Three events are coming up next week. Preliminary PMI readings for many high-income countries and the People’s Republic of China’s policy meetings. The geopolitical background remains high with the build-up of Russian forces and armaments seemingly on the verge of invading Ukraine. No new talks between Russia and the United States scheduled (yet?). Meanwhile, the increase in coronavirus cases appears to be slowing in some parts of Europe and the United States, while Japan has imposed semi-emergency rules in Tokyo and thirteen prefectures through mid-February. China appears to be stepping up its efforts to stem the spread of the virus as the Olympics approach.
The collapse in December in the US (-1.9%) and the unexpected decline of the world’s largest economy give little impetus. Indications last week showed that the new year was off to a bad start. January crashed to -0.7 from nearly 32 in December. Economists realized that activity had slowed. The median forecast was at 25.0 in a Bloomberg survey, warning that the slowdown could be more severe than economists understood. The evaporation of new orders (-5.0 vs. 27.1 in December) is particularly alarming. While the January poll showed better results, the details were disappointing.
The slowdown also appears to be taking place in the Eurozone. The German Statistical Office warned that the economy contracted between 0.5% and 1.0% in the fourth quarter of 21. Market rates are rising. The German yield rose by about 20 basis points since the end of last November to reach its highest level since April 2019 (~ -0.55%), before declining in the second half of last week. The yield briefly turned positive for the first time since May 2019. The January survey found that the assessment of the current situation fell to -10.2, the lowest level since last May, and worse than economists had expected.
Preliminary PMIs for January will be released this coming week and weakness is expected. However, this is not new. The eurozone was at 53.3, the lowest since March. Fell in four of the past five months. The trend in the UK was similar. It has fallen in five of the past seven months, and at 53.6 it is the weakest since last February.
The United States was in a better position. At 57.0 in December, it was the lowest since September. But here, too, the latest trend was evident. December was the sixth month of slowdown in the last seven months of 2021.
Japan runs to the beat of a different drummer. It recovered from the long coronavirus slump in September, although remember it was below the 50 boom/breakdown level in the fourth quarter 19. The Composite PMI rose above 50 last October, despite a slight dip in December. Circumstances that lead to the imposition of new restrictions may affect the
Due to the COVID outbreak in July and September, Australia’s composite PMI profile looks somewhat similar to Japan’s with a rebound before declining in December. The composite spent the third quarter below 50. It fell in August at 43.3 and improved to 55.7 in November before easing back to 54.9 at the end of the year. Closures may affect activity.
Most notable are the Bank of Canada and Federal Reserve meetings. The Bank of Canada meeting concludes early in the North American session on January 26 and the FOMC meeting ends later in the day. Rather than re-hashing how we got here, let’s simply realize that both central banks are about to embark on a series of rate increases. Markets were pricing in a violent move in the coming months.
The Overnight Index Swaps (OIS) curve contains about 160 basis points of the Bank of Canada’s rate tightening this year and another 30 basis points in 2023. In fact, compared to the end of last year, the market moved to discount another interest rate increase this year. The yield jumped 30 basis points in the first three weeks of the year. At the end of 2021, the market tilted slightly in favor of a January rate hike (~55%). Now it is just above 70%.
The Bank of Canada finished buying bonds last October. In addition to raising rates, the Bank of Canada may also provide some forward guidance on its balance sheet strategy. The most aggressive would be to stop recycling revenue almost immediately, say next month. However, most likely, officials will give investors more notice. The next meeting is March 2. The point is that, like the Bank of England and the Federal Reserve, the Bank of Canada is likely to allow its balance sheet to dump much earlier than after the Great Financial Crisis.
Although most of the real sector data eased in December, the function of the market reaction to official and official comments is to set a more aggressive course for Fed policy. Keep in mind that on New Years Eve, the futures market was pricing in about a 63% chance of a 25 basis point hike in March and nearly three hikes this year. Now the market is fully pricing in a rally in March and a small chance of 50 basis points. Moreover, the market is 100% confident of four hikes this year. At its peak, before stocks exploded, Fed fund futures had a one-in-three chance of getting a fifth lift. The swaps market has 102 basis points of discounting tightening this year and about 50 basis points next year.
In his confirmation sessions, Fed Chair Powell suggested that officials have begun discussing balance sheet strategy. It may take two to four meetings to reach an agreement. This would also cause the Fed’s balance sheet to begin resolving late in the second or third quarter. In fact, many observers seemed to be split between June and July. When the balance sheet starts to fall, that’s a problem, and the pace is another. Last time, it started at $10 billion per month, and a year later raised it to $50 billion per month. Bostick of the Federal Reserve Bank of Atlanta suggested that he would prefer to shrink the balance sheet by $100 billion per month.
Also, unlike the previous episode, Fed officials seem to be talking about a balance sheet solution to complement or even replace rate hikes. The December FOMC meeting minutes said that “some participants” argued that more tightening in the balance sheet than raising interest rates “could help limit the flattening of the yield curve.” Price pressures are much stronger now than they were in 2017-2018.
There is still a great deal of uncertainty about quantitative easing and its reversal. Bernanke once said that QE works in practice but not in theory. While most discussions revolve around volumes and prices, we find that the signals channel is often undervalued. Let’s take Japan, for example. It has quietly reduced its asset purchases and indicated no effects on monetary policy, which will remain very accommodative. To be sure, the market reaction has been muted. The European Central Bank has also fluctuated in its sovereign bond purchases but it appears to have little impact on the market.
Finally, we note that the day after the conclusion of the FOMC meeting, the US will announce its first estimate of . The day of the FOMC meeting provided economists with impetus for last-minute adjustments. Unfortunately, PCE will release key inputs of GDP at the end of the week. However, the 1.9% decline in retail sales in December actually pressured expectations of lower PCEs. The median forecast (Bloomberg) is for a contraction of 0.4%. Bloomberg’s median forecast for fourth-quarter GDP recently fell from 6% to 5.3%. The Atlanta Fed’s GDP tracking rate fell to 5.1% from 7.3% late last year.
With the focus on inflation, the PCE deflation factor will attract attention. It may have settled in December. It may not be the top, but it’s close. The 0.3% rise in the headline rate in January and February 2020 (0.2% and 0.1%, respectively) may make for easy comparisons. One implication is that in the near term, the essence may converge to the title and not the other way around. However, the year-over-year slowdown may start later in the first quarter or second quarter. Polls have found inflation being held against Biden and help explain why Democrats are still expected to lose both houses of Congress in November.
Politics always explodes near the surface of the foreign exchange market. The focus next week will be on the Italian presidential selection process. One possible scenario in which the market might be better received would entail the incumbent (Matarella) agreeing to stay in a little longer, as Napolitano did in 2013. This would allow Draghi to lead his coalition government until the end of the legislation. next year’s session. It will provide a steady hand at what is arguably an inflection point. Italian bonds are likely to rise in such a development and could provide support. Meanwhile, in the UK, Gray’s internal investigation of government parties during social restrictions is expected. It may not reveal a powerful weapon, but it may do little to bolster the prime minister’s support, while other reports speak of a handful of Tory MPs considering a defection from Labour. One increasingly feels that Johnson is fighting for his political life.