Highlights

SGH reports are highly valued for keeping clients and policymakers informed and well-ahead of consensus and the news cycle on the macro policy events driving global markets.

2023
January 17, 2023
SGH Insight
Late last week an article came out flagging the possibility that after a 50 bp hike at the next ECB meeting on February 2, and another 50 bps on March 16, lifting the benchmark deposit rate from 2.0% to 3.0%, the “doves” within the ECB’s Governing Council might push to slow the pace of rate hikes to 25 bp increments at the following meeting on May 4.

Whether there is a stepdown or not in May, when policy rates are at 3%, is an entirely reasonable question to ask, and it may not even have to result from a Manichean struggle between doves and hawks as analysts like to frame such stories. The more debatable question to us is where the landing zone will be once the ECB crosses the 3% threshold, a zone which we continue to expect will end up in the 3.5% to 4% region.

Today, markets were jolted by a Bloomberg news article saying the ECB may consider a 25 bp hike -- not in May -- but as early as at the March meeting, when rates will be at 2.5%.

Filled with caveats (“the prospect for 50 remains likely”), that article does not capture the dynamics that matter at the ECB, and only serves to needlessly shake some positions out on the back of what has been a powerful, and very cyclically different, downdraft in US rates.

A 25 bp hike in March flies entirely in the face of the eurozone’s inflation dynamics, rate position, and explicit guidance from ECB President Christine Lagarde and a host of her colleagues after what was in fact a seminal, hawkish meeting on December 15. Unless there is a truly dramatic and completely unforeseen change in the world, it is simply not going to happen.
Market Validation
Bloomberg 1/18/23

Villeroy Says Lagarde’s Half-Point ECB Guidance Still Valid
French official won’t speculate on size of March rate increase
Moderating inflation has prompted talk of smaller hikes

Guidance from European Central Bank President Christine Lagarde that borrowing costs will continue to be lifted in half-point steps for some time still holds, according to Governing Council member Francois Villeroy de Galhau.
Speaking to Bloomberg TV at the World Economic Forum in Davos, the Bank of France chief said it’s too soon to talk about the size of the likely interest-rate increase in March, after people familiar with officials’ thinking told Bloomberg that moderating inflation and declining energy prices may warrant a smaller hike.
“We said very clearly we still decide meeting by meeting, we are data driven, so it’s much too early to speculate about what we will do in March,” Villeroy said. “Let me remind you of the words of President Lagarde at her last press conference in December: We should expect to raise rates at a pace of 50 basis points for a period of time. Well, these words are still valid today.”
Lagarde on Dec. 15:
“So we will continue that at a steady pace. Based on the information that we have available today, that predicates another 50-basis-point rate hike at our next meeting, and possibly at the one after that, and possibly thereafter, but everything will also be determined by the review of data. So don’t assume that it’s a one-shot 50; it’s more than that.”
Read Full Report
January 13, 2023
SGH Insight
The Bank of Japan (BOJ) will tilt guidance toward an April exit of ultra easy policy at next week’s meeting as Prime Minister Fumio Kishida prepares to hand over the reins to a new Governor ahead of Haruhiko Kuroda’s departure before April 8.
A breach of the BOJ’s upper limit on 10-year government bond yields (JGB) Friday, forced a round of central bank bond buying and has increased pressure on the nine-member board to move again after it raised the upper limit on the 10-year yield to 0.5% from 0.25% in December.
Whether the BOJ opts to tweak the limit again at this or at the March 9-10 meeting, we expect the BOJ to eliminate yield curve control (YCC) during April, once Kuroda’s successor takes office.
At his December post meeting press conference, Kuroda stridently characterized the move as a technical tweak to improve market functioning. Since 2016 the BOJ has operated the YCC limits to achieve its 2% inflation target. The policy is a band set around the 0% target to allow long-term rates to move up or down by 0.50bp.
The January 17-18 meeting has been billed as a “technical” discussion to prepare the market for the BOJ to end its curve control policy (YCC) before April, once Kuroda’s successor takes office.
In particular the BOJ is uncomfortable with the kink in the curve, an inversion that shows a gap between seven- to nine-year yields and 10-year yields. In addition to how to correct ongoing market distortions from YCC, the meeting agenda will include an upward revision to the outlook for consumer prices and support further bond purchases.
Market Validation
MT Newswire 1/18/23

Bank of Japan Defies Market Speculators, But Pressure to End YCC
(MT Newswires)
The Bank of Japan defied market pressure and kept its ultra-low interest rate policy firmly in place after a two-day monetary policy meeting that ended today.

The yen fell and yields on Japan's government bonds plunged on the news, while stocks surged on the prospect of continued low rates.

