Central banks

The final furlong of 2023

Here’s a trading review on where central banks stand and where they might be going in the last meetings of 2023

In a post at the beginning of the year, one of my timelines was that we would be well into playing the rate cut game by the end of the year. Well, here we are and with one last round of central bank meetings in 2023, the market is eager to see what they set up for 2024.

Let’s start with the Fed

The market is well into playing the guessing game for when hikes happen and how much rates will be cut. As usual, there’s a fairly large spread but the main consensus is that rates start to get cut from around the middle of 2024.

We have one more CPI report (12th Dec) before the FOMC (13th) and that will likely be a big mover for last minute rate expectations.

I believe that the Fed will use this meeting just to take them into 2024 with as little drama as possible. That would mean keeping the “job’s not done” stance on inflation, and saying that rates are still “restrictive” but not “sufficiently restrictive”. There is no need to start talking cuts, nor allow the market (which is pretty much always dovish) to get extremely dovish.

In fact, as I type this, Powell’s been out to give that exact message but the makret has given him the middle finger with USd selling and yields dropping.

There is a risk that Powell states that rates are “sufficiently restrictive”, and that might be what’s decided by the CPI report. A 2 handle on headline CPI would most certainly rule out a last hike and then that could give them the green light to use “sufficiently restrictive”. However, if that does happen, expect an uber strong message about “higher for longer” and making it clear cuts are not on the table yet (not that that might mean anything given the price action right after Powell).

For USD. There’s no outcome where the Fed are uber hawkish so any such rally is likely to be sold into. If Powell doesn’t deliver a ‘no change to view’ meeting, USD and yields will likely get smoked further than they are today.

The ECB

Given the latest rounds of inflation data, we can also further rule out any more expectations for hikes. The ECB is comfortable where rates are and markets are playing the same “when will they cut?” game. The vast difference in Europe is that the fundamentals are looking far less rosy than currently in the US, and that’s a pressure that’s going to weigh on the ECB. We’ve also just had an inflation print of 2.4%, which puts them closer to their target than any of the other major central banks. Even if the core number remains higher, the headline is the number that guides them in their mandate.

It might be a tougher sell for Lagarde to keep the “higher for longer” message valid in her presser. I also think we may be approaching a situation where the market will start to worry whether they can ‘soft land’ inflation to target, or if it’s going to run straight through and keep going. That might not be something anyone will worry about for this meeting but it might become valid early in 2024, depending on the next inflation data.

We do potentially have the PEPP reinvestment discussion to think about, after recent comments from ECB sources but like the Fed and BOE, QT isn’t seen as a big hawkish monetary policy stick. We may get a move up in EUR if they do a bit more than stopping reinvestment but I doubt that will be a lasting move.

Overall, Lagarde will also not want to let the market get too dovish and therefore prematurely ease financial conditions.

For EUR. Today as I write this the euro is under the cosh for the very rate cut expectations I mentioned above. The Fed had its turn and now it’s the ECB’s turn. If anything, that means Lagarde might have to sell the ‘higher for longer’ message even more strongly at the ECB meeting. Like the dollar, any euro rise on strong non-dovish language might become a selling opportunity for some but we might also just find ourselves developing a new range to work into 2024.  Same as the Fed, any weakness in the message from Lagarde and EUR gets hit hard.

The BOE

In this last week, I’ve slowly come around to the conclusion that the BOE might be becoming the most hawkish bank of the majors. Despite Bailey & Co being very bearish on the UK, they’re still troubled by sticky inflation and particularly wages and services inflation, which happens to be only the biggest sector in the UK economy…

While the Eurozone PMI’s wove a tale of accelerating price drops, the UK PMI told us that while input prices might still be falling, output prices were still rising. That’s the sticky effect right there.

I’ve had a view that the UK might be at risk of its economy tipping over faster than the others due to the height speed of hikes, and while it’s not out of the woods, it seems to be doing a touch better than Europe. It can all change in a heartbeat though but for now, the pound is down the charts for being spanked on cut expectations.

For the 14th Dec meeting, once again, hike expectations are low but there might be more of a hawkish tilt on the sticky inflation, which will then be offset by that dour view of the economy from Bailey. Only someone like him could manage a central bank meeting where the outcome might be both hawkish and bearish.

For GBP. Always the wild card currency but if a non-dovish/hawkish monetary policy message balances out a weak economic outlook message, GBP will probably do nothing and be thankful it’s not in the limelight like the others may be. GBPUSD and EURGBP will be the key movers for the trio of banks and the Fed and ECB will likely drive the moves more than the BOE will, so the strength or weakness of USD or EUR will define those pairs, more than the BOE will for GBP.

For the BOC and BOJ

These should pass by without incident. The BOC has been calmed by the pullback in inflation, after panicking over a two month hot streak. 

The BOJ will not be ruffling any feathers into the year-end. Their stall is set out about watching the wage negotiations in spring 2024.

However, one big question might raise its ugly head, and that’s what happens if inflation starts to drop going into the spring? The BOJ will be in a position to potentially start tightening on the higher wages, even while inflation might be down, or below target. Now they’ve made wages a big thing, they’ve done the unusual thing of painting themselves into a corner. If wages aren’t enough to tighten policy on, or if inflation is too low when those wages deals come through, and that keeps them easing, I dread to think where USDJPY goes on the upside. They might be getting into a bit of a hope trade that all the ducks align for them to tighten, and that happening is the only thing that could see JPY strengthen significantly.