That said, Powell will still note that faster growth could slow the return to price stability and, if it continues, that could warrant another rate hike. I think the Fed will want to see if the third quarter growth spurt sustains momentum in the fourth quarter before deciding if another rate hike is necessary. Such data likely won’t be available until the December FOMC meeting at the earliest. I also expect the usual hawkish talk about the job not being done and a reminder that inflation progress could reverse as seen more than once in this cycle.
I think the Fed retains another rate hike in the 2023 dots. The balance of risks favors some downward drift in the distribution of the 2023 dots, but I think the improved growth outlook will justify retaining that last rate hike in the SEP. The risk is that the last dot disappears, although that would be akin to a declaration that the cycle is definitely over.
The improved growth outlook all will reduce the number of projected rate cuts in 2024 compared with the June SEP. The easy way to think about this is that the Fed’s forecast will simply push forward the slowing that was anticipated for the second half of 2023. If the Fed pushes it back three months, it probably delays the timing of the first rate cut in the next cycle by a quarter, which then translates into 75bp of cuts for 2024. If the Fed pushes forward the slowdown by six months, the risk is that the Fed will then expect only 50bp rate cuts in 2024.

The ECB has every reason to convey a far more tempered stance at this juncture, and a hope that this could be it for rate hikes, and that time, especially if inflation eases and thus real rates stay tight, will now be on their side.
But we suspect that our “hawkish lean” still lurks as well in the Governing Council very close beneath the surface.
With just one inflation print between now and October, that meeting will clearly be a hold. But we doubt that the decision at hand by December will be whether and when to cut, but rather an assessment of whether the ECB has done enough, as Lagarde said today, “to reinforce” the trajectory of easing inflation that it has penciled in for 2024 and through 2025.

Markets are still favoring a pause and are pricing a European Central Bank rate hike this week at less than even odds.

But we are switching our expectations for the ECB interest rate decision this Thursday from a pause to a 25-basis points hike.

The more we re-run in our minds what we have heard from ECB officials, wargame their tactical choices, and analyze the data and risk management dynamics that will be debated at the Governing Council meetings tomorrow and Thursday, the less comfortable we are with our briefly held, and highly unusual for us dovish call that they will pause at this meeting.

The forecasts, as characterized by ECB Vice President Luis de Guindos, are likely to show a lower growth trajectory than expected in June, and an inflation outlook that is “more or less” as expected in June.

Putting a finer point on that inflation outlook, analysts expect that is likely to translate into a slightly higher figure in the near term, and perhaps a small tweak lower to the 2.2% outlook for 2025 due to slower economic activity. But even a small revision to 2025 inflation, if it does show up in the numbers, will be insufficient progress for ECB hawks, and the leadership, to hang their collective hats on.

Bottom Line
It’s always risky to shift a position on a call where the market odds are sitting at 50-50, and perhaps even risky ahead of a CPI report. It’s a space where it is easy to find yourself on the other side of your own call with each new data point. After all, the odds are 50-50 for a good reason. The data is stronger than expected and the Fed has highlighted that stronger than expected activity could lead it to hike rates again. At the same time, however, lower inflation reduces the urgency to hike rates again, and the Fed is balancing policy against these two considerations. While my optimism hasn’t change, and indeed the data flow has supported the growth story, the tone of the conversation now leads me to believe that even with growth coming in faster in the third quarter, as long as core inflation stays low in these next two prints, the Fed will believe it can wait past the Oct/Nov meeting until it has much more visibility on the fourth quarter to decide if it needs to push rates up another notch.

The Canadian and Australian central banks, either finishing out or done with tightening, are turning their attention to how to fend off growing speculation that rate cuts will be brought forward – in Australia’s case, to early next year.

In Canada too, where the Bank of Canada (BOC) has not yet declared its 2% inflation goal in sight let alone attained, markets are assuming that with a headline CPI inflation rate at 3.3% in July, the BOC has topped out at a cycle peak of 5% and are expecting the BOC to cut rates by the summer of 2024.

This is notwithstanding important data in the interim including Friday’s release of second quarter GDP, forecast to have grown an annualized 1.2% in the second quarter from 3.1% a year earlier. If it fails to show growth moderating in line with the BOC’s projection of an annualized 1.5% rate, it could raise the odds of another hike sometime this year.
To be clear, while we see 5% as the BOC’s policy peak, the BOC noted in July persistent excess demand, reflecting its intention to hold rates higher and for longer than markets are pricing.


...The Canadian and Australian central banks, either finishing out or done with tightening, are turning their attention to how to fend off growing speculation that rate cuts will be brought forward – in Australia’s case, to early next year.

The RBA is just as cautious regarding the path to 2% inflation, notwithstanding this week’s stark slowing in July inflation data that has markets already tipping the RBA is done at its 4.1% cash rate.
While we agree the RBA won’t move rates again at its September 5 policy meeting, it is more likely than Canada to finish out its cycle with a final 25bp-hike, to 4.35%, though not until its November 7 policy meeting, a few days ahead of the November 10 release of the upgraded economic projections.