But with current BoJ Governor Haruhiko Kuroda only in office until April, speculation of imminent change to the bank’s policy regime is unlikely to go away.
Read Full Report
January 09, 2023
SGH Insight
The employment report sent mixed messages between solid job growth, a low unemployment rate, and weaker wage growth. While this may appear to be a “Goldilocks” outcome, that’s only the case if it encourages the Fed to back down from its current policy direction. That’s not going to happen just yet. The Fed can’t really back down without revising downward the 2023 dots, which is not crazy if the then high but now lower wage growth drove December’s 50bp increase in the SEP policy rate forecast, but that is not something Powell wants to do anytime soon. That would be as good as a rate cut from the market’s perspective.

Fedspeak will not yet retreat from the December SEP. Once the Fed digs itself in on a position, it takes a great deal of time and evidence to dig it out. One report isn’t going to do it. More likely it would take the totality of the data between now and the March meeting to convince the Fed it went too far with the December SEP, but even then, that view creates a potentially disastrous communications challenge for the Fed as I will explain below.
Market Validation
Bloomberg 1/9/23

Daly Sees Fed Raising Rates Above 5% But How Far Is Unclear
Federal Reserve Bank of San Francisco President Mary Daly said she expects the central bank to raise interest rates to somewhere above 5% before pausing, though the ultimate level is unclear and will depend on incoming data on inflation.
As for the Fed’s next meeting at the end of the month, the central bank could either raise rates by 50 basis points for a second straight time or slow down to a quarter-point hike, Daly said Monday in a live-streamed interview with the Wall Street Journal.
Mary Daly
“Doing it in more gradual steps does give you the ability to respond to incoming information,” said Daly, who doesn’t vote on rates this year. She stressed that it’s too early to “declare victory” over persistent inflation.

*BOSTIC: VERY HESITANT TO DECLARE VICTORY IN BID TO COOL PRICES
*BOSTIC:SERVICES INFLATION HAS PASSED GOODS INFLATION AS PROBLEM
*BOSTIC SEES LIKELIHOOD SERVICES INFLATION WILL PROVE PERSISTENT
Read Full Report
January 06, 2023
SGH Insight
Where the ECB will need to firm up its communications is in why the ratcheting up of rate hike expectations, as this stepped-up hawkishness is coming at a time when they are finally seeing some glimmers of hope in the ever elusive “peak inflation” narrative. Otherwise, we suspect, markets, and indeed many governors, will continue to misread data, inflation risks, and even mislead on the ECB reaction function.
That headline inflation relief is from nose-bleed levels and driven largely by energy prices finally coming off, but it is some relief, nevertheless. ECB officials have indeed been looking for inflation to come down around the first quarter of this year, and markets will understandably be cheered to see any confirmation of continued signs that it is, indeed, finally coming down.
But markets would be well advised against leaning too much on that narrative, as they tried to do after last November’s CPI reports. This “Phase Two” of the ECB tightening cycle, a markedly more hawkish reaction function than many in the markets or even across the Council itself were hoping for, is, as we have been writing repeatedly, entirely about shaking out the dreaded and far more problematic, underlying, core inflationary pressures that have been creeping up.
This bears repeating: “Phase Two,” if we want to call it that, is all about hitting underlying inflationary pressures.
The hawks at the ECB, including notably Isabel Schnabel at the Executive Board, have been warning about these pressures now for months, and their materialization is now coming through in spades — even in the Chief Economist’s staff economic forecast.
Market Validation
Bloomberg 1/9/23

European Central Bank Chief Economist Philip Lane said price pressures in the euro area will remain elevated even if surging energy costs are starting to ease.
“This is not conclusive for the overall inflation dynamic,” Lane told a panel discussion in New Orleans. The original energy shock resulting from Russia’s war in Ukraine and pandemic reopening effects will feed into wages “for the next two or three years,” he said.
Euro-area inflation slowed to 9.2% in December, more than economists had predicted, according to data released Friday. The slowdown was driven by energy, though a measure of price growth that strips out such volatile items reached a record 5.2%.

With wage increases so far falling short of these price gains, there’s now a gap that will “keep pressure on inflation for the next number of years,” Lane said.
Still, if the slowdown in energy costs persists, it should over time feed into “less pressure on food inflation, less pressure on core inflation,” Lane said. “We should recognize that but, of course, we also should recognize the uncertainty about the future path of energy prices.”
The ECB raised borrowing costs by 250 basis points last year and pledged that more hikes will follow. Simulations show that the current level of interest rates isn’t enough to return inflation to the 2% target in a timely manner, Lane said.

