Nagel Gazing

By Benjamin Picton, Senior Macro Strategist at Rabobank

US stocks lifted, yields rose and both gold and crude traded higher yesterday as markets rebalanced after Friday’s non-farm payrolls report and the European elections over the weekend. There wasn’t much new data of note, but we did see a softer than expected Italian industrial production number for April (-1% vs +0.2% expected) and a slight moderation in the New York Fed’s 1-year inflation expectations gauge to a still-too-high 3.17%, while 5-year expectations rose from 2.8% to 3%(!).

With data off to a slow start to the week, traders will be looking ahead to Wednesday’s US CPI report and FOMC rate decision, and then the BOJ’s policy rate meeting on Friday. No change is expected from the Fed or the BOJ, but that won’t stop traders watching those meetings closely for clues as to the likely timing for future policy rate moves.

The FOMC meeting this week ought to be a rich vein on that score. Along with the decision on the Fed Funds rate and Powell’s post-meeting presser, the Fed will be releasing an updated dot plot. Surveyed economists are expecting the FOMC to raise the median Fed Funds forecast for this year and next, and the long-run rate forecast (an analogue for the ‘neutral’ rate) is expected to shift 19bps higher to 2.75%.

A higher path for policy rates would suggest stickier inflation, which continues to be a theme in global markets. The “data-dependent” ECB cut rates last week despite a two-tenths upward revision to their inflation forecasts, faster growth in wages, and core CPI rising from 2.7% to 2.9% in May. Lagarde said at the time that the cut was informed by the ECB’s confidence in their inflation forecasts for Q4 next year, but has since warned not to set too much store in forward guidance. Clear as mud.

Economist estimates published by Bloomberg suggest that headline US CPI this week will be unchanged from the 3.4% result recorded in April, while the ex food and energy figure declines by one tick to 3.5%. The Fed targets PCE, not CPI, but a 3.5% core inflation figure isn’t suggestive of a central bank that can be confident it has inflation back in the box. FOMC members will also have to deal with conflicting signals in the payrolls report, where the Establishment Survey recorded bumper employment growth of 272k in May, but the Household Survey showed the unemployment rate rising and large losses in full-time employment.

There might have been a hint of buyer’s remorse from ECB speakers overnight. Joachim Nagel from the Bundesbank suggested that it might take a while before the ECB cuts again: “…I don’t see us on a mountain top from which we will inevitably come down. Rather I see us on a ridge where we still have to find the right point for a further descent.”, while Christine Lagarde similarly warned that the descent will not be “linear”. Austria’s Robert Holzmann – the lone dissenter in the rate cut decision-  said last week that the ECB has little latitude for divergence from the Fed. Happily for Holzmann, Rabobank expects the next two ECB rate cuts to arrive in September and December, which coincides with our forecast on Fed cuts.

On the subject of divergence, we still hold a contrarian forecast of two more rate hikes in Australia. We issued that forecast at the start of May after the Q1 inflation report showed price growth running ahead of the expectations of the RBA and the broader market. Our view is not reflected by RBA-dated OIS pricing and the case for further hikes may have been dealt a blow by a moderate minimum wage determination and slightly softer than expected wages and growth figures for Q1.

Even so, the Q1 national accounts showed that productivity growth remains non-existent in Australia and that the household savings rate is substantially below the RBA’s forecasts. A lower savings rate suggests that the current 4.35% cash rate is not providing as great an incentive to forego consumption in favour of saving as the RBA might have thought, while lacklustre productivity (and lower labour force growth in the future) could mean that potential growth is weaker and Australia’s output gap may therefore be larger. That could be a problem for an economy where inflation has lately been rising, especially since it is about to be injected with tax cuts and new government spending equivalent to several percentage points of GDP.

Aussie jobs data to be released this Thursday will be critical to the outlook ahead as the dual-mandate RBA places great weight on labour market outcomes. We’re forecasting employment growth of 25,000 in May, and a slight drop in the unemployment rate to 4.0%.