Naturally, the multi-year spending path agreed between the Commission and a country might be overshot from time to time. To keep track of this, the Commission will set up a “control account” for each country where it will record how much the agreed expenditure was exceeded. If the agreed path is breached by 0.3% of GDP in a single year, or 0.6% of accumulated breaches over several years, the Commission will start disciplinary steps against the country, forcing it to cut the deficit by 0.5% of GDP a year. The control account will be reset at the end of each four- or seven-year period.
This deal now goes to the European Parliament where negotiations over it will start in January. Some tweaks are possible, but the main thrust of the reforms is unlikely to be changed.

Though the BOJ will keep its options open for the March 18-19 and April 25-26 meetings, we suspect it continues to favor the latter meeting to make its move.
In the leadup to April, look for the BOJ to use its published meeting materials to recast its language on overshooting the inflation goal and to tilt its risks assessment from focusing on downside risks to a more balanced risk outlook.

(2) The Bank of Japan (BOJ) is targeting an April 2024 exit from negative interest rates, with a risk that the decision is brought forward to March.
A January move is off the table. Instead, the Bank will use its January 22-23 forecast round meeting to signal via updated forecasts that its inflation goal is in better view and that it is closer to a live meeting.

Monday Morning Notes, 12/18/23
Reconsider the growth numbers as the immediate consequence of a disinflationary shock. With inflation collapsing, growth receives a mechanical boost, and this appears to have begun in the third quarter. Inflation effectively returned to a 2% annualized rate in June on a monthly basis and has held there, and we were so busy looking at three-, six-, and twelve-month averages it just slipped right past us. Inflation has simply collapsed:

Quick Note on CPI
Core CPI inflation came in as expected at 0.3% for November:

There is less momentum here than it appears if we strip out shelter and used vehicles:

But CPI inflation is not the Fed’s target, PCE inflation is the Fed’s target. It’s the read-through from CPI to PCE that is important, and forecasts for November core-PCE inflation are coming in below 0.2%, and in some cases below 0.1%, post-CPI but albeit ahead of tomorrow’s PPI release.
Carefully consider the implications of soft core-PCE numbers. If, as seems reasonable, the next two core-PCE inflation readings average 0.15%, this will be the picture at the time of the January FOMC meeting:

By January, it is very possible, if not very likely, that inflation would have been effectively at target in six of the past seven months.

The Bank of Japan (BOJ) will keep policy unchanged on December 18-19 but introduce subtle language changes that will herald a likely exit from negative interest rates between January and April next year.

January signaling of an impending move would light up the BOJ’s March 18-19 meeting as an option for a move, especially if the Bank wants to get a move in before the US Federal Reserve sends rates in an opposite direction.
The BOJ’s March two-day meeting overlaps with the Fed’s March 19-20 forecast round meeting. The BOJ is sure to be contemplating whether a smoother exit from negative rates is more likely if it moves before the Fed.

Monday Morning Notes, 12/11/23
If You Don’t Have Time This Morning
In the beginning of November we took an aggressive position is establishing a baseline scenario that the Fed would begin cutting rates in March 2024 for a total of 100bp in 2024. The logic of that scenario followed directly from Fed signaling, including from Chair Powell, that low inflation alone was enough to cut rates because the Fed needed to adjust policy to prevent the real policy rate from rising and overtightening monetary conditions. With inflation falling faster than expected, the Fed would pull forward the timing of rate cuts to ensure a soft-landing for the economy, in practice turning its attention to the employment mandate to prevent an unnecessary rise in unemployment. Given policy lags, if Powell was going to make a play for the soft-landing, which we believe he will attempt, the Fed would need to cut rates ahead of any significant slowing in the labor market. The longer rates stay high, the higher the chance of a hard landing, and the Fed would then need to cut rates more aggressively. A soft path for the labor markets or growth is not necessary for a rate cut but increases the probability that the Fed cuts rates in March and for a total of more than 100bp cuts in 2024.
This remains our baseline scenario.