Bloomberg 1/9/23

The European Central Bank predicts wage
growth — a key indicator of where inflation is headed — will be
“very strong” in the coming quarters, strengthening the case for
more interest-rate hikes.
A study of salary developments since the start of the
pandemic shows underlying pay growth has been “relatively
moderate” and is currently close to its long-term trend, the
institution said Monday in an article to be published in its
Economic Bulletin.
Even so, “looking ahead, wage growth over the next few
quarters is expected to be very strong compared with historical
patterns,” it said. “This reflects robust labor markets that so
far haven’t been substantially affected by the slowing of the
economy, increases in national minimum wages and some catch-up
between wages and high rates of inflation.”

Read Full Report
January 03, 2023
SGH Insight
The Fed’s level of commitment to slowing growth and raising the unemployment rate will determine the path of policy and economic activity this year. I sometimes think that we fail to appreciate the depth of the Fed’s hawkishness as revealed by the December Summary of Economic Projections (SEP). On one hand, a slowing in the pace of rate hikes with the terminal rate in sight appears to be a dovish shift. But hawkishness is not really about the pace or extent of rate hikes, it’s about the willingness to endure elevated unemployment to restore price stability.
Market Validation
Fed minutes: No rate cuts in 2023, inflation risk remains in focus
Wed, January 4, 2023
No Federal Reserve officials thought it’d be appropriate to begin cutting rates in 2023, and officials worried easing financial conditions could complicate the central bank's efforts to bring down inflation, according to internal discussions at the Fed's policy meeting three weeks ago.
Minutes from the central bank's December policy meeting released Wednesday showed while Fed officials welcomed easing October inflation data, they stressed it would take substantially more evidence of progress to be confident inflation was coming down in a sustained manner.
Read Full Report
2022
December 22, 2022
SGH Insight
Final Thoughts Ahead of the Holidays
This is how I am thinking about the economy and the Fed as we approach the New Year:
The Fed is very certain it needs to loosen labor markets to prevent another year of rapid wage growth, and that requires a substantially higher unemployment rate by the end of next year. It sees wages as ultimately driving inflation, and that the current disinflation will not be sustained in 2024 if it can’t bring wage growth under control. The labor market resilience has surprised the Fed, and it believes it needs to keep tightening until it sees clear evidence that the labor market is in retreat. Only then can the Fed be confident it will bring inflation under control over the longer run.
Market Validation
WSJ 1/5/23

Fed Officials Warn on Their Resolve
Minutes of December meeting show fear that market rallies would pressure rates upward
Federal Reserve officials offered uncharacteristically blunt words of warning to investors that cautioned against underestimating the central bank's determination to hold interest rates at higher levels to bring down inflation.
Minutes of the Fed's policy meeting last month, released Wednesday, highlighted the tricky communications task that has vexed the central bank over the past six months.
The Fed's rapid rate increases last year have fanned investors' hopes that inflation will slow quickly over the coming year. In the run-up to the December meeting, longer-term bond yields tumbled, reflecting both optimism about a speedy decline in inflation and fears of a recession this year.
But many Fed officials are anxious they won't be able to defeat inflation unless they can slow the economy by tightening financial conditions, such as by raising borrowing costs or lowering stock prices.
Any market rallies that ease financial conditions threaten to hinder officials' effort to cool hiring and wage growth. That, in turn, could prompt them to continue lifting rates or holding them at higher levels for longer, increasing the risk of a deeper or longer economic downturn.
Read Full Report
December 15, 2022
SGH Insight
European Central Bank hawks may have lost a skirmish when the Governing Council decided, as widely expected, to de-normalize the “jumbo” 75 bp rate hike pace of the last two meetings and hike interest rates today by 50 bps, taking the benchmark deposit rate to 2.0%.

But they won the war, in a major way, as ECB President Christine Lagarde came out guns blazing with the message that the ECB has “significantly” more wood to chop on rate hikes, and that all the market assumptions around the 3% or so end point for this rate hike cycle, with some of the doves and market participants even eyeing as low as 2.5%, will need to be revised up — by a lot.

