European consumers not expecting a hard landing
After what was a relatively quiet week in terms of data and economic news, markets are preparing for quite the opposite this week. The main highlights are expected to be the CPI prints in the Eurozone and in the United States, along with central bank monetary policy decisions from the ECB, the Fed and the BoJ. There will be a few BoE members speaking as well including Governor Bailey testifying to the House of Lords. In the case of the Fed, the decision will be accompanied by an update on their Summary of Economic Projections which will contain, amongst other things, a new “dot plot” with FOMC members’ expectations for rates going forward.
Starting with the US, the market is forecasting a continuation of the downward trend in CPI that started in June 2022. On a MoM basis the expectation for headline CPI is for 0.2%, down from 0.4% last month, which would take the YoY number from 4.9% to 4.1%. Core CPI is expected to come in at 0.4% MoM which would take the YoY number down from 5.5% to 5.2%. We think these numbers would be consistent with a hawkish pause by the Fed, albeit one which will very likely leave the door open for one last hike in July depending on how data behaves till then. The Fed’s emphasis will be on rates staying higher for longer and in extending market expectations for the gap between the last hike and the first cut. Afterall, it was only a month ago that markets were pricing in monetary policy rates of 4.5% by year end. Although this has corrected meaningfully to just over 5% as of today, we do believe the Fed would like expectations to be slightly higher than this for year end rates.
Moving on to the Eurozone, inflation is not forecast to move on the YoY measurement, with headline CPI inflation expected to come in at 6.1% with Core CPI inflation doing so at 5.3%, both the same as in April’s readings. This would equate to MoM headline at 0% and Core at 0.18%. The ECB will announce their monetary policy decision on Wednesday, one day before the release of CPI numbers, and it is widely expected rates will move higher by 25 bps which would leave the deposit rate at 3.5% and the main refinancing rate at 4%. Markets are expecting one further hike before year end with cuts priced in for Q1 next year. We think the ECB will keep on adding to their hawkish rhetoric given that inflation is refusing to move more decisively downwards, unlike in the US. In line with the aforementioned we believe it is possible the new staff projections show a slight increase in 2023 inflation, which in March’s projections were at 5.3% and 4.6% for headline and core respectively.
Although it is not unusual for short term volatility to pick up in a week when central banks announce their moves and latest projections, we tend to think that we’re in line to receive confirmation that, barring very large surprises in coming months, both the Fed and the ECB are in the final stages of their monetary policy tightening cycles. The uncertainty about monetary policy rates this year is more of a “25 bps” uncertainty in our view rather than last year’s when markets were unsure as to whether terminal rates would end up being in the 3%, 4% or 5% range. We think the Fed’s idea of a “skip” rather than a “pause” goes in the same direction as it would effectively imply that the hiking cycle is close to being over but the pressure in the shorter end of the curve would continue until more rate cuts are priced out as markets continue to move towards the Fed’s “higher for longer” stance.
In summary, in a context of decelerating growth and considering the uncertainty on future access to credit introduced by the regional bank issues in the US, we think central banks will keep their options open while at the same time emphasising that the most relevant question is rather how long rates are to be at these elevated levels as opposed to if rates will go up by 25 bps or not this meeting or the next.