Market Validation:
FOMC Press Conference 12/13/2023
>> STEVE LIESMAN: Steve Liesman, CNBC. Happy holidays, Chairman. Fed governor Chris Waller said if inflation continues to fall, then the Fed in the next several months could be cutting interest rates. I wonder if you could comment on whether you agree with Fed Governor Waller on that, that the Fed would become more restrictive if it didn't cut rates if inflation fell? Thank you, sir. >> JEROME POWELL: Of course, I don't comment on any other officials, even those who work at the Fed. But I'll try to answer your question more broadly. So, the way we're looking at it is really this. When we started out, right, we said, the first question is how fast to move -- and we moved very fast. The second question is, you know, really how high to raise the policy rate. And that's really the question that we're still on here. We're very focused on that, as I mentioned. People generally think that we're at or near that and think it's not likely that we will hike, although they don't take that possibility off the table. When you get to that question, and that's your answer, there's a natural -- naturally, it begins to be the next question, which is when it will become appropriate to begin dialing back the amount of policy restraint that's in place. So, that's really the next question. And that's what people are thinking about and talking about. And I would just say this. We are seeing strong growth that appears to be moderating. We're seeing a labor market that is coming back into balance by so many measures. And we're seeing inflation making real progress. These are the things we've been wanting to see. We can't know -- we still have a ways to go. No one is declaring victory. That would be premature. And we can't be guaranteed of this progress. So, we're moving carefully in making that assessment of whether we need to do more or not. And that's really the question that we're on. But of course, the other question, the question of when will it become appropriate to begin dialing back the amount of policy restraint in place, that begins to come into view and is clearly a topic of discussion out in the world and also a discussion for us at our meeting today.

SGH Insight
Monday Morning Notes, 12/11/23

We believe the dots will show the median FOMC participant expects the Fed will cut rates 75bp in 2024. In anticipation of client questions, we attached probabilities to three different scenarios for the 2024 dots:

Market Validation
Bloomberg 12/13/2023
The Treasury market rallied and swaps traders dialed up bets on interest-rate cuts after the Federal Reserve opted to hold rates steady at the conclusion of its policy meeting Wednesday but surprised markets with a more aggressive forecast for monetary easing in 2024.
Yields tumbled, with the policy-sensitive two-year note’s plunging as much as 23 basis points to just under 4.50%. The yield on the 10-year note fell more than 14 basis points to a low of 4.06%. Fed swaps show about 133 basis points of reductions next year, up from 113 basis points prior to the central bank’s decision.
“The Fed is definitely more in easing mode than people were projecting. This is definitely not hawkish,” said Andrew Brenner, head of international fixed income at Natalliance Securities LLC. “They upped the number of rate cuts in 2024 to three — a lot of people were thinking two,” said Brenner, adding that Fed Chair Jay Powell might look to portray the Fed’s decision-making as more hawkish during his upcoming press conference.

SGH Insight
Monday Morning Notes, 12/11/23

At the press conference, Powell will continue to move the ball forward toward declaring the risk to the outlook as balanced but fall short of the mark. Given the normalization in the labor market, the increased confidence that third quarter growth was a fluke, and the general trend of inflation, the risks are clearly more balanced. The dovish risk here, and in the statement, is that Powell acknowledges that rates have been sufficiently restrictive since July and given that the SEP will show the Fed expects the next move will be a rate cut, that the risks are now balanced.

Market Validation
>> MIKE McKEE: Bloomberg Television Radio. Mr. Chairman, you were behind the curve in raising rates to fight inflation, and you said earlier, the full effects of our tightening cycle have not yet been felt. How will you decide when to cut rates, and how will you ensure you're not behind the curve there? >> JEROME POWELL: So, we're aware of the risk that we would hang on too long, you know. We know that that's a risk, and we're very focused on not making that mistake. And we do regard the two -- you know, we've come back into a better balance between the risk of overdoing it and the risk of underdoing it. Not only that, we were able to focus hard on the price stability mandate, and we're getting back to the point where -- which is what you do when you're very far from one of them, one of the two mandates -- you're getting now back to the point where both mandates are important, and they're more in balance, too. So, I think we'll be very much keeping that in mind as we make policy going forward.

On a final note, there is a good deal of interest as always on the GDP target for 2024 that will be set at the upcoming Central Economic Work Conference later this month. Our expectation is that Beijing will aim for an “appropriate” economic growth target of around 5% for next year.

(2) Looking ahead at economic releases next week, officials in Beijing appear to be generally in line with market expectations for a 5.7%, or perhaps even higher, year-on-year increase in industrial production in November from last month’s 4.6%. But we suspect the consensus forecasts as published by Bloomberg of a 12.5% year-on-year increase in November retail sales may be on the optimistic side.

