps market is pricing in almost a 10 bps ECB rate hike in 12 months. The December 2022 Euribor futures imply a yield of -32 bp compared to the yield of -53 bp of the December 2021 contract. That would seem to indicate that the APP would wind down around the middle of 2022, or maybe a little later. However, some officials seem to favor some kind of standby facility, which can be used as needed, suggesting that the central bank’s balance sheet will be a permanent tool in its policy kit.
The day after the ECB meeting, the first estimate of the aggregate Q3 GDP will be released. Forecasts have been shaved, and the median (Bloomberg survey October 8-14) projection is now for 1.9% vs. 2.2% previously. Recall that the regional economy surged in Q3 20 before contracting again in Q4 20 and Q1 21. It rebounded by 2.1% in Q2, which now looks to be the peak. The median forecast in Bloomberg’s survey for Q4 growth is 1%
As Lagarde’s press conference gets underway on October 28, the US will report its preliminary estimate of Q3 GDP. Disappointing data and a flare-up of covid cases have prodded economists to slash their forecasts. The Atlanta Fed’s GDP tracker is exceptionally pessimistic. In early August, it was looking at something slightly above 6%, and by the end of the month, it was still at an impressive 5%. By early October, it has fallen to a little more than 1%. As of October 19, following the disappointing industrial production (1.3% in September and the August series was revised to -0.1% from 0.4%), and housing starts (-1.6% vs. expectations for a flat report, and August’s 3.9% increase was cut to 1.2%), the Atlanta Fed’s GDPNow shows the US economy practically stagnated (0.5% annualized pace in Q3).
Economists surveyed by Bloomberg cut their forecasts as well, even if not by as much as the Atlanta Fed’s tracker. The median now sees 2.8% annualized growth in Q3 compared with 5% in the previous survey. Previously, the median anticipated 5.3% growth in Q4, and that has been revised to 4.9%. While we suspect there may be downside risk to the median forecast, the Atlanta Fed’s tracker seems too dour. But, even if it is even reasonably accurate, talk of a recession still seems far off the mark. Growth next year is still expected to be well above trend. The IMF’s latest forecast projects the US economy will expand by 5.2% in 2022, while the World Bank’s estimate is 4.2%. The OECD sees 3.9% growth, while the median Fed official forecast is for 3.8%, the lowest among this selected group.
The GDP estimate will incorporate September’s personal consumption expenditures, released the following day separately, alongside personal income. Despite more people working, the end of the federal supplemental unemployment compensation likely dragged down income. The 0.7% increase in retail sales was a pleasant upside surprise, but it also accounts for around 45% of overall consumption. The median forecast is for PCE to rise by a still-solid 0.6%. However, the market will instead focus on the deflator. The Fed targets the headline rate at 2% (average over some purposely unspecified period), and the core rate is expected to have ticked up to 4.4% and 3.7%, respectively. These both would be new cyclical highs.
Bannockburn Global Forex