And while Lagarde did not place a number on that elusive “terminal rate,” we believe, as we wrote in SGH 11/30/22, “ECB: A Major Disconnect with Markets,” that means the ECB is increasingly eyeing a 3.5%-4% landing zone when all is said and done.
Market Validation
Bloomberg 12/16/22

Traders Raise Peak Rate Bets After Further Hawkish ECB Comments

Money markets are betting the ECB will lift
the deposit rate as high as 3.36% after policy maker Olli Rehn
adds his voice to calls for more tightening.
* Traders price 89bps of rate hikes by March and add as much as
17bps to peak rate wagers after Rehn says rates are likely to
rise by 50bps in February and March and is not convinced markets
are pricing the terminal rate correctly
** Earlier, policy maker Muller said rates will need to raised
further while Villeroy said rates will rise as much as necessary
Read Full Report
December 15, 2022
SGH Insight
Bottom Line: If the Fed didn’t like yesterday’s market response, we are going to start hearing about it. I don’t know, however, that market participants will react to jawboning given the view that the next few inflation numbers will be soft. They might need to see Baoard members coming out in favor of another 50bp rate hike before absorbing that message. Even then, what market participants really need is data to support the Fed’s projected policy path, and that will take time.
Market Validation
Bloomberg 12/16/22

Fed Officials Reinforce Hawkish Message on Need for Higher Rates
Federal Reserve officials, hammering home an
unapologetically hawkish message, said that they won’t relent on
tighter policy until inflation is under control.
New York Fed President John Williams and San Francisco Fed
chief Mary Daly both stressed the central bank’s commitment to
lowering inflation back to their 2% target and the need for
clear evidence of easing price pressures.
“We’re going to have to do what’s necessary,” Williams said
Friday during an interview on Bloomberg Television with Kathleen
Hays.
Referring to the central bank’s forecast that rates will
peak above 5% next year, he said “it could be higher than what
we’ve written down” if that’s what it takes reduce inflation.
Read Full Report
December 13, 2022
SGH Insight
Quick CPI Note

Federal Reserve Chair Jerome Powell will welcome the inflation number as good news but will remind us that the Fed still believes it needs to maintain restrictive financial conditions for an extended period to ensure a more balanced labor market, which is key for restoring price stability. Although core services inflation was softer in November, it is too early to expect Powell will change that narrative.
The disinflationary trend will make it easier for the Fed to pause, but Powell will want greater evidence of weaker labor market conditions before he will be comfortable pausing. He will remind us that the Fed doesn’t expect to cut rates soon after reaching the cycle peak.
Market Validation
FOMC Press Conference 12/14/22

>> CHAIRMAN POWELL: So if I -- I think I got your question. So, you know, one thing to say is I think our policies in getting into a good place were restrictive and we're getting close to the level of sufficiently restrictive we laid out today what our best estimates are to get there. And I mean, it boils down to how long we think the process is going to take. And of course we're -- we welcome these better inflation reports for the last two months. They're very welcome but I think we're realistic about the broader project. So that's all -- that's the point I'd make. You know, we see goods prices coming down. We understand what will happen with housing services. But the big story would really be the rest of it and there is not much progress there, and that's going to take some time. I think my view and my colleagues' view is this will take time and we'll hold policy for a sustained period so -- so two good monthly reports are, you know, very welcome. Of course they're very welcome. But we need to be honest with ourselves that there is inflation, 12-month core inflation is 6% CPI. That's three times the 2% target. Now it's good to see progress but let's understand we have a long ways to go to get back to price stability.
Read Full Report
December 12, 2022
SGH Insight
The Fed is poised to raise rates 50bp at this week’s FOMC meeting and project that at least another 50bp of rate hikes remains in this cycle. That projection will place the terminal rate in sight, just two meetings away assuming the Fed downshifts to 25bp at the Jan/Feb meeting. Such a projection is something of an act of faith on the Fed’s part given that incoming data has yet to show all but the earliest signs of the labor market retrenchment the Fed believes necessary to restore price stability. Still, given the speed at which the Fed has raised rates, it would not be surprising to see the impacts of tighter financial conditions limited to only the most interest rate sensitive sectors. We know the Fed is already considering the cumulative tightening to date and policy lags when setting policy and we are looking for signs the Fed is increasingly comfortable viewing rates near 5% as the likely end of this cycle. Note that the Fed hasn’t been trying to guide rate hike expectations substantially higher. We still believe the terminal rate will be 5.125%, but that requires evidence sufficient to leave the Fed confident that the labor market will soften substantially over the next year...

