The three main European Union countries that have been holding out for a lower, more aggressive price cap by the EU and G7 allies on imports of Russian oil via tanker – Poland, Lithuania, and Estonia – have made the case that the $65-70 per barrel price cap presented by the European Commission to EU governments on behalf of the G7 last Wednesday was a level fixed in September, when the Russian Urals crude traded on the market between $68 and $76.
This reflected a U.S. administration view apparently that a price cap of about 5% below the market price would be just right as it would be a level at which Russia could swallow the discount, but not low enough to make it worthwhile for Moscow to set up elaborate by-passing and smuggling schemes.
Since then, however, Russian crude prices have been trending down to below $65, so setting a price cap at that level does not make much sense — it will not be a cap at all.
Moreover, these hawks point out that Russia’s 2023 budget was built on the assumption that it would be able to sell its oil at $65 per barrel, so setting the limit at that level would do nothing in terms of diminishing the Kremlin’s expected ability to finance its war in Ukraine — Putin would get exactly the price he planned for.
Indeed, these three countries say that Russian production costs are $20-25 per barrel, so even with a cap at $30 there would be profit for Moscow. That said, EU officials believe Washington would be amenable to a price cap in the $50-$60 per barrel range, leaving the impression that this is where they expect the landing zone to be.
Talks between EU countries and G7 capitals will continue this week. They are likely to continue through the weekend, but ambassadors involved in the discussions seemed cautiously optimistic a deal is possible before their December 5th deadline in time for the rollout of what was originally a ban on Russian sea-borne oil imports.

The Fed is poised to hike rates 50bp at the upcoming FOMC meeting. The Fed will hike rates at subsequent meetings, but we still don’t see a clear reason to expect the terminal rate will be greater than 5.125%. We expect Fedspeak, particularly from Powell, will reiterate that slowing the pace of rate hikes does not mean any less commitment to the inflation target. We think his comments on the labor market will emphasize that although there are signs of cooling, the labor market remains overheated. The Fed would like to hold financial conditions steady here, but if market participants remain predominantly focused on the potential for a Fed pause and concerns about recession, any jawboning intended to keep the “higher for longer” story may fall on deaf ears.

In yesterday’s report, (SGH 11/22/22, “ECB: Frontloading Pressures”), we outlined ongoing pressures beneath the surface across the ECB to continue the process of frontloading interest rate hikes. And while 50bps is by all standard measures an aggressive move, we wrote that what had been seen to date in markets and by analysts as a lack of agitation from ECB hawks for another 75bp hike at their next meeting should not be interpreted to mean there might not end up being a good deal of support for that by December 15, and that 75 would be a serious option on the table, and that the 50bp hike assumed by many would be in fact a razor’s edge decision in light of continued problematic inflation figures and what we expect will be another upside revision to the ECB’s inflation forecast at the same meeting.

We are now switching our call from leaning 50 (“just barely”), to leaning to 75 for December, under the assumption that some last few data releases, and most importantly the ECB staff forecast revision on December 15, pan out broadly along the lines we expect.

The Fed plans to raise its policy rate to a level that is sufficiently restrictive to restrain the demand side of the economy and put downward pressure on what it views as the persistent component of elevated inflation. The Fed does not know exactly what the appropriate level of the terminal rate will be, but given the cumulative tightening already in place, the Fed is ready to downshift to 50bp-increments at the December FOMC meeting. The Fed does not want to see financial conditions ease markedly now, especially if the easing reflects a misunderstanding of the Fed’s reaction function. From the Fed’s perspective, the market reaction to the October CPI report, specifically the equity rally and decline in longer term interest rates, was premature and does not recognize the Fed’s belief that labor market restraint is a prerequisite for restoring price stability. We expect the Fed will emphasize that it expects to hold policy rates restrictive until labor markets soften substantially to try to front run a soft November CPI report.

The preference for 50 in December should not be news to many followers of the ECB, nor to our readers, and it is not the story for today.
What is newsworthy at this juncture is that the arguments and support for a continued front loading of rate hikes are under the surface still very much alive.
Indeed, the lack of public agitation for a 75bp hike in December from traditional hawks within the Council should not be interpreted to mean it will not be on the table as a serious option on December 15. Whether it carries the day remains to be seen, but what appears certain is that the glidepath from 75 to 50 to 25bp hikes in 2023 as envisioned by many ECB officials is very much in doubt.