With Governor Tiff Macklem having all but declared the peak in the Bank of Canada’s (BOC) hiking cycle, this week’s meeting will hold rates at 5% and likely pivot to conditional dovish language that suggests the central bank will ease rates early next year.
The Bank’s efforts now are focused on trying to maintain a “higher for longer” policy strategy that extends through the turn of the year before it shifts to signaling rate cuts.
For this week’s meeting, BOC staff have likely crafted language options for the post meeting statement that acknowledge the aggressive campaign of higher rates are working even as the central bank reiterates its resolve to seeing inflation back to target.
Though this meeting’s message will continue to reiterate the central bank’s willingness to raise rates again “if high inflation persists,” the Bank will note that it is patient in looking for additional confirmation that tells it the inflation job is done.

Monday Morning Notes, 12/4/23
If You Don’t Have Time This Morning
The Fed is on a path to a March rate cut. All the pieces are there, the Fed just needs to put them together. It’s a long way off, and I have high confidence the data will unfold in a way that allows for the Fed to cut by then. I don’t know easing at the March meeting will be sufficient to stave off a hard landing; real rates are very high if, as it appears, inflation has come down faster than the Fed expected. I am beginning to suspect that the anecdotal labor market reports tell us that a soft-landing requires the Fed to cut rates by January, but for now I think the Fed needs to see some hard-landing type of data to pull the cut into January.
Recent Data and Events
The PCE inflation numbers were last week’s data highlight.

For all intents and purposes, the Fed has restored price stability. There may be some bumps in the road over the next few months, but they won’t change the underlying story now that it looks like the third quarter growth surge didn’t have legs. If inflation is tracking close to 2% in the last half of 2023, it will be below 2% in the last half of 2024 if the Fed holds policy rates at current levels much longer.

Upcoming Data and Events

We get a steady stream of data this week but note that the November employment report won’t arrive until next week.

Monday we get new home sales for October, with the number expected to be weaker than November as buyers delayed purchases due to high mortgage rates.

...Track Waller’s evolution of his thinking on the economy and implications for monetary policy. He said this ahead of the November FOMC meeting:
What does that mean for monetary policy? I will be looking carefully at the data to see whether the real side of the economy begins to cool off or whether prices, the nominal side of the economy, heat up. As of today, it is too soon to tell. Consequently, I believe we can wait, watch and see how the economy evolves before making definitive moves on the path of the policy rate. Should the real side of the economy soften, we will have more room to wait on any further rate hikes and let the recent run-up on longer-term rates do some of our work. But if the real economy continues showing underlying strength and inflation appears to stabilize or reaccelerate, more policy tightening is likely needed despite the recent run up in longer term rates.
Waller can build on this and simply say that data since this speech indicated a cooler economy with lower-than-expected inflation, validating the Fed’s decision to stay on hold in November and to remain on hold (watch and wait) in December. He will likely continue to couch his outlook as a debate about the need for another rate hike and not say that rates are “sufficiently restrictive.” Obviously, it would be a dovish surprise if he couches his outlook in terms of “how long to hold rates at this level.”

...Waller will need to tread carefully around the issue of financial conditions. I suspect he thinks any further easing is premature, but also would say that conditions have tightened since the Fed’s last rate hike, implying that the easing since the November meeting still leaves conditions restrictive. As a hawkish surprise, Waller could say the recent easing lowers the bar for another rate hike, something some market participants believe. I suspect this would be counterproductive given recent data, but if he wants to go that direction, then market participants will likely push long yields back up to 5% and will bring back that 8% mortgage rate Powell clearly didn’t like.

We will know in the coming days how Berlin intends to handle the fallout, but suspending the constitutional debt brake for another year or two appears to be shaping up as the best option for all as things now stand. Indeed, sources close to Lindner, from within his FDP party, are acknowledging that a suspension of the debt brake may be the only solution here. One idea is to suspend the brake for 2023 only, instead of for two years, which would secure the 60 billion euros for now but effectively punt the larger problem to 2024.
A decision is likely this week possibly by or at a cabinet meeting scheduled for Thursday.

