Markets have been pricing more rate cuts again on the back of somewhat weaker data releases, specifically in the US. Yet, central banks remain reticent in telegraphing rate cuts clearly. Can the latter change and make markets price in even more?

Participants:

• Peter Schaffrik (Desk Strategy), Head of UK/European Rates & Economics
• Blake Gwinn (Desk Strategy), Head of US Rates Strategy
• Simon Deeley (Desk Strategy), Canada Rates Strategist
• Cathal Kennedy (Desk Strategy), Senior UK Economist

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.

Peter Schaffrik:

However, the one thing that has clearly been missing is very clear communication, very clear telegraphing of what the next steps are. Maybe central banks don't really trust in their own forecast models, so clearly maybe they have learned some of the lessons, for instance from the ECB that had previously flagged quite clearly that they want to cut rates and when they did so they probably feared that this was the wrong step and delivered a hawkish cut in June. However, we shall see, we'll discuss all the central banks in the coming call. I will quickly start with the ECB, which is up again on Thursday. We'll then move to the US with Blake Gwinn to Simon Deeley who is going to discuss the Bank of Canada and we shall conclude the call in the UK with Cathal Kennedy. So on the ECB on Thursday they're going to meet again and the question is not whether they're going to cut rates.

The market is pricing almost nothing, and we think that's exactly the right thing. They will not cut rates. The question is rather whether they're going to prepare the ground by once again telegraphing that they will go again in September. We think it's possible even if it's not going to be as clear cut as it was before the June meeting. Most ECB members have said that there's going to be one or two more rate cuts this year, and they've also said that the policy meetings where new forecasts are being delivered September and December are much more likely are much more natural points where they would do so. Therefore, the question for Thursday is whether they're going to telegraph once again that they will have an easing bias that they want to reduce rates further and if so, how much further? Again, we think they have been a bit scarred by the clear communication month in advance that June would be the meeting where they start cutting rates and then when June came around, the data hasn't really delivered what they wanted. Therefore we think they will be a bit more careful. They will not use the word September. They will probably just indicate rather than very strongly confirm what they want to do. But the takeaway for markets is probably that the next step is going to follow in September and maybe in December as well. So it is all about the telegraphing rather than the actual action for Thursday. With that, let's see what the story is in the US over to Blake.

Blake Gwinn:

Thanks Peter. So I think what I wanted to mostly focus on today is that we recently changed our fed call. Most of that came on the backs of the soft CPI data that we got last week. I think the big story there was not only the shopper than expected improvement but also the big decline that we saw in OER. This has been a component that a lot of folks including ourselves have been expecting to turn and start providing some more sustainable downward pressure on inflation prints going forward. I think there was a little bit of disappointment that it didn't show up last month, but finally this month that help did arrive, and I think this is one of the components that the Fed was really looking for when they were saying they wanted more confidence that inflation was heading sustainably back to 2%. They wanted to see the confirmation that this long awaited shift in OER was happening.

So they got that in this most recent print. I think with that improvement, Trump an expected improvement in the data from both a headline perspective but also that start of OERs turn lower, that pretty much takes away any roadblocks. I think the Fed might've had to cut in September. They're still going to get two more months of CPI data before that September meeting, but I think the bar is pretty high there for them to consider delaying until December. At this point, I think something in the 0.3, 0.4 month over month for core, that's what it would take to really get them to consider a delay. That's not really our base case. We think those inflation prints are going to stay relatively low in the coming months. So I think consistent with that, we needed to shift our base case for the first cut to September.

So really each cut in that cycle very independent from the one before it versus what I think markets and the Fed are forecasting, which is this more automatic straight line back to neutral. There's a couple reasons for that. I think partially this is because we think Powell and Fed more broadly is giving very little weight to these concepts of neutral as a guide for setting the policy rate. It may be fine for submitting SEP dots, but I don't really think the Powell and most of the others on the Fed are really using these estimates of neutral as a strong guide of where they need to take rates if we are correct and each cut is more reliant on the data that we received since the last meeting. Even if that is somewhat backward looking, I think you have to look at our more optimistic view on labor and I also think some potential upside risks to inflation in 2025 and think that it'd be very easy for them to reach a point in the first half of next year where they were considering pausing much like they did in the 95, 98 and 19 cycles.

If you're taking out those insurance cuts against downside risks, those downside risks do not materialize. As we've seen in those prior cycles. The Fed has really had no problem leaving rates well above what would've been considered a neutral rate in those periods. We think they would similarly have no problems doing that this time around they won't be on this automatic autopilot back to three 50. So like I said, that's pretty out of consensus. It's definitely not what is priced into markets right now. So I think that's where a lot of the conversations around this call change have focused on rather than the move from December up to September over the last week. I think the narrative has even tried to shift beyond that. We've gotten a lot of questions coming in about whether the Fed could cut in July, whether maybe they do 50 basis points at September.

I think that is a little bit overdone. I think to some extent that is price action that's been driven by some short covering which has pushed market pricing beyond fully priced for September. I think that's what's gotten markets thinking about this idea rather than the other way around where the fundamentals are pulling market pricing. This is market pricing, pulling the conversation. I do think that some of the Fed speed we've gotten in the last few days, plus the very strong retail sales report has taken a little bit of that pressure off, but our overall view has been that this improvement in inflation that we're seeing is enough to basically get you this very slow gradual correction rates, but it does not create any urgency. Urgency has to come from further deterioration in labor, meaningful deterioration in consumption or growth and we're just not seeing that at this point.

So there's really no urgency on the Fed and I think waiting until September really gives them rather than going in July, really gives them kind of a free look at two more months of inflation data before they start that process. So we would definitely fade against any possibility of a July cut or more than 25 basis points in September. Just really quickly, I did want to mention briefly the US election just because it's been a very big topic for the last few weeks. We've seen over the last few weeks two large bumps in Trump's probability of winning the US presidency. First on the US presidential debate and second following the assassination attempt over the weekend. Markets clearly seem to have decided that the Trump trade in rates is bearish curve steepening. We've seen five thirties moving steeper in line with both of those moves and Trump's odds of winning.

Peter Schaffrik:

Thank you. Thank you, Blake. Very comprehensive as always. Over to Canada, Simon, what the Bank of Canada going to do.

Simon Deeley:

Thanks, Peter. In terms of telegraphing, the bank is low to