...Bottom Line
The Fed will take another step forward in its campaign to bring policy rates to a sufficiently restrictive level to restore price stability. But with 450bp tightening already completed, the Fed will step down from the blistering 75bp pace of the last four meetings to a still substantial 50bp hike. The Fed’s rate projections will imply that the Fed anticipates the economy will evolve in such a way that the peak of this cycle is not far away. At this point, the data have yet to reveal the substantial rebalancing of the labor market the Fed is hoping to achieve in its quest to restore price stability. Looking for the peak of the cycle under these circumstances very much depends on the Fed having a forecast that includes a very high probability of recession. The Fed is moving closer to that point.
Market Validation
Washington (AP) 12/14/22

-- The Federal Reserve reinforced its inflation fight Wednesday by raising its key interest rate for the seventh time this year and signaling more hikes to come. But the Fed announced a smaller hike than it had in its past four meetings at a time when inflation is showing signs of easing.
The Fed boosted its benchmark rate a half-point to a range of 4.25% to 4.5%, its highest level in 15 years. Though lower than its previous three-quarter-point hikes, the latest move will further increase the costs of many consumer and business loans and the risk of a recession.
The policymakers also forecast that their key short-term rate will reach a range of 5% to 5.25% by the end of 2023. That suggests that the Fed is poised to raise its benchmark rate by an additional three-quarters of a point and leave it there through next year.
In its updated forecasts, the Fed’s policymakers predicted slower growth and higher unemployment for next year and 2024. The unemployment rate is envisioned to jump to 4.6% by the end of 2023, from 3.7% today. That would mark a significant increase in joblessness that typically would reflect a recession.
Consistent with a sharp slowdown, the officials also projected that the economy will barely grow next year, expanding just 0.5%, less than half the forecast it had made in September.

Bloomberg 12/13/22

A dovish post-CPI repricing in the Fed-dated swaps market has seen the odds now favoring a downgrade to a 25bp rate hike move as early as the February policy meeting.
Swaps are still solidly pricing in a 50bp move for Wednesday’s policy announcement, little changed on the day but now an additional 84bp of hikes are priced for the February meeting, down from 91bp Monday close
An 84bp hike premium for the meeting consistent with a 50bp move for December and then 34bp additional priced for the Feb. decision
Further out, Fed peak policy rate has now dropped to around 4.82% consistent with below 100bp of additional hikes; consistent with the Fed pausing in the May meeting next year after 50bp, 25bp and 25bp hikes over the next three meetings
Read Full Report
December 09, 2022
SGH Insight
The United Kingdom’s ongoing battle with inflation is likely to see the Bank of England (BOE) raise rates 50 basis points to 3.5% at next week’s meeting despite concerns that tighter policy threatens to deepen a looming recession.
The UK has the most to do among the major central banks but also faces the greatest risk of recession. The BOE raised rates 75bp in November as inflation continued to surge higher than officials expected. It has raised rates eight times in the past year to 3% in an effort to avert a wage-price spiral.
At the time of the November meeting the BOE’s chief economist Huw Pill indicated there was more work to do to guide prices back to the Bank’s mandated 2% target over time. UK inflation is running at 11.1% – five times the target.
Governor Andrew Bailey’s proposal to the December 15 meeting will likely draw at least two dissents from committee members. One will be from Silvana Tenreyro who has consistently fought larger increments through the central bank’s tightening cycle. Also, the Bank’s latest addition to the committee this year, Swati Dhingra argued in an interview published on Saturday that higher interest rates could lead to a deeper and longer recession.
Dhingra believes there are few signs that demands for higher wages risk a wage-price spiral. In contrast others on the committee like external BOE rate setter Catherine Mann worry about what she sees as higher inflation expectations already having become embedded into psychology. Mann wants rising inflation dynamics stamped with larger moves to avoid the Bank having to inflict greater pain via a severely restrictive policy setting later.
Market Validation
Bloomberg 12/15/22

The Bank of England raised interest rates for a ninth time in a row to a 14-year high of 3.5%, pressing ahead with efforts to tame sky-high inflation.
The nine-member Monetary Policy Committee split three ways on the decision as officials tried to balance the risk of inflation getting entrenched against squeezing too hard on growth just as the economy enters a recession.
Six members including Governor Andrew Bailey voted for the half-point rise. Catherine Mann favored three-quarters of a point, while Silvana Tenreyro and Swati Dhingra backed leaving rates unchanged.
Read Full Report
December 05, 2022
SGH Insight
The Fed is gearing up for a 50bp rate hike at next week’s meeting and given the repeated guidance of a “somewhat” higher terminal rate, we anticipate the peak rate implied by the SEP will rise 25bp compared to September. The risk to this outlook is a 50bp increase in the terminal rate. Either way, we still can’t yet guide our expected terminal rate higher than 5.125%.
Market Validation
Bloomberg 12/13/22