Published on November 20, 2023
Monday Morning Notes, 11/20/23
The Fed releases the minutes of the November FOMC meeting on Tuesday. We expect the tone of the minutes will reflect further gradual shifting toward “sufficiently restrictive,” but think the minutes will fall short of declaring that July was definitively the last rate hike. We are looking to see if participants generally agreed that rates were “probably significantly restrictive” and risks “more broadly balanced” as signals of a more dovish policy direction. We think it remains too early for the Fed to declare that this cycle’s pause began back in July because the Fed knows that with such a declaration, markets will pull forward expectations of a rate cut. The Fed won’t make such a move until it has more confidence that it is closer to a rate hike.

...Better-than-expected inflation numbers drove market pricing last week. Market participants prepared for an upside miss to the consensus expectations of 0.3% core CPI inflation; the whisper number was 0.4%. Instead, core inflation printed at 0.2% and was subsequently followed by soft PPI numbers. Combined, expectations are the core-PCE will come in below 0.2% for March and help ensure that 2023 inflation will come in well below the Fed’s September forecast of 3.8%.

Published on November 13, 2023
According to sources accompanying Xi on his trip, the Chinese leader said his talks with President Biden will be mainly to show the world that the two countries can manage their differences and avoid and prevent misunderstandings or fierce competition from veering into confrontation or conflict. China, he said, cannot expect economic and trade relations with the US to get back on track overnight, but the talks will inject confidence into the market if relations do not get worse.

In the run up to the summit, the Biden administration has laid out its top agenda items extensively in the media; foremost of which is a resumption of the military-to-military contacts between China and the US which Beijing cut off after the visit by then Speaker of the House Nancy Pelosi to Taiwan in August of 2022.
It is also notable that the White House has elevated to the top of its agenda the export from China of the precursor chemicals used to synthesize the deadly opioid fentanyl, which has led to the mass poisoning of around 250,000 Americans since Biden took office three years ago. It will come as no surprise that China’s exports of fentanyl precursors are not on the list of Xi Jinping’s top agenda items.
According to officials from China’s security apparatus, the most important topics for Xi will be overall US-China relations, bilateral military relations, Taiwan, the South China Sea, the Israeli-Palestinian conflict, and Ukraine.
As to economic matters, there is little to no expectation from any side of a major change to the issues important to either party, and Xi has indicated that he will not engage in these at any length.

European Union finance ministers are slowly getting closer to an agreement on revisions to the Stability and Growth Pact (SGP) rules that govern member states’ fiscal budgets.

They will meet tomorrow (Thursday) to discuss how they feel about the latest "landing zone" - a proposal that narrows rather than solves all the differences between the EU north and south.

There seems to be agreement on the point however, that the overall focus of the new rules should be on net expenditure growth, as a single operational indicator that is completely in the hands of the government, and which would be set annually to make possible the agreed debt reduction path.

There is also agreement that defense spending should be a "relevant factor" for the Commission when it decides whether to start disciplinary steps against a government for breaching the 3% deficit limit – in effect if the excess is for military spending, the Commission will let it slide.

The deal that the EU wants to reach on the new fiscal rules this year will be among governments only. It is only expected in December since despite some overall progress, which both fiscal hawks and doves acknowledge, there is still a long way to go.

...Monday Morning Notes, 11/6/23
With it increasingly clear that the Fed reached the peak of this cycle back in July, we can begin wargaming the first rate cut of the cycle. This isn’t any more about just setting policy to prevent the 2024 inflation forecast from rising. It’s about managing that while preventing the 2024 unemployment forecast from rising as well. Regardless of any Fed protestations otherwise, market participants will likely start pricing in a greater risk of a March cut on weaker economic data.
The Fed will cut rates before inflation returns to 2%. Powell has already made this point clear, and it has long been in the SEP. The June SEP had 100bp of 2024 rate cuts with a year-end core inflation projection of 2.6%. Unless you believed that 100bp was going to all come in the fourth quarter, some of those rate cuts would come when inflation was above 2.6%. Still, doing so requires the Fed to see enough softness in the inflation numbers to be confident that inflation would remain on a path to price stability even with a rate cut.

Questions and Answers
SGH Insight
What will Governor Waller say Tuesday?
His topic is “using economic data to understand the economy,” which could lend itself to new insights into the path for policy but in practice Waller typically gives one economic update per inter-meeting period and that is usually closer to the blackout. Consequently, I think he will follow the message of his last speech or Powell’s press conference and not add any new insights during the Q&A. If anything, he could use this topic and the latest JOLTS and employment reports to take a victory lap as he correctly predicted that the Fed could take the heat off the labor market without mass layoffs. That would speak toward peak rates, but I suspect he would add the caveat that the Fed has been fooled by inflation before. That said, if I were him, I would feel pretty confident about the path of inflation.

