The near-term path for rates remains unchanged. Fed speakers consistently endorse the consensus view of 50bp rate hikes at the June and July FOMC meetings. The September meeting is a potential opportunity to transition back to 25bp rate hikes if the data allows. If the Fed can’t find sufficient cover in the data to see a path back to 2% inflation within the forecast horizon, it will press forward with another 50bp. Ultimately, the decision may hinge on the September SEP inflation forecast. I think that if FOMC participants see they can hold steady or even lower the 2022 and 2023 inflation forecast, they will be inclined to transition to 25bp. However, I have been skeptical that the data will break in that direction, leaving me leaning toward another 50bp hike in September. The Fed will try to form a consensus around the September outcome at the July meeting but may not have sufficient data to establish a consensus either way. That of course would put the August Jackson Hole conference in the spotlight, although arguably it’s always in the spotlight.

European Central Bank officials have rapidly coalesced around lift-off and the near-term monetary policy normalization path that we have been expecting for quite some time.

That consensus now lies squarely around a hard stop to the ECB’s Asset Purchase Program on July 1, followed rapidly by liftoff from the -0.50% deposit rate at the July 21 Monetary Policy Meeting. Barring any major shocks, that will most likely be followed by a 25-basis point hike at each of the ECB’s quarterly forecast round meetings on September 8 and December 15, to end the year at +0.25%...

...Likewise, unlike the US Federal Reserve, the ECB base outlook and consensus still leans heavily towards 25 basis point increment moves, and not 50s. Nevertheless, hawkish president of the Dutch central bank Klaas Knot noted just today that 50 basis point moves should not be ruled out if inflation fails to top out as expected.
With the ECB on path to be still adding accommodation well into next year, we believe an argument could already be made that the conditions for a 50-basis point hike are in place. That said, we do not get a vote, and we think a move to 50s is unlikely, even if not impossible. We suspect, if needed, the easier path to consensus at the ECB would be to add that fourth rate hike in October...

...Given the strength of the underlying economy – firms continue to add employees at a rapid pace, for example – the natural lags between policy and outcomes suggests September is still too early for a 25bp rate hike. But September could still be at a pivot point by signaling a 25bp hike at the next meeting. A transition back to a slower path of rate hikes would reduce the odds of a hard landing for the economy...

...Right now, it is beginning to feel like something of a sweet spot for the Fed where conditions have tightened enough to offer a path to trimming the demand side of the economy but not so much as to force a shift in the Fed’s rhetoric. That doesn’t mean the Fed won’t eventually need to bring rates even higher than current expectations, but it can potentially move more gradually later this year.

For now, it’s a waiting game for the Fed. Barring a market accident, the Fed is looking for clear and convincing evidence of a path to price stability to back down from 50bp rate hikes. The magnitude and speed of financial tightening will have an impact on growth. Reduced wealth due to lower equity and crypto prices, layoffs in tech as firms scale back and venture capital money dries up, higher interest rates on consumer lending, a stronger dollar, and slower global growth will weigh on spending, job growth, and, ultimately, consumer prices. But this will take some time. To be sure, the near-term data will be solid, it’s baked in the cake at this point. But we need to be looking toward the future; tightening cycles always have economic impact...

A soft landing does not mean unemployment rates will remain at current levels. The Fed believes that with labor demand outstripping labor supply, the economy can be put on the path to price stability by bringing down the excess demand for labor. For example, this from New York Federal Reserve President John Williams:
Although we are facing highly unusual and challenging circumstances, I am confident we have the right tools to achieve our goals. In fact, we have an advantage over previous inflationary episodes: Our monetary policy tools are especially powerful in the very sectors where we see the greatest imbalances and signs of overheating—such as durable goods and housing. Higher interest rates will cool demand in these rate-sensitive sectors to levels better aligned with supply. This will also turn down the heat in the labor market, reducing the imbalance between job openings and available labor supply.
Still, Williams added in the Q&A:
“When I think of a soft landing, it’s really a matter of, yes we could see growth below trend for a while and we definitely could see unemployment moving up somewhat but not in a huge way…I think that’s the challenge,” Williams said.
Similarly, Mester said that unemployment may need to rise, and the economy may experience another “quarter or two” with negative growth. To me, this is the Fed setting the stage to redefine a “soft landing” as a mild recession. Arguably, the shift in the Beveridge curve suggests that the natural rate of unemployment has risen, so the Fed can’t regain a healthy labor market without unemployment rising and, historically, the Fed can’t engineer a rise in the unemployment rate without a recession. I think the Fed is coming to terms that a return to price stability will require some turbulence and likely a period of very low growth at best.

