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Let It Slow! Let It Slow! Let It Slow!
Episode 6517th December 2024 • Macro Minutes • RBC Capital Markets
00:00:00 00:23:46

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The BoC ended the year with another large rate cut but they are expected to SLOW the pace in 2025, while the Fed has already SLOWed down after an outsized move in September and seems locked in to deliver a regular size move tomorrow. The ECB should take it SLOW and the market is increasingly pricing a SLOW pace for the BoE. Central banks should proceed at a variable and uneven pace reflecting differences in macro fundamentals.

Participants:

  • Jason Daw (Desk Strategy), Head of North America Rates Strategy
  • Blake Gwinn (Desk Strategy), Head of US Rates Strategy
  • Peter Schaffrik (Desk Strategy), Head of UK/European Rates & Economics
  • Simon Deeley (Desk Strategy), Canada Rates Strategist

* Research Analyst opinions are their published views, independent of those expressed by Desk Analysts

Transcripts

Jason Daw:

edition of Macro Minutes for:

The ECB should take it slow and the market is increasingly pricing a slow pace for the Bank of England. Central Banks in general should proceed at a variable and uneven pace reflecting differences in macro fundamentals. So today Blake's going to kick it off discussing the outlook for the Fed. I'm going to discuss the monetary policy outlook for Canada and Simon on recent fiscal and issuance developments. Peter's going to review last week's ECB meeting and provide insights on whether the remaining odds of 50 basis points for cuts in early 2025 can be faded and in the uk whether the market pricing out more and more Bank of England cuts. Make sense? So with that over to Blake on your thoughts on the Fed tomorrow and going forward.

Blake Gwinn:

Thanks Jason. So as you mentioned up top there, the Fed is set to cut rates by another 25 basis points this week. That's essentially fully priced at this point, but markets are expecting a hawken skew to the SEP and Powell's comments, but we think those risks around the dots are actually perhaps being slightly understated. That's largely because this meeting comes against a significantly different economic backdrop than the last SEP update in September. Back in September, the FMC was coming off of multiple downsides to surprise to inflation. Payroll growth was starting to slow. We had a large negative QCEW revision that subtracted a lot of jobs that we thought we had created. The SOM rule had recently triggered and downside risks generally we're seen as rising pretty quickly. So the FMC responded with a 50 basis point cut commitment not to get behind the curve and the SEP showed a pretty big do a shift applying a pretty quick convergence with the longer run dot.

growth and inflation into the:

I also think the path may show that the longer run median is no longer expected to be reached by 2026. So basically just an even slower convergence with that long run neutral rate and the SEP in September, the Fed was showing that they basically expected to hit that longer run level for the Fed funds rate in 2026 and then just stay there in 2027. Given the messaging shift towards gradual cautious, all these kind of keywords we've been seeing from Fed speakers, I think a slower path back to that longer run neutral rate wouldn't really come as a surprise put another way, I think there's probably a growing acceptance on the committee for one of our long held views and that's the various impacts from the pandemic even if they're very long lingering are likely to keep the short run neutral rate elevated into 2025 and 2026.

At the same time, I do think that longer run.is going to continue, its creep higher. We continue to hear from Fed speakers questioning neutral rate estimates and a lot of those questions are centered around the recent economic resilience and the short run neutral level. But I wouldn't be surprised if those are also bleeding into some of those longer run estimates and we continue to see those longer run, that longer run plot start to continue to creep higher. Turning to PALS presser caution is likely going to be the name of the game. Powell has been very stingy with forward guides of late given the amount of uncertainty around next year, we doubt he's going to provide much insight to a potential skip in January. His remarks on current conditions likely are going to echo what we've heard from him in the lead up to the FOC meeting, which is that the economy is strong.

The Fed can afford to move cautiously as they kind of try to find neutral. We'll be paying most attention to his framing on recent inflation prints and upward revisions to the SEP. He had this kind of line that they're well positioned for many potential outcomes. I think that's probably still his main response to any questions about hypothetical economic scenarios going forward. So playing things very, very close to the vest. Lastly, I should note we're cautiously expecting a five basis point overnight RRP adjustment, although there's still a chance that they wait to do that until January. This really doesn't have anything to do with the policy stance. It's all about front end plumbing and the fed's ability to control front end rates. We wrote about this in some considerable depth and a piece last week, so please check out that if you want to know more about this move, it could have some implications for funding spreads.