...With it increasingly clear that the Fed reached the peak of this cycle back in July, we can begin wargaming the first rate cut of the cycle. This isn’t any more about just setting policy to prevent the 2024 inflation forecast from rising. It’s about managing that while preventing the 2024 unemployment forecast from rising as well. Regardless of any Fed protestations otherwise, market participants will likely start pricing in a greater risk of a March cut on weaker economic data.
...With it increasingly clear that the Fed reached the peak of this cycle back in July, we can begin wargaming the first rate cut of the cycle. This isn’t any more about just setting policy to prevent the 2024 inflation forecast from rising. It’s about managing that while preventing the 2024 unemployment forecast from rising as well. Regardless of any Fed protestations otherwise, market participants will likely start pricing in a greater risk of a March cut on weaker economic data.

President Xi pointed out that China accounts for one-fourth of global foreign exchange reserves. As the country seeks to advance its financial market opening amid external turmoil, its key goal he said is to manage well such a large-scale reserve ensuring the security, liquidity, and appreciation of the reserve assets.
China will continue to reduce its holdings of US debt in its strategic objective to greater diversify its FX reserve assets, and to ensure FX market stability “amid a rising de-dollarization trend” in international trade. [NB – the movement for the redenomination of global trade away from dollars has been pushed aggressively by China for the last few years].

The Fed held rates steady at the end of this week’s FOMC meeting as expected. While Powell left open the possibility of another hike, he made no effort to actually guide us toward expecting another rate hike this year. The Fed thinks it is done hiking rates for this cycle, and while it could still be wrong, the data that would convince it to hike again likely would not come in time for the December meeting.

With little faith in the Bank of England’s (BOE) willingness to return UK inflation back to the 2% target before the economy slides into recession, markets are already speculating how soon next year the central bank will begin to cut rates.
The BOE, in part, is unintentionally fueling that speculation by indicating that it believes it might be done with rate hikes, which is likely to be reiterated when it holds rates steady again this week.

(1A) If You Don’t Have Time This Morning
The Fed will leave rates unchanged at this next meeting. Recent Fedspeak has been more aggressive than necessary to reinforce the expectation that rates will end the week unchanged and instead is more consistent with the Fed setting up for an extended pause. That said, we are going into the week with very low odds for a rate hike in December but it’s unlikely that Powell will close the door entirely on another rate hike


(1) The Federal Reserve will leave interest rates unchanged at this week’s FOMC meeting. This really isn’t in question at this point. At the September FOMC meeting, Powell signaled a likely pass at this next meeting while Fed speakers since have made no effort to push back on that expectation despite a steady flow of hawkish data.

(2) The Fed thinks, or maybe just hopes, it has likely finished hiking rates for this cycle. With policy rates now above inflation and a disinflationary trend in place, the current level of rates allows the Fed to move more cautiously. That also means policy is more resilient to stronger-than-expected data such as that seen in recent weeks. The Fed appears content to wait a few months to see if the economy remains on path to price stability before considering the need for another rate hike.

(3) Tighter financial conditions argue for additional patience on the part of the central bank. The Fed had been coming around to the idea that the policy rate was already high enough to restore price stability before the recent runup in longer-term yields further tightened financial conditions. While growth has been faster than the Fed expected, the Fed sees higher yields as the market working to counter that growth and substituting for additional rate hikes.

(4) Powell will not declare that the Fed has concluded with rate hikes for this cycle. Although the risks to the outlook are more balanced, with growth accelerating it must be the case that the risk to inflation is higher than the risk of recession, and that means there is scope for another rate hike. Moreover, the Fed won’t want financial conditions to ease too early, and one way to prevent that is to always dangle another rate hike in front of us.

(5 )It’s almost certain that journalists will be looking for some clarification on the dots. Governor Chris Waller raised the bar to another rate hike, arguing that if the economy evolves generally as expected in the SEP, he does not expect another rate hike will be necessary in contrast with the additional hike penciled in the SEP. If you can’t get the hawks on board with another rate hike, it isn’t happening. The dovish commentary overall from Fed speakers suggests that many of the 12 participants that anticipated another rate hike in this cycle have already erased that hike from their forecast.