On the Other Hand

“Give me a one-handed Economist. All my economists say 'on the one hand...', then 'but on the other...” ? Harry Truman (US President 1945-52)

Despite a plethora of central bank announcements over the past week, it isn’t clear to me whether financial markets have advanced their collective thinking around the roadmap for the rest of the year.

Highlights of the week ahead

This week, markets will focus most closely on the US February core private consumption expenditures (PCE) price index. While the market probably anticipates a more elevated February core PCE (released on Friday 29 March), coming in the wake of elevated February CPI and PPI reads, it will nevertheless be closely watched.

A monthly outcome of around 0.025 per cent would imply a 3-month annualised rate of growth around 3.3 per cent, the highest since May 2023. That seems hard to reconcile with any surprise early rate cut from the Fed (see Fed commentary, Fed Chair Powell: sagacious or complacent? below).

Locally, the February monthly CPI indicator (released Wednesday 28 March) will be of interest but unless it is some way away from expectations, it is unlikely to move the dial for the RBA which has the more comprehensive quarterly CPI to view before its next meeting on 6-7th May.

In any case, annual inflation is expected to have risen slightly to 3.6 per cent from January’s 3.4 per cent reflecting the greater coverage of the more inflation prone service sector in the February report. Given the weakness in household spending, the February retail trade report (released Thursday 28 March) will be of some interest (see Michele Bullock executes a “verbal pivot” as she traverses the narrow path below).

Also of interest will be the provisional CPI for March for Spain, Italy and France. ECB President Lagarde reiterated on Wednesday last week that “we will know a bit more by April and a lot more by June.” Markets are expecting a June cut by the ECB subject to a benign enough inflation trajectory.

Fed Chair Powell: sagacious or complacent?

The Fed provided few surprises when it chose to keep the policy rate unchanged at its 5.25 - 5.5 per cent range.

Furthermore, the updated projections reflected some acknowledgement of “sticky” inflation and more resilient economic activity and labour market conditions.?

The median “dot plot” still projects three 25 basis point (bp) policy rate reductions by end-2024, taking it to 4.6 per cent, although the pace of policy rate reduction in 2025 was tempered to reflect just three 25 basis point policy rate reductions compared to four such moves back in December, leaving the policy rate at 3.9 per cent as opposed to the 3.6 per cent projected back in December.

The median projection for the core private consumption expenditures (PCE) price index was revised slightly up to 2.6 per cent for 2024 from the 2.4 per cent projected in December (unchanged at 2.2 per cent for end-2025). The unemployment rate projection was subject to a marginal downward revision for 2024 to 4.0 per cent from the 4.1 per cent in December (unchanged at 4.1 per cent for end-2025).

What was a little surprising (certainly for this writer) was the apparent equanimity that Fed Chair Powell exhibited regarding the last couple of inflation reads.

Powell maintained that the broader disinflation narrative remains appropriate even if the path to the 2 per cent target is often “bumpy”. He added that higher inflation prints in January and February didn’t dent policymakers’ confidence in that narrative.

Powell noted that the Fed was “looking for data that confirm the kind of low readings that we had last year and give us a higher degree of confidence that what we saw was really inflation moving sustainably down toward 2 per cent.” He added that it was “likely in most people’s view that we will achieve that confidence and there will be rate cuts.”

Financial markets, which may have anticipated more hawkish commentary, took heart from Powell’s words as equities surged higher and bond yields ticked lower.

Whether that equanimity begins to look like complacency is to my mind a pertinent discussion.

There is now arguably some nascent risk that the Fed goes down the path of the ill-fated Arthur Burns / G. William Miller led Fed of the late 1970s. Of course, the orders of magnitude involved in terms of policy mistakes and their consequences are currently much less but there is the genesis of a parallel.

Having said that, Powell has a large store of credibility and has exhibited considerably sage judgement over the past couple of years.

Financial markets, US households and probably President Biden are hoping that his sagacity remains intact.

Michele Bullock executes a “verbal pivot” as she traverses the narrow path

The RBA left the policy rate unchanged, but as I read it, verbally pivoted from a tightening bias to a more neutral outlook.

In my view that is an appropriate rebalance.

In the February Statement, the Governor noted that “a further increase in interest rates cannot be ruled out.”?

That is missing in the March Statement. Instead, the Governor notes that “the path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain and the Board is not ruling anything in or out.” (my emphasis).?

I think that is, to all intents and purposes, a shift from a tightening bias to a neutral one, although Governor Bullock was reluctant to describe it in those terms at her press conference.?

For an RBA charged with a dual mandate on containing inflation and minimising unemployment, balancing those risks is a tricky undertaking.?

Indeed, up until the release of the February labour market report, charting that course was looking more like a tightrope than the “narrow path” cited by the previous Governor. However, the blockbuster February labour force report showing a 116.5k increase in employment for the month along with a decline in the unemployment rate back to 3.7 per cent (the lowest since September 2023) from the 4.1 per cent in January, removed any vestige of the softer labour market conditions that had emerged late last year and has given the RBA Board a wider path to traverse. Whether that is maintained in the face of tepid activity growth is still a big question.?

Nevertheless, a reasonable central case scenario has the inflation picture and the labour market moving more-or-less in line with the current RBA projections.?

That would be consistent with an appropriate balancing of the RBA’s dual mandate and consistent with a policy rate cut (or cuts) in the second half of the year.?

Inflation readings remain critical and in my view, the RBA would like to see both the March and June quarter CPI data before deciding on a rate cut making August the earliest possible date for the first policy rate reduction.?

Too “sticky” an inflation rate could still upset any emergent positive narrative on policy rate reductions.?

Bank of Japan: sayonara old world?

The Bank of Japan (BoJ) moved to end its policy of a negative policy rate (NIRP) that had persisted since January 2016, along with abandoning yield curve control (YCC) and equity buying via ETF purchases.

The move had been openly telegraphed for some time and was met with little reaction in Japanese currency and bond markets.

Bank of Japan Governor said the BoJ was not yet certain of hitting its 2 per cent inflation goal and sought to downplay the risk of serial policy rate increases based on the existing outlook.

However, with Japan now joining the rest of the developed world in exiting from emergency settings of monetary policy the higher level of currency and bond volatility that has accompanied recent speculation of such a move may continue.

Bank of England: an economy like the cricket team (weak) points to a June rate cut?

After successive monthly downside surprises on inflation, the Bank of England (BoE) can now present a more unified front, even if inflation remains well north of the BoE 2 per cent target. At Thursday’s Monetary Policy Committee (MPC) meeting, the vote was 8-1 to keep policy unchanged with the two more hawkish members of the MPC dropping their previous disposition for a further increase (there was one vote to cut the policy rate).

The Statement suggests the MPC is becoming more confident that the transmission of policy through the economy is working and that they are moving closer to cutting. That reflects a belief that weak activity growth will ultimately see an easing of price pressures.?

June probably is a bridge too far for the first cut, given the hawks are just back in the fold. August looks a more likely prospect.?

Swiss National Bank: Gnomish inflation sees a cut?

On Thursday, the Swiss National Bank (SNB) became the first major developed central bank to ease policy. The move was somewhat of a surprise but hardly a shock. The SNB meets quarterly so were a move not to occur in March, markets were of the view that one would likely occur in June.

The cut took place against a background where CPI inflation had fallen to 1.2 per cent. The idiosyncratic nature of Swiss inflation limits the implied consequences for other central banks. Having said that, subject to inflation developments, weak activity growth is likely to see the European Central Bank cut policy rates in June. ?

?Stephen Miller is an Investment Strategist with?GSFM. The views expressed are his own and do not consider the circumstances of any investor.