The market environment over the last two weeks may be best described as chop. Yields have been bouncing around day-to-day but market narratives seem to be settling with year-end in sight.

Participants:

• Michael Reid (Desk Strategy), US Economist
• Blake Gwinn (Desk Strategy), Head of US Rates Strategy
• Jason Daw (Desk Strategy), Head of North America Rates Strategy
• Peter Schaffrik (Desk Strategy), Head of UK/European Rates & Economics

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

Jason Daw:

Hello and welcome to Macro Minutes. During each episode, we'll be joined by RBC capital Markets experts to provide high conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures.

Blake Gwinn:

Welcome everyone and happy Thanksgiving to any of our US listeners. This is the November 21st edition of Macro Minutes, which I'm calling Writing the chop. I chose that title because we've had some pretty large price swings over the last few weeks, but ultimately they don't really seem to have gone anywhere. Just for some context around that, since our last episode two weeks ago, US two year yields have traded in a 30 basis point range. The day of the October CPI released last week alone saw a 20 basis point rally, but for all that movement, we're actually within two basis points of the close on the day of our last recording as we sit here to record this week's edition. So anyway, we've got a great slate of experts today we're going to start with our US economist, Michael Reid, to talk about US economic data. Then I will jump back in a little bit, talk about how the US rate narrative has shifted heading into year end.

Then we'll have head of North America's rate strategy, Jason Daw to talk about swings in BOC pricing and its impact on curves. And then finally we'll head over to head of UK and European Rates and economics, Peter Schaffrik. He's going to discuss fiscal plans and whether central banks are going to remain at the center of the European market discussion. So with that, let's turn it over to Mike Reid to talk a little bit about US economics.

Michael Reid:

Just last week we saw the October headline retail sales report and that contracted for the first time after six consecutive months of gains. And this is particularly notable because this is really the first month of data that shows the impact of federal student loans resuming up for consumers. And next week we will see the fuller picture in terms of spending from the personal income and spending report in there. It's worth highlighting that when you look at real spending and real incomes for the past four months, spending has outpaced incomes. And what's worrying there is that even before you account for the impact of student loans, the consumer is really starting to show signs of weakness. When you look at what's been driving the strength in consumer spending, we saw the personal savings rate fall to 3.4% in September, and that's from a high of 5.3% in May for 2023.

So really a lot of that spending was driven by the savings rate moving lower. Add to this, the increasing reliance of credit card spending for consumers. We saw the revolving consumer credit outstanding continuing to grow. And what's more worrying is that if you look at the New York Fed report on household debt and credit that showed that delinquency rates increased across all product types except for student loans. But what's really important about that, that data point is the report only covers up to quarter three. So it does not yet show the broader impact of those federal student loan repayments resuming there. And guess what? The groups that saw the fastest pace of serious delinquencies for credit cards and auto loans were the 18 to 29 year olds and 30 of the 39 year olds, those are the two groups with the highest burden of student debt.

Blake Gwinn:

Alright, thanks for that Mike. So on the US rate side, I do think last week's CPI print marked a fairly important pivot point for the US rates narrative. If you recall, from August to basically the end of October, I think markets were really looking at the world through a very bearish lens, grabbing onto the data beats to all the supply developments we had, any kind of hawkish fed speak we were getting and really any other bearish impulses.

Shorts were very quick to add, slow to take profit. And at the same time, I think dip buyers were remaining extremely timid. So anytime we did get those opportunities, we just didn't see that buying materializing. That environment essentially rested on I think two bearish pillars, the extraordinarily hot run of data, which culminated in October with September N-F-P-C-P-I retail sales print. And then finally that Q three GDP number. And second was the huge amount of angst that markets had around the supply and demand for US treasuries. That drove a resurgence of this term premium theme that I think accounted for roughly two thirds of the second half selloff. But both of those pillars have started to crumble a bit. In November 1st we had the US refunding announcement, which we did discuss in a prior episode that relieved some of the concerns about US treasury supply. As treasury revised down their deficit expectations pulled back a bit on longer end issuance, but then the data narrative started to crack a bit too.

We had the software than expected NFP print a few weak ISM prints. We've seen a continued rise in continuing jobless claims, but to me it's really last week's soft CPI print that solidified that turn in the narrative. I think if CPI had coming hot or really even on consensus, the market fears of breaking to new highs and rates, if you recall several weeks ago, we were bumping up against that kind of 5% level in tens a number of other key levels across the curve. I think fears of breaking above those would've probably persisted into year end without that CPI print. But as it stands now, I think it's extremely difficult to envision any kind of scenario that's going to take us back to those yield highs over the next few months. Even if we see data rebound into the December FMC meeting, the context that the software CPI print last week provides should make it pretty easy I think for markets and the Fed to look through any bounce on the data as really just noise rather than signs of a potential reacceleration.

