Macroeconomics: The Day Ahead for 18 September

FOMC day has finally arrived and is the highlight of a relatively busy programme of data, central bank rate decisions and speeches, BoC meeting minutes and a modest flow of govt bond supply. There are UK inflation, Japan’s Trade and Private Machinery Orders to digest, while ahead lie South African CPI (ahead of tomorrow’s expected SARB rate cut), UK ONS House Prices, Eurozone final CPI, and US Housing Starts. Outside of the FOMC meeting, Bank Indonesia cut rates 25 bps, not wholly unexpected despite the consensus having been for no change, while Brazil’s COPOM is expected to hike rates by 25 bps to 10.75%.

** U.K. – August CPI, PPI **

– CPI was very much in line with expectations at 2.2% y/y, with the largely base effect driven rise in core to 3.6% y/y and Services to 5.6% y/y also in line, though below the BoE’s expectation of 5.8%. In the detail, Transport at 1.3% m/m was the biggest upward pressure, largely due to a huge 22.2% m/m jump in airfares (and running very much counter to my own personal experience, if the volume of promotional activity by budget airlines is anything to go by), along with a typical seasonal bump in Clothing & Footwear (0.6% m/m), and Health 0.5% m/m. Notably Restaurants & Hotels posted a second consecutive fall (-0.7% m/m after -0.4% m/m), which suggests one source of upward pressure on Services is easing, and should continue to fall after the summer holiday season. PPI continues to signal a very clear absence of pipeline goods inflation. The data is unlikely to prompt the BoE to follow up with a second rate cut tomorrow, but sequential cuts in November and December do look like a strong probability, particularly given expectations that the Budget will bring further fiscal tightening.

** U.S.A. – FOMC rate decision **

– The consensus for the much anticipated first Fed rate cut is for 25 bps to 5.0-5.25%, which yesterday’s slightly higher than expected Retail Sales, and much stronger than expected Industrial Production (primarily a function of sharp swings in July and August in auto output) served to reinforce. There remains considerable speculation about a 50 bps cut, and markets still have 120 bps of cuts priced in by year end, and a further 100 bps by June (see chart), though as the attached chart of market rate expectations over this year, those expectations are fluid and fickle, and lack a lot of conviction. The decision is very finely balanced and will hinge on the FOMC balancing concerns that labour market loosening is getting too much momentum (per se justifying taking out some insurance to avoid being ‘behind the curve’), and on the other hand sending a rather negative signal on the economic outlook, which recent data hardly justifies. One possible workaround would be to emphasize that a more aggressive cut is justified by the high level of real interest rates, which thanks to the fall in inflation have become too restrictive with headline PCE deflator at 2.5% y/y, and core at 2.6% y/y, implying current real Fed Funds at 2.6/2.7%. Under that scenario they would likely still emphasize data dependency, and note that if inflation continues to fall, and/or there is a further rise in Unemployment, then further cuts are likely. But this effectively binds the rate trajectory to real rates, which runs counter to a balanced view of its two pillars Inflation & Employment. A further argument against 50 bps is that financial conditions are de facto loose, even if this is in part due to market rate expectations. Much as always will depend on changes to the Summary of Economic Projections (SEP), above all the ‘dot plot’, which will have to shift very sharply to accommodate market expectations for 2024 and indeed 2025, given that in June an end 2024 rate of 5.0-5.25, and an end 2025 rate of 4.0-4.25% were anticipated. Whether the cut is 25 or 50 bps, the biggest risk for markets is that the dot plot signals a slower glide path for rates than is currently being discounted.

** Brazil – COPOM rate decision **

The anticipated rate hike will be predicated less by inflation (at 4.24% y/y well within the BCB’s target range), robust growth (July GDP 5.3% y/y) or a tight labour market, and far more related to a continued weakness in the BRL and persistent market and BCB concerns over rising fiscal expenditures, which has caused a lot of tensions with the Lula govt. The primary question is how much they expect to raise rates in this cycle, particularly as this rate hike would come only 3 months after the last rate cut, and there is also likely to be some push back against markets discounting a total of 175 bps of rate hikes. It is worth noting that ‘real’ rates are already restrictive at 6.36%, against a BCB assumed ‘neutral rate’ of 4.75%.