So definitely worth read just as far as how the market is likely to take this, I think it's pretty well priced, well prepared for hawkish outcome. I think dovish in the dots if we are surprised at the dovish side, I think that's probably going to be dismissed to some degree given that the Fed really isn't incorporating any fiscal or administrative policy expectations into their forecast. So while the market's kind of accounting for this red sweep, the Fed has very clearly stated they're not working that into their base case yet. And Powell, if he were to lean a bit dovish dismissive of some of the sticky inflation prints leaning towards risk management approach on labor, et cetera, et cetera, that's largely par for the course at this point, I wouldn't think would come as a major surprise to markets. I would doubt that even if we get a hawkish outcome that we're expecting that's really going to be enough to drive us out of these post-election yield ranges that we've been stuck in.

basis point increase in the:

We are a bit closer to the top end of the post-election range in tens after a bit of a selloff this morning that we're recording this. But even still, I doubt a hawkish outcome is going to create enough of momentum to sustainably break through that range and see yields start trading in a higher range into 2025. Once the FMCs out of the way. I think trading conditions should be full fledged holiday mode. Feds beacon data are winding down into year end and I think markets are unlikely to take any political headlines too seriously, at least until inauguration and the Trump administration is actually in place signing executive orders, putting bills on the floor of Congress, et cetera. So basically expecting noisy somewhat listless price action post FMC as positions are squared into year end. As far as long run view on the Fed, we are still expecting a final 25 basis point cut at the January meeting and a long pause that lasts through the entirety of 2025 to start at the March meeting.

Jason Daw:

So moving over to Canada, the Bank of Canada delivered a 50 basis point cut last week, so that was back to back moves in October and December and we expected them to cut 50, but they did surprise with their policy guidance that essentially raised the bar quite significantly to another large move. So we did think they would downshift from 50 to 25 starting in January, but it was surprising to us in the market that they didn't keep their optionality more open for January. It seems like we need to see a material positive surprise for them to consider skipping and a large negative surprise for them to do another 50 and put another way, the path for 25 seems very wide at this moment. Today's CPI data, it was quite mixed to be honest. The core measures were higher. Super core was soft and CPI excluding items like mortgage interest costs showed a benign trend with still overall downside risks going forward.

So the inflation data should really be irrelevant in our opinion for what the bank does next month growth that's going to be important and surely that's going to undershoot the Bank of Canada's Q4 forecast by a wide margin and in this context, the growing accumulation of excess supply gives the bank probably enough comfort that downside inflation risks are greater than upside ones and that policy needs to push well into neutral territory and more likely an accommodative stance in our opinion. So looking at market pricing today, it's giving a 70% chance of a 25 basis point cut in January, which makes sense to us. For us, the biggest mispricing right now is what the market's expecting for the Bank of Canada terminal rate. So when you look at the meeting date strip for the Bank of Canada, it only has two more 25 basis point cuts priced in next year.

basis points in:

And when you compare that to the market pricing of only two more rate cuts and a terminal rate of 2 75, we think the bar's quite low for the bank to deliver more than what the market's pricing, which means there's still some juice left in the long Canada duration trade and also in the Canada outperformance trade versus treasuries, especially in the front end of the curve and before passing it along to Simon. I guess a couple of words on politics, there's been some unusual political drama in Canada yesterday with the finance minister resigning just before the fall economic statement. There is growing speculation that Trudeau's days are numbered as the liberal leader, but I think importantly if there was a new liberal leader that was brought in, it does not mean that there necessarily has to be an early election, but the chances of an early election have definitely risen and a likely window for that would be January to June of next year.

Now, from what politics mean for the economy or the Bank of Canada right now at least the conservatives have a large and probably insurmountable lead in the polls and they could be handed one of the biggest mandates in Canada's history. So the implications we think are pretty straightforward. The conservatives when they come into power would be a little bit more balanced, budget friendly than the liberals, so that would reduce issuance requirements modestly over the medium term. There would be a likely change in the tax and spending mix compared to what we've seen over the past 10 years and it would probably be a government that would be more conducive to business investment compared to what we've seen over the past decade. So if we get to a point where the Bank of Canada is near the end of the rate cutting cycle and a new government that is maybe a little bit more pro-growth comes into power, that's probably the time when the duration trade in Canada has run its full course. With that, I'll turn it over to Simon for some comments on the budget and the issuance side in Canada.