So if we're going to break them, I think at this point it's much more likely we're going to break to the downside rather than to the upside. That's partially because as I've been discussing a lot of those sources of upside risk, mainly the supply concerns and concerns about sustained re-acceleration, the economic data, those have been clipped over the last few weeks. But also I think you tend to assume, I think heading into year end the positioning is going to continue to lighten up. And if so, I think that's a little bit supportive of yields given that markets have been pretty heavily short for quite some time now. So let me go ahead and pause there and let's go ahead and swing over to Jason Daw to talk about BOC pricing and curves.

Jason Daw:

Okay, thanks a lot Blake. So there's two interrelated items that I want to discuss. One the wild swing in Bank of Canada over the past month or so and how that has affected the entire yield curve. So there has been a massive swing in the market's view on the path for the BOC. If we look back to just before the bank's October meeting, the market was giving a 50% chance of a hike by the January meeting and it was firmly in the camp of the higher for longer theme IE no rate cuts by mid-year. And that's drastically changed. And now the market's giving a 40% chance of a cut by March. It's fully priced for a cut by June and has almost two cuts baked in to July. So it does feel like the pendulum has maybe swung a bit too far, at least for rate cut pricing to April.

That has been consistent with what we've seen in the bond market. And we do think over the medium term that yield should edge lower, but the path is going to be choppy. The market's going to continue to grapple with the timing and magnitude of rate cuts and this is going to swing the bond market around. But ultimately rate cuts being delivered probably a hundred basis points in the second half of this year that continuing into 2025 should provide a better macro environment for the bond market over the medium term.

Blake Gwinn:

Thanks a lot for that Jason. And finally, let's head over to Peter to talk Europe.

Peter Schaffrik:

Thank you, Blake. I also want to talk about essentially these two pillars that Blake has mentioned. I just want to reverse the order a little bit because it's very pertinent over here in Europe. So I'll talk about the fiscal side first and then secondly and therefore the supply of ones. And then secondly about the amount of rate cuts priced. So when we look at fiscal, it has obviously been a major contribution to the economy and economic growth or the little bit of growth that we have over here in Europe. And we have essentially two fiscal events, one voluntary and one less voluntary that's coming up. One is the UK autumn statement or the budget announcement, and that's taking place on Wednesday. And then the other bit is this announcement about the German constitutional court ruling some of the budget in the largest European economy as unconstitutional.

So let's quickly tackle those two. So as far as the UK's budget is concerned, I mean there is a little bit of leeway because the tax revenues have been better and we expect that this will lead to a drop in the funding remit in the UK over here by around about 20 billion in gilts. That's slightly higher than what the market is seeing. We think the consensus around about 30 to 15 billion, and by and large, the market is tilting in the same direction. The bigger question I think is what is going to be announced in terms of tax reduction for the forthcoming fiscal year because again, there is a little bit of leeway that the government has to fulfill its budget rules and they're probably going to use it knowing that we're also going into an election year. And there is quite a lot of speculation in the press at the moment about various rate cut options, inheritance tax, income tax, all of that.

But it seems plausible at this stage to expect some of that will probably mean that the leeway for lower bond issuance going forward will be reduced somewhat. So that's taken place tomorrow. The other item that I just highlighted is that there was this ruling in Germany that constitutional court essentially ruled out some of the budget arithmetic that the German government has put forth in its various, so-called special funds. And in this one, particularly the one tackling climate change. So essentially for this ruling, that means that 60 billion of spending that the government has put in cannot be happening within the current budget context. And what we're already reading in the press is that new projects are currently being shelved and the government is scrambling to get them back on the roads. There's two problems with this that I see, or maybe two and a half. Let's start with a half one first is that this is not the only special fund that the government has used and there's other special funds that have essentially used the same arithmetic and it seems at least plausible to expect that those will be challenged as well.

And that means that the government has to come up with a different solution. And that different solution could either be finding a different way to fund it or finding other items that it can reduce spending. And obviously, and this is maybe the last point on this, what this fundamental challenge highlights is that there is a big rift within the current government as well where there's a coalition government and the greens want to spend more money particularly on the environment, whereas the, sorry, excuse the free Democrats, they want to prevent that and want to return to a much more, what they call a much more stable budget. And I think that this will create challenges going forward not in the here and now because over the next couple of weeks it's probably unlikely going to affect the market, but certainly it'll have some implications for expectations where the economy can go next year.

And this is a good segue into the pricing of central banks because just in line with all the other markets that we have just spoken about, we are pricing the first cut, excuse me, in the first half of the year. And we're pricing close to a hundred basis points a little bit both in the UK as well as in the Euro market by the end of the year. And the biggest question that we are discussing with our clients in meetings is whether or not that comes to fruition. And one of the things that we constantly point out that over in Europe, the fundamental issue that we have is that base inflation or domestically generated inflation. No matter how you look at that, whether you look at core inflation or whether you look at service inflation is still running relatively high. So as an example, in the UK service inflation, which is typically a proxy for domestically generated inflation is still running at about 6%, which means a contribution of 3% to the overall basket core inflation.

Blake Gwinn:

Thanks for that, Peter, and thanks for dialing in. That wraps it up this week and we'll see you again in December.

Speaker 5:

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