A dovish post-CPI repricing in the Fed-dated swaps market has seen the odds now favoring a downgrade to a 25bp rate hike move as early as the February policy meeting.
Swaps are still solidly pricing in a 50bp move for Wednesday’s policy announcement, little changed on the day but now an additional 84bp of hikes are priced for the February meeting, down from 91bp Monday close
An 84bp hike premium for the meeting consistent with a 50bp move for December and then 34bp additional priced for the Feb. decision
Further out, Fed peak policy rate has now dropped to around 4.82% consistent with below 100bp of additional hikes; consistent with the Fed pausing in the May meeting next year after 50bp, 25bp and 25bp hikes over the next three meetings
Read Full Report
December 05, 2022
SGH Insight
Xi and MBS will both confirm the increase in the use of their respective local currencies (RMB and SAR) for settlement in bilateral trade, especially in crude oil trade.
Beijing expects that the first summit between China and the Arab League (League of Arab States – LAS) will mark the entry by both sides into the stage of “all-round cooperation” in China’s Belt and Road Initiative. The summit between China and the Gulf Cooperation Council will mark the final stage of negotiations on a free trade agreement between the two sides. The summit between Xi and Saudi Arabia’s MBS will mark a new stage of “comprehensive strategic partnership” between the two countries including on MBS’ controversial NEOM city project in the desert, oil and gas resources, clean energy, e-commerce, high technology, people to people exchanges, and national defense.
Market Validation
Bloomberg 12/8/22

Xi Says China Willing to Boost Crude Oil Trade With Saudi Arabia

China is willing to strengthen energy policy coordination, expand crude oil trade, and strengthen cooperation in energy exploration and development with Saudi Arabia, Chinese president Xi Jinping told Saudi’s Crown Prince Mohammed bin Salman at a meeting on Thursday, according to a statement by Chinese foreign ministry.
China supports the kingdom’s Vision 2030 and Middle East Green initiatives while implementing connection of the vision with China’s Belt and Road Initiative
China willing to deepen cooperation in construction of production capacity and infrastructure, improve trade, investment and financial cooperation, expand cooperation in e-commerce, digital economy, clean energy, advanced technology, and aerospace research and development

Bloomberg 12/9/22

Xi Says China to Make Efforts on Oil & Gas Trade Yuan Settlement

China is willing to make efforts with Gulf Cooperation Council (GCC) countries in the next three to five years in key areas including energy cooperation “new pattern”, President Xi Jinping said in a speech at the China-GCC summit in Riyadh on Dec. 9, CCTV reports.
China willing to make efforts in the following areas: continue to increase import of crude oil and liquified natural gas from GCC countries
Use Chinese currency for oil & gas trade settlement
Set up joint forum on the peaceful uses of nuclear technology
Build up co-investment federation to support cooperation of sovereign investment funds
Co-build big data and cloud computing center and implement 10 digital economy projects
Cooperate on aerospace area; welcomes astronauts of GCC countries to enter Chinese space station and study the establishment of joint lunar and space exploration center
Read Full Report
December 01, 2022
SGH Insight
Impatient that Canadian inflation is not yet broadly declining, the Bank of Canada (BOC) will likely deliver its last 50bp of the cycle when the governing council meets next week, taking its official cash rate to 4.25%.
Governor Tiff Macklem struck a mostly hawkish tone in testimony to a parliamentary committee last week when he reiterated that the economy remains overheated with inflation too high and still broad based, reflecting large increases in prices of goods and services.
While Macklem’s lean was hawkish regarding the December 7 meeting outcome, the tone of his broader comments is beginning to show increased sensitivity to the potential end point of the Canadian policy cycle.
That means the BOC may opt to hold rates at 4.25% to wait for prior tightening to show up in the data.
“We are trying to balance the risks of under- and over-tightening,” Macklem told the hearing.
Market Validation
Dow Jones 12/7/22

The Bank of Canada on Wednesday raised its main interest rate by a half-percentage point to contain elevated inflation, and signaled it's at or near the end of its rapid-fire tightening campaign because of slowing growth.
The Bank of Canada increased its target for the overnight rate by a half-percentage point from 3.75% to 4.25%, the highest level in nearly 15 years. The Bank of Canada said any future policy decisions would be guided by incoming data.
"Looking ahead, the governing council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target," the central bank said in a statement outlining its decision.

Read Full Report
December 01, 2022
SGH Insight
A surprising dip in a new monthly measure of Australia’s consumer inflation will not knock the Reserve Bank of Australia (RBA) off its path to nudge rates another 25 basis points next week to 3.10% though it will likely tee up a possible pause in hikes early next year.
The headline annual monthly inflation rate eased to 6.9% in October from 7.3% in September due to smaller rises in prices of fruit, vegetables, and travel, while the trimmed mean measure eased to 5.3% from 5.4% in September.
Still given inflation has not yet peaked, the RBA is keeping its options open.
“Acknowledging the uncertainty, (RBA board) members did not rule out returning to larger increases if the situation warranted,” the Bank said in the minutes of its November 1 meeting.
“Conversely, the Board is prepared to keep rates unchanged for a period while it assesses the state of the economy and the inflation outlook. Interest rates are not on a pre-set path.”
Even if the RBA lifts the cash rate again in the new year it is looking to pause to allow the full impact of prior tightening to work its way through the economy.
Market Validation
Bloomberg 12/20/22