...To be sure, I wouldn’t read too much into this report. It’s noisy data and we already knew that productivity would be weak given the decline in headline GDP in the context of still strong job growth, and we already know that labor cost growth is elevated. Still, recent trends of persistently weak productivity and high labor cost growth suggest some firms have become overstaffed – think Amazon and tech companies. A shift back to more aggressive cost control would put some downward pressure on employment growth...

Bottom Line
The goal is to tighten financial conditions to reduce the pressure on the economy, not break the economy or the markets. Powell will need to feel his way through this process. Things I am watching include the impact of higher rates on housing, firms seeking productivity improvements via cost controls on labor, layoffs in the wake of the collapse in technology stocks, and the impact of slower global growth (lost in this discussion is the fact that both Europe and China are struggling). This doesn’t mean looking for a recession. It means looking for the space that allows the Fed to ease back on the throttle. It’s about whether the transition back to 25bp happens at the September meeting or later.

...For those who may not remember, the ECB stepped in on May 10, 2010, in the depths of the European sovereign debt crisis, to intervene directly in peripheral markets with the Securities Market Program (SMP), then established the European Financial Stability Facility (EFSF), which morphed in 2012 into the never-used Outright Monetary Transactions (OMT) program, and the robust and well-funded European Stability Mechanism (ESM), respectively.
In more recent memory, when peripheral European spreads came under pressure again, this time from a US bond market mini tantrum in March 2020, the ECB enhanced its Asset Purchase Program with a new Pandemic Emergency Purchase Program (PEPP) that gave it the freedom to buy bonds across jurisdictions, with little concern for “capital key” limitations, meaning of course a heavy overweight in Italian bonds.
As things stand, the ECB has committed to reinvesting these PEPP bonds proceeds, and is willing to continue to do so, flexibly if needed, to temper any fragmentation or dislocation across peripheral markets. Furthermore, a version of the PEPP program can be reactivated at any time. To think that the ECB needs to reinvent the wheel, with yet another facility, is failing to listen to what ECB officials are saying, or to acknowledge their success in managing outsize market dislocations, when necessary, for over a decade...

...In a series of reports starting in early March, we wrote that consensus across the European Central Bank was coalescing around an accelerated end to the Asset Purchase Program in July, followed by lift-off from its negative 50 basis point benchmark deposit rate in Q3 of 2022.
We followed that with reports in April flagging how momentum was building in the ECB to pull lift-off into the July 21 Monetary Policy Meeting immediately following the end of APP, which would then open the door to three 25 basis point rate hikes in 2022.
That consensus formation process appears to be now all but complete.
Indeed, without prejudging decisions that are still many months away, key ECB officials from across the policy spectrum have highlighted July as their preferred date for lift-off, along with their expectation that rates will likely be in positive territory by the end of 2022, meaning three 25 basis point hikes by then.
We expect those hikes to come at the July 21 meeting, followed by the September 8 and December 15 quarterly forecasting round meetings, with the intervening October 27 meeting as a live but much less likely option for a fourth 2022 rate hike if desired...

JOLTS, Final Thoughts Ahead of the FOMC Meeting
The JOLTS report is sure to reinforce Federal Reserve Chair Jerome Powell’s conviction that the labor market is overheating. Job openings unexpectedly rose to 11.5 million, slightly surpassing the previous high of 11.4 million:

Higher mortgage rates should bite harder into the housing market in April (note that mortgage purchase applications have now fallen to pre-pandemic levels), but this is a very unhealthy market characterized by elevated builder costs, strong demographic demand supported by rapid job and wage growth, low inventories, and an inflationary mindset among purchasers. Odd dynamics might evolve.

The European Commission has now formally issued guidance to EU governments explaining why setting up a second, ruble account as demanded by Russia is in fact tantamount to breaking EU sanctions.
The logic, exactly as we noted when Putin released his March decree, is that while until now paying euros or dollars into an account at Gazprombank completed the transaction of buying Russian gas, after the Putin decree the purchase is only legally finalized once the euros or dollars are converted into rubles and deposited in the ruble account.
The conversion of euros or dollars into rubles is effectuated by the Central Bank of Russia, and that is the point at which the sanctions regime is broken — EU entities cannot do any business with the sanctioned Russian central bank and because the conversion is done by Gazprombank on behalf of the EU entities, they are, indirectly, doing business with the Russian central bank...