Beijing expects the hawkish US Taiwan Policy Act to pass in Congress most likely in the spring of next year once the new legislature is in session. Officials also note that House GOP leader Kevin McCarthy has declared that if the Republicans win the House majority he plans to create a China select committee to confront China in all areas. They expect GOP focus and pressure to extend far beyond the planned select committee, with weapons sales to Taiwan as a front and center focus for the Republicans.
Furthermore, they believe that as long as the Republicans win the House majority, McCarthy or whoever may end up as House speaker will visit Taiwan during their two-year term, compounding the escalation that followed the visit this year by Speaker Nancy Pelosi to Taipei.

The October CPI report reinforced our caution last week about pushing the expected terminal rate for the Fed’s tightening cycle above 5.125% for the time being. Even if like us you believe that inflation will not be dispelled quite so easily, there is simply too much risk of reports like this between now and next May to have much visibility beyond 5.125% for the time being. Indeed, now there is a path to 4.625%, although we think that is unlikely. The CPI report locked in expectations that the Fed will step down to a 50bp rate hike in December, and that is widely seen as a precursor to stepping down to 25bp, and then to a pause. We will be living with this CPI report until the next one is released in December.

The Fed is heading toward a 50bp rate hike in December, and we think odds favor pushing through another 50bp rate hike at the January/February FOMC meeting. Still, the Fed does appear to be looking for a place to pause and although Federal Reserve Chair Jerome Powell guided the terminal rate higher again last week, we can see the makings of a peak of this cycle if core inflation does not accelerate, but it will be higher than the doves think is appropriate. For us, an important question is whether Powell pushes that peak past the point where “higher for longer” is no longer a viable policy option.

On tomorrow’s FOMC meeting, our baseline hasn’t changed. The Fed will discuss the pace of rate hikes at upcoming meetings, and Federal Reserve Chair Jerome Powell will acknowledge the discussion, but will most likely claim that the Fed makes policy decisions on a meeting-by-meeting basis with nothing decided in advance.

At issue is how much guidance Powell provides regarding the path of monetary policy. We believe he will retain the option of 75bp in case the Fed needs to respond to upside surprises to the inflation outlook. That said, we don’t think he will leave us flying completely blind; we think he will need to define the Fed’s reaction function more carefully...

...We don’t think Powell will embrace the idea of a pause at the SEP-implied terminal rate. Although a group of presidents has been unusually vocal in their desire to find a place to pause, that’s still too far in the future to commit to, and could easily change with the December SEP. Indeed, our expectation is that the dots move higher again in December, albeit a nudge rather than another leap...

...That said, as with US rates, European rates traders have also latched on to a deceleration story to aggressively drop their estimates for the terminal rate for this cycle. While reporters kept pressing Lagarde on whether she agreed with the market’s expectations of a 3% peak, that bird flew some time ago, and markets have already dropped well below that, to a bit over 2.5%.
As to where markets are today, color us skeptical that the cycle will end at 2.5%. Barring the materialization of a deeper geopolitical shock, for which we must of course always be on alert, we suspect that is a view that is shared by many ECB officials...

...The Fed will follow through with another jumbo-sized rate hike this week but will signal a high likelihood that this will be the last 75bp rate hike in the cycle...

...I repeat my mantra that it is ill-advised to bet against the consumer in the absence of substantial job losses. To be sure, we get a fresh read on the labor market this week, but initial unemployment claims clearly tells us that the labor market is not coming unglued:

...Xi stressed that the most important task in the next six months is to ensure economic stability, financial market stability, the stability of the RMB exchange rate, and the stability of attracting foreign investment. He particularly stressed that it is necessary to strive for economic growth in the current fourth quarter of 2022 to return to the “normal” level, that is, 5.0%.
Xi particularly emphasized the need to take corresponding measures to stabilize the stock market, to ensure that the RMB does not depreciate in a disorderly manner, and to make foreign investors have confidence in China, as well as help Hong Kong to stabilize its financial market...