Australia’s central bank considered pausing
its policy tightening cycle this month but decided against it as
incoming economic data didn’t yet warrant a change of stance,
minutes of the Dec. 6 meeting showed.
The Reserve Bank’s board raised interest rates by a
quarter-percentage point to 3.1% two weeks ago after considering
three options –- 25 basis points, 50 or a pause, the minutes
released Tuesday in Sydney showed.
This is the first time during the RBA’s eight-month
tightening cycle that board members put the case for no change
on the table. The discussions come as a majority of economists
see two more quarter-point hikes in 2023, taking the cash rate
to 3.6%.

Bloomberg 12/6/22

Australia’s central bank raised its key
interest rate for an eighth consecutive month and said it
expects to tighten policy further as it seeks to cool the
hottest inflation in three decades.
The Reserve Bank increased its cash rate by a quarter-
percentage point to 3.1%, the highest level since November 2012,
at its final meeting of 2022. Tuesday’s widely anticipated
decision brings the RBA’s cumulative hikes since May to 3
percentage points, the sharpest annual tightening since 1989.
“The board expects to increase interest rates further over
the period ahead, but it is not on a pre-set course,”

Read Full Report
November 30, 2022
SGH Insight
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.

Market Validation
Bloomberg 12/2/22

EU Agrees to Set $60 Price Cap Level for Russian Oil Exports

The European Union agreed to put a price cap on Russian oil at $60 a barrel, paving the way for a wider Group of Seven deal, according to a Polish diplomat.
The price is higher than where Russia already sells most of its crude. That’s because one of the main aims of the measure is to try to keep Russian oil flowing to global markets. But it’s less generous than an earlier proposal after pressure from Poland and the Baltic countries.
After long negotiations, those countries succeeded in securing additional conditions aimed at punishing Moscow, including a mechanism that would allow for revisions of the price every two months, There’s also a plan to make sure any resetting of the cap should leave it at least 5% below average market rates.
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November 28, 2022
SGH Insight
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.
Market Validation
Bloomberg 12/13/22

A dovish post-CPI repricing in the Fed-dated swaps market has seen the odds now favoring a downgrade to a 25bp rate hike move as early as the February policy meeting.
Swaps are still solidly pricing in a 50bp move for Wednesday’s policy announcement, little changed on the day but now an additional 84bp of hikes are priced for the February meeting, down from 91bp Monday close
An 84bp hike premium for the meeting consistent with a 50bp move for December and then 34bp additional priced for the Feb. decision
Further out, Fed peak policy rate has now dropped to around 4.82% consistent with below 100bp of additional hikes; consistent with the Fed pausing in the May meeting next year after 50bp, 25bp and 25bp hikes over the next three meetings

Bloomberg 11/30/22

Treasuries Pare Losses After Powell; Target Peak Priced Below 5%

Treasuries pare declines, led by front and belly of the curve, after Fed Chair Jerome Powell says the time for moderating hike pace may come as soon as December.
Treasury yields flip to richer on the day at the long-end of the curve, while 2-year yields moved to be 1bp up on the day and and well off session highs; 2s10s and 5s30s spreads pared earlier flattening move although remain tighter on the day
Over the release volumes spike with around 40k March 10-year note futures trading in move from around 112-21 up to 113-01 -- price action remains inside session range however
Swaps showed a dialing back of expectations for Fed terminal rate to just under 5%, down from level pre-remarks and similar to end of prior day

FT
In a wide-ranging speech about the outlook for monetary policy, Powell said that in order to bring inflation back down to the Fed’s 2 per cent target, the labour market must become substantially softer and there would need to be a “sustained period of below-trend growth”. He said that job gains still remain far too high, at about 290,000 positions per month over the past three months. And wage growth remains well above than the figure that would correspond to inflation falling back to target, he added.
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November 28, 2022
SGH Insight
European Central Bank Executive Board member Isabel Schnabel, who we have long considered to be the most important and influential thought leader on the Board in support of President Christine Lagarde, delivered a speech over the US Thanksgiving holiday in which she laid out the case for another aggressive rate hike when the ECB Governing Council next meets on December 15.

Some of the financial press summarized her speech as simply stating that “incoming data so far suggest the room for slowing down the pace of interest rates remains limited,” but in our view Schnabel went significantly farther than that, and the real message of this important speech may have been lost in the holiday markets.