...EU sanctions on Russian oil, however, are drawing closer, with Germany declaring on Tuesday that it may be able to wean itself off Russian oil “within days,” rather than by the end of the year as declared before.
This could pave the way for some form of sanctions on buying Russian oil by the whole of the EU soon, perhaps as early as next week, maybe the week after that, depending on how quickly other countries heavily dependent on Russian oil like Lithuania, Finland, Slovakia, Poland, Hungary, Germany, Belgium, and France find alternatives.
Interestingly while the EU, and most notably Germany, as we expected has been moving closer towards sanctioning Russian oil, some of the hesitation it appears now is emanating from the White House, sensitive to its continued inability to drive oil prices lower before the US mid-term elections in November.
Nevertheless, political pressure keeps mounting to turn the economic heat up even higher on Russia, and a special summit of EU leaders to discuss Russia, Ukraine, sanctions, arms deliveries, migration, and food shortages caused by the war has been set for May 30-31.
Some EU officials have indicated to us that oil sanctions could be the big “deliverable” of that meeting, even though that is a month away. The timing is in fact hard to pinpoint, especially with EU officials aware that new, tragic developments in the Ukraine war could force their hands into a major measure more quickly than they might be prepared.

The Bank of England is set to deliver its fourth successive rate increase on May 5 as it struggles to contain inflation exacerbated by the pandemic and Ukraine invasion, whose twin price shocks are also weighing on domestic activity.
A June move still remains more likely than not, albeit less certain as we have written, and the window for the BOE’s campaign to modestly “front load” hikes is beginning to close. The Bank does not meet in July and will resume from August 4.
Some policy committee members, absent sagging activity, would prefer to move again in June, probably by bigger increments and opt to keep moving until the key bank rate ranges somewhere around a consensus estimate of neutral.
As domestic budgets become increasingly constrained, the Bank will have to face off the political blowback from its next couple of moves, before stepping to the sidelines to let households catch their breath.
The BOE is on the precipice of what we have described as a “second phase” of tightening, characterized by less frequent moves over a longer time horizon, with data dictating meeting-to-meeting outcomes.

While Macron’s La Republique en Marche party might secure a majority on its own in these elections, it appears as things stand that he may have to enter in coalition with the far-left’s Jean-Luc Melenchon.
Melenchon’s party, La France Insoumise, currently holds just 17 of the 577 Assembly seats, but with a strong 22% third place showing in the first round of the presidential elections, he is hoping to unify support of other voters from the left. Melenchon has expressed an ambition to serve essentially as an opposition Prime Minister if Macron were to be forced to invite him into the coalition, as has, incidentally, Le Pen.
They would make for strange bedfellows.

If You Don’t Have Time This Morning
The Fed’s near-term path is clear, with a series of likely three and maybe more 50bp hikes beginning at the May FOMC meeting. Although it seems like there should be a point we should stop pricing in additional rate hikes, it is difficult to shift gears until the data shows signs of moderating inflationary pressures. Otherwise, the Fed has been remarkably complacent in validating seemingly any market pricing. Higher interest rates should start showing some results.
Recent Data and Events
We are at the stage of the cycle where the game becomes watching the data for signs that spending is beginning to crack under the weight of higher interest rates. Housing becomes the central focus given the short channel between policy signals and mortgage rates, the latter rising sharply in recent weeks. Now we need to sort through the consequences. At a basic level, the rise in rates will shake out the weaker players and stem the pace of home price appreciation, but as I have written in the past factors such as income growth, demographics, and inflation expectations lean the other direction. About inflation expectations, for example, though the increase in long rates has been rapid in both nominal and real terms, 30-year real mortgage rates remain in their recent range while 5-year ARMS are still a relative bargain:

New buyers could reasonably take on ARM financing on the expectation that over the next five years the Fed induces a recession and presents buyers an opportunity to refinance into a 30-year rate at that point. This would help mitigate the immediate impact of higher rates – at least until ARM rates rise further.

...Fed Speak and Discussion

Federal Reserve Chair Jerome Powell wiped away any residual doubt about the near-term policy path. Last Thursday, Powell said that a 50bp hike was on the table for the May meeting. While he wouldn’t say if 50bp was already a done deal, he effectively took the guidance one step further, saying “[t]here’s something in the idea of front-loading” rate hikes, which speaks to the expectation for a string of 50bp rate hikes. There really is no question about what is happening here – moving “expeditiously” to a more neutral policy setting by the end of the year requires stepping up the pace of rate hikes to 50bp increments. As of now, 50bp rate hikes in May and June are all-but-certain, July very likely, and August, assuming the inflation or employment data continue to dispel hope that price pressures will endogenously moderate enough to put the Fed’s inflation target in sight...