Battlelines Drawn Heading into Powell’s Speech
Bottom Line: The Fed wants to be done as every rate hike increases the risk of a hard landing. I don’t think the Fed was committed to an Oct/Nov rate hike at the July FOMC meeting, but that’s because it had a very pessimistic outlook for growth at that time. And I think participants were very confident in that outlook, but incoming data has shaken that confidence. Reiterating our outlook, our baseline going into Powell’s speech is that he wants to say, “policy is in a good place,” but he can only really be confident this will hold at the September FOMC meeting. Thinking beyond September, I think he will recognize that the possibility of an upside surprise to growth means the Fed “may have more work to do.” It doesn’t make sense to take that option off the table now given that the Oct/Nov meeting is still a long time away and in theory the data could cut decisively either direction by then.

Bottom Line: The Fed is walking a fine line here. Despite disinflation trends, it has proven difficult to keep rates from rising in the absence of softer growth data. It’s not evident, however, that the Fed wants conditions any tighter, but at the same time sending that signal could backfire in the form of higher inflation expectations. Without a catalyst to refocus market participants on downside risks to the economy, there looks to be room for rates to break still higher

Many economists and analysts, however, are sticking with their calls for another ECB rate hike. They point to the underlying price components of the PMIs that do not paint a pretty picture and reinforce concerns over the durability in particular of service sector inflation.
Expectations in the forecasting community are that the preliminary Eurozone August CPI figures that will be released next week will paint a similar picture of stickiness in core prices, with most forecasts showing just slight improvement from July’s 5.5% reading.
While they may be right on the data, we no longer agree with the call for a September hike and now expect that the ECB will take a pass and leave rates unchanged at 3.75% at their upcoming meeting

The Fed’s Forecast is at Odds with Reality
at the time of the July meeting, the Fed anticipated growth would continue to slow, and below trend growth is a prerequisite to restoring price stability. Second, the Fed’s growth forecast is quickly turning into a complete disaster.
I think we need to have an honest but harsh conversation about the second point in particular. The Fed’s GDP forecast in the June SEP was at best dead on arrival, and at worst simply ludicrous. It implied basically no growth for the second half of 2023, which was plainly wrong even at that time. It required a sudden stop in the economy that just clearly was not happening when those forecasts were made. That forecast was in June, at which point the Fed staff should have known with almost 100% certainty that growth wasn’t falling off the cliff.
Before the Fed minutes were released, the Atlanta Fed raised its estimate of Q3 growth to 5.8%. Even if the reality is half that number, it’s still a major forecasting error on the Fed’s part, and we have been pounding the table for weeks that the Fed has completely underestimated the strength of the economy. Granted, I understand in theory I might need to eat my words on that at some point, but I feel pretty safe for now given that we are already halfway through the third quarter with no sudden stop evident. And if growth is that fast in Q3, I suspect it will retain that momentum in Q4 and put a January rate hike on the table.

Despite what looks like still solid growth in Q3, low inflation keeps the Fed on track for holding rates steady at the September FOMC meeting. I think the growth will be strong enough to keep another rate hike in the SEP and that more likely than not, the Fed will deliver that hike at the Oct/Nov meeting.

....If You Don’t Have Time This Morning
Despite what looks like still solid growth in Q3, low inflation keeps the Fed on track for holding rates steady at the September FOMC meeting. I think the growth will be strong enough to keep another rate hike in the SEP and that more likely than not, the Fed will deliver that hike at the Oct/Nov meeting. That said, I suspect the Fed also worries that policy is getting too tight, and hence we get mixed messaging that “maybe we need another hike, but rate cuts will be on the table in 2024.” The Fed can’t let policy become too tight if it wants to stick the soft landing, but I don’t think it can change its reaction function without letting inflation expectations rise. I don’t think sticking the soft landing will be as easy as the consensus increasingly appears to suggest.

Published on August 10, 2023
Regarding monetary policy for the remainder of the year, one senior official says, rather tentatively it must be noted, that, “The central bank will not implement a monetary policy that is tighter than the existing one, but relatively looser in the remaining months of the year. Unlike former Premier Li Keqiang, Premier Li Qiang prefers to use monetary policy to stimulate the real economy.
Broadly speaking, Premier Li’s request of the PBoC has been to ensure that monetary policy serve the real economy, and especially at present China’s high-tech sector and private enterprises. New loans in H2 2023 should be used to stimulate four areas: 1 – the high-tech sector; 2 – private enterprises “with the characteristics of specialization, refinement, and innovation;” 3 – the real estate markets; and 4 – major infrastructure investment projects.

...While touting the need to direct policy towards the “real economy,” Premier Li has also stressed the need to support the development of financial markets, pointing to the need to “invigorate” capital markets, especially China’s domestic stock and bond markets. The task, a daunting one, is to try and lift these markets to break the psychology of retrenchment in China’s consumers.

With a crisis of confidence deepening in the Bank of England’s (BOE) ability to wrestle the UK’s inflation problem without precipitating a recession, its Monetary Policy Committee (MPC) may opt to limp through its August 3 meeting with a 25bps hike, taking Bank rate to 5.25% even as it signals more tightening to come