In her keynote speech on Thursday at the Bank of England Watchers conference, focused on the interplay between monetary and fiscal policy, we believe Schnabel intended to make a full-throated case to the public, markets, and to her fellow policymakers for more frontloading of rate hikes, meaning another 75 bp hike in December.
Market Validation
1/19/23 Market Watch

Lagarde tells traders they are wrong to bet on slower pace of ECB interest rate rises

Benchmark European bond yields rose and the euro was firm after Christine Lagarde told traders they were wrong to bet the European Central Bank is about to slow the pace of interest rate rises.
The ECB president pushed back against reports earlier this week that suggested the central bank might trim its interest rate hikes from 50 basis points to 25 basis points at its next meeting on February 2nd in response to signs inflationary pressures were easing.
"I would invite [financial markets] to revise their position; they would be well advised to do so," Lagarde told a panel at Davos.

ECB Account of December monetary policy meeting

A large number of members initially expressed a preference for increasing the key ECB interest rates by 75 basis points, as inflation was clearly expected to be too high for too long and prevailing market expectations and financial conditions were plainly inconsistent with a timely return to the ECB’s 2% inflation target. Hence, the worsened inflation outlook required an interest rate hike larger than that priced in by markets. Failing to exceed market expectations could be regarded as confirming market views on the future policy path, which could result in the yield curve not shifting upwards to the extent required to bring inflation back to target. It was argued that, given the unfavourable data and inflation outlook that had become available with the December projections, the Governing Council’s data-dependent, meeting-by-meeting approach required an interest rate increase of the same size as in October to counter an unwarranted loosening of financial conditions and the monetary policy stance. It was maintained that a 75 basis point increase would speak for itself and was preferable to relying on the alternative approach of a 50 basis point move accompanied by strengthened communication on the way forward. A risk management approach to addressing persistent inflation pressures was also seen as calling for decisions that erred on the side of determined action to prevent an unanchoring of inflation expectations. Raising interest rates by less than 75 basis points would send the wrong message and risked being perceived as inconsistent with the 2% inflation target in the medium term, thereby reinforcing the perception of an asymmetry in the Governing Council’s reaction function.
Some of these members, nonetheless, expressed their willingness to agree on a 50 basis point rate rise if a majority were to support the proposal put forward by Mr Lane, taking into account the strengthened communication on the Governing Council’s policy intentions and the enhanced message that the Governing Council would continue raising rates significantly at a sustained pace, which were also part of the proposal. This was in some ways seen as broadly equivalent to raising rates by 75 basis points at the present meeting, because a less frontloaded but steadier approach to bringing interest rates to restrictive levels could be seen as consistent with the more persistent nature of the inflation process and continued elevated uncertainty.
Taking all into account, a broad majority of members supported Mr Lane’s proposal to raise the key ECB interest rates by 50 basis points and to communicate that interest rates would still have to rise significantly at a steady pace to reach levels that were sufficiently restrictive to ensure a timely return of inflation to the ECB’s 2% medium-term target.
Read Full Report
November 22, 2022
SGH Insight
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.
Market Validation
Bloomberg 11/25/22

Eurozone Bonds Drop as More Hawkish ECB Comments Stall Rally

A rally in European bonds ground to a halt
on Friday, with investors betting on a faster pace of interest
rate hikes as they digested more hawkish comments from central
bank policy makers.
German 10-year yields rose as much as 13 basis points to
1.98%, trimming what’s set to be the third weekly drop in
yields.
European Central Bank policymaker Isabel Schnabel signaled
on Thursday that it may be premature to scale back rate
increases, pushing back against a market watching for signs that
global monetary policy tightening can ease. ECB Governing
Council member Madis Muller echoed the sentiment on Friday,
saying that the main risk in the battle to quench record
inflation is halting the hiking process too soon.


Read Full Report
November 21, 2022
SGH Insight
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.
Market Validation
Bloomberg 11/26/22

Federal Reserve officials concluded earlier
this month that the central bank should soon moderate the pace
of interest-rate increases to mitigate risks of overtightening,
signaling they were leaning toward downshifting to a 50 basis-
point hike in December.
“A substantial majority of participants judged that a
slowing in the pace of increase would likely soon be
appropriate,” according to minutes from their Nov. 1-2 gathering
released Wednesday in Washington.
In addition, while Chair Jerome Powell said during his
post-meeting press conference that rates will probably
ultimately go higher than officials’ September forecasts
indicated, Wednesday’s report gave a more nuanced take:
“Various” officials -- a descriptor not commonly used in the
minutes -- had concluded that rates would ultimately peak at a
higher level than previously expected.
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