...An even bigger hike of 75bp is not happening. St. Louis Federal Reserve President James Bullard has discussed the possibility of the larger hike, something former Federal Reserve Chair Alan Greenspan pushed through in 1994, and an option we questioned Bullard on at an SGH/Columbia event on February 17th. Bullard looks favorably on the 1994-95 cycle as an example of where the Fed managed a soft-landing in the context of aggressive policy action on both sides of peak rates for a cycle. That said, the consensus at the Fed is not eager to surprise markets with a bigger move at the next meeting. That includes the generally hawkish Cleveland Federal Reserve President Loretta Mester who made clear last Friday that in her view 75bp was not needed. Remember, the Fed wants to move expeditiously but doesn’t want to break the economy or markets in the process. Still, arguably Bullard has planted the seeds for the bigger move at the June meeting, and it may be a more attractive option at that point, just as the possibility of 50bp moves was scoffed at back in January, although I find it unlikely...

...While the idea of “neutral” sounds like a promising pausing point, the Fed lacks confidence that it can pause at neutral. Fed speakers repeatedly discuss the possibility of moving past neutral, something already evident in the March Summary of Economic Projections but even those forecasts are all-but-certainly too optimistic if unemployment keeps falling while inflation remains stubbornly high. I think the Fed knows this but remains wary to push this story too far because it is obviously in tension with the soft-landing story it is trying to sell.
Moreover, neutral is a moving target. Clients frequently ask if the Fed’s view of neutral is moving, and the answer is that we don’t see any indication that is happening yet. Fed speakers have largely centered that on a 2.25-2.5% range for some time now. Thinking on it, I don’t think the Fed can easily change this estimate. Consider that it follows from a forecast of the real neutral rate plus the Fed’s inflation target. The former is difficult to observe in real time and the latter is fixed. A more appropriate estimate of the inflation component is arguably derived from 10-year TIPS break-evens, currently 3%. Subtracting 30bp as a rough conversion from CPI to PCE inflation makes that 2.7%, which combined with a 0.5% real rate suggests the true neutral rate is currently around 3.2%. The same exercise using the 5-year breakeven suggests a neutral rate of 3.6%. Arguably, these are estimates of the near- or medium-term neutral rate, while the Fed’s reported number is a long-term estimate. Still, this exercise suggests to me that monetary policy will remain stimulative until policy rates climb above 3%...

Though BOJ officials expect a temporary bump in inflation in the next few months as government cuts to mobile phone fees roll off, underlying inflation as reported by the central bank is still only around 0.5%. There is furthermore an understanding that headline inflation pressure on energy prices and consumers is not just the result of a weaker yen but fueled also by Russia’s invasion of Ukraine and the rush toward green energy policies by the European Union.
Intervention Noise and Yen Weakness
So even as the US Federal Reserve and other central banks (outside China) lean into tightening cycles, Bank of Japan Governor Kuroda has continued to pledge to keep Japanese short-term rates firmly anchored to the floor, or to be more precise just below the floor, at -0.1%.
Out of contention as well is an “early” end to the BOJ policy of yield curve control on the long end that has been in place since 2016, which is considered by Kuroda to be a critical backstop against a “premature” exit from accommodative policy. That however has not precluded speculation that the 25-basis points YCC band around 10-year JGBs could be widened.
Something will give after the collapse in the currency.
The first shoe to drop we expect will be the psychological 130 yen to dollar threshold that has held to date.

Pushing rates to neutral by the end of the year requires a series of 50bp rate hikes, which we know begins at the upcoming May FOMC meeting. Speakers have positioned the Fed for 50bp rate hikes at the May and June meetings, and I believe the Fed will know at the June meeting if it plans to hike 50bp a third time in July as well. That sets the stage for the equivalent of ten 25bp rate hikes in the June dots, with the risk at that point that the Fed already believes it needs to get rates above current long-run neutral estimates by the end of the year, meaning a fourth and even fifth 50bp hike added to the series. That, however, is only speculation at this point. There will be a lot of data to process between now and then.

...That said, a senior official concedes, as we have written, that April may indeed prove to be the toughest month for economic growth this year. He goes on to suggest that China’s State Council will step up fiscal, investment, and monetary stimulus efforts if consumption during China’s five-day International Labor Day holiday, starting on May 1, falls short of expectations...

Bottom Line: The Fed continues to press forward with its plan to get rates to neutral this year with front loading rate hikes. That sets us up for a series of 50bp moves, starting in May. The Fed has yet to commit to any steps beyond that point, with the consensus wary about pushing rate hike expectations too much above neutral until it has a clearer sense of the level of underlying inflation. Now we wait, tracking the inflation data and any wobbles in activity triggered by the rise in market interest rates that have already occurred. My expectation is that the Fed will eventually need to take rates above the current estimate of neutral, and there is a reasonable chance that the neutral rate has risen. That’s speculation, however, and if true the Fed and market participants will need to learn their way to that outcome.

China will cut its Reserve Requirement Ratio tomorrow, as we have been anticipating and is increasingly expected by markets.

At a State Council Executive Meeting on April 13, local time, Premier Li Keqiang decided “to give greater weight to lower[ing] the provision coverage ratio of large-sized banks with high provisioning levels in an orderly manner and to cut banks’ reserve requirement ratio in a timely way in order to boost financial services for the real economy, especially for micro, small, and medium-sized enterprises (MSMEs).”

...while the ECB has punted the decision on which specific month in Q3 it will end APP purchases until its June 9 forecasting round meeting, as things stand and barring some massive unforeseen shock, we fully expect the last 20-billion-euro monthly round will be purchased in June, and APP will stop as of July 1.

Of course, the last time the ECB hiked rates was in 2011, and a decision as momentous as lift-off into a rate hiking cycle will ideally need to be tied to a forecasting round, no matter how flawed, and that presents an interesting timing dilemma. Namely, with the need to move off negative interest rates so glaringly obvious, can the ECB make a case in June that the conditions are met for the end of APP, but not yet for liftoff in July, and wait another full three months for lift-off?
We’ll see, but we suspect not...

...On a final note, we would like to toss out the “scoop” reported by a wire service about an emergency program in the works at the ECB to stop fragmentation of Eurozone markets as an utter non-story.

Since well before the conclusion of the ECB’s Pandemic Emergency Purchase Program (PEPP) program in April of this year, ECB officials have talked about the desirability of retaining optionality in the case of an emergency to purchase sovereign bonds on a more discretion based, flexible manner, meaning away from the ECB’s self-imposed Capital Key restrictions. The PEPP, of course, did just that.

This appears to have morphed into a wire article about an emergency program in the works evoking former ECB President Mario Draghi, the OMT program, “everything it takes” vows, and other such trips down memory lane and the European debt crisis. Having intervened multiple times in the course of its history to manage fragmentation and spiking yields in times of crisis, one would think the ability of the ECB to do just that if needed would be glaringly obvious to all. Indeed, when asked about it multiple times, Lagarde merely shrugged.

On Friday, April 8, nine government departments submitted their economic analysis reports to China’s State Council, inputs which will be also incorporated into the country’s aggregated National Bureau of Statistics reports due to be released on Monday, April 18.

Of the nine departments, seven estimated that China’s Q1 2022 GDP had grown by more than 5.0%, with estimates ranging from a low of 4.8% to a high of 5.4%. Notably, our understanding is that China’s foremost economic planning department, the NDRC (National Development and Reform Commission) pegged Q1 GDP growth at 5.2%, with the People’s Bank of China estimates coming in a bit lower, at 5.0%.

While the NDRC report voiced confidence that the country would achieve its growth target of “around 5.5%” this year, a view that is not shared by many private sector forecasters, it also acknowledged that the solid Q1 growth numbers – initially expected to come in as low as 4.0% — were largely due to a strong recovery in January and February.

The explosion in headline inflation in March will feed into the story that the worst is behind us on a year-over-year basis. Further feeding into that story would be any downside miss on the core number attributable to falling used car prices, something foreshadowed by the Manheim index:

(See graph on full report.)

One inflation view is that inflation is primarily not a macro event, but a micro, supply side event. That view still holds onto a decline in used vehicle prices leading the way back to a primarily transitory inflation story.
While a miss on core driven by used prices would be welcomed by the Fed, I think overall the consensus at the Fed will lean towards caution. From a pure symmetry perspective, the fact that the Fed looked through the rise in used vehicle prices last year means it should look through any decline this year. More importantly though, no one expects inflation to remain running over 8% annually...

...That said, the speed at which rates are moving will eventually cause some heartburn for the Fed. For now, it is full steam ahead for monetary policy. The Fed wants to push rates to neutral, and even a little beyond, but hopes that enough of the inflation surge will be transitory and that a soft-landing can be achieved with only modestly tight monetary policy. Too rapid of a rise in rates, however, may become disruptive for the economy and raise concerns that the Fed is prematurely courting a recession. There will be a limit to how much tightening the Fed will tolerate being priced into markets in the near term. The trick of course is that we don’t know where the limit is, only that we are closer to it than three months ago.