Simon Deeley:

for last fiscal year, fiscal:

And that's in particular in response to tariff threats from President-elect Trump. Importantly, the pledge to send most working Canadians $250 checks in the early spring was absent from the fiscal update, remains unclear whether that ultimately be delivered in a slightly different form at some point or just scrapped altogether. Now on the issuance side, even though this fiscal year saw only a 9 billion increase in the actual deficit, the financial requirement increase relative to budget 2024 was 36 billion higher in total. So that reflected 27 billion of additional non-budget financial requirements. So of that 23 billion will be funded through a higher treasury bill stock by the end of the fiscal year on March 31st and some of that already incorporated into the current T bill stock, which is above the previous fiscal yearend estimate, but we'll focus on the 13 billion. That is an increase in bonds and that will be exclusively in the final fiscal quarter, which is Q1 of calendar 2025.

And this will result in 68.5 billion in our estimate for issuance across the different bond sectors and that would be highest on record on a net basis. So excluding Bank of Canada purchases, this will be spread across the curve. Two, seeing the biggest increase of 6 billion and actually seeing one additional auction next quarter versus what we've seen this fiscal year so far. Five to tens will each see 3 billion increase, so that would mean 1 billion per auction for each of those sectors and then 1 billion increase for longs or 30 year bonds, and that means 0.5 billion for each auction of the thirties. One thing to note, we do think that this means higher benchmark sizes for the current issuance. So for example, Feb 20 sevens, we'll see that one additional auction should be at 28 billion rather than 22 billion. Well, for the current benchmark tens these 30 fours and 30 these 50 fives, we think it means one more auction for each of those bonds relative to what we had previously expected.

s will end relatively soon in:

Jason Daw:

Okay, great. Thanks a lot, Simon. Now over to Peter for insights on the ECB and Bank of England.

Peter Schaffrik:

Thank you Jason. So first of all, I'm going to discuss the ECB and the aftermath of the meeting and then I'm going to review the data that has come in since and preview the Bank of England and obviously what it means for the market. So first of all, the ECB on balance on paper, you could have come out with the view that it was a relatively dovish meeting. They cut rates by 25 basis points as expected. They changed the policy statement that could be interpreted in a way that they've been guiding the market for further cuts and many speakers afterwards have suggested that more rate cuts will be coming. They've also the new forecasts, they've lowered growth quite a bit and lowered inflation also a tad. And they've even kickstarted a debate about where the landing zone might be, where neutral is. And in that debate the guard mentioned that the lower end of the potential range to be discussed is 1 75, whereas most market participants would probably have put it at two.

So overall it has been a relatively dovish meeting, at least on paper, yet the market reaction was relatively negative market sold off afterwards. And in my mind that goes to show that there's already a very negative perception about the Euro area out there. You can clearly see where it comes from. The Germany economy is not doing well. French politics and finances are a mess and we get the Trump election potential tariffs coming. So all of these type of things put there into investors when it comes to the Euro area, and that means you have to be relatively optimistic that the central bank will cut rates. Now in reality, therefore, however, it was very difficult for the market to rally because the market was probably pre-positioned for this already and we have started to price out some of the future rate cuts that were in the arrival strip or in the asta forwards.

Now going forward, we actually think that the possibility of 50 basis point rate cuts is fairly slim and nothing in the ECB meeting or indeed the data that came out, I'll speak about that in a second, suggests that the ECB will have to speed things up. So therefore we think if you look at particularly the January or also the March meeting and the implied odds, we think that the 50 basis point probability that's still in there needs to be faded. Now the data that has come out since has actually been decent, not great, but decent. We had the pmi, which is a good leading indicator for GDP growth. That was back to where it came from for December reading compared to October and the November reading, which was very weak, looks a bit like an outlier now that it might have something to do with the US elections around the time because it's a survey of basically purchasing manager's sentiment and they might've been quite worried.

But at the end of the day, the data now bounced back and when we plug it into our GDP models, it is spitting out roundabout 0.2 on the quarter, which is where the ECB sits as well. So really no need to speed things up. Now the other data points that came out were for the uk, and this is really interesting because I think this gives us a bit of a glimpse into what might lie ahead. The labor market data in particular that came out today on the 17th when we're recording, was relatively strong even though it needs to be taken with a pinch of salt, given that the data quality is not that strong and particularly the wage data was relatively firm. Now the market has reacted very strongly. It has priced out about 15 basis points of rate cuts out of 25, and we're now pricing in just a little over two rate cuts for the whole of next year.

of what might be to come for:

Jason Daw:

oing to remain a hot topic in:

Speaker 5:

This content is based on information available at the time it was recorded and is for informational purposes only. It is not an offer to buy or sell or a solicitation and no recommendations are implied. It is outside the scope of this communication to consider whether it is suitable for you and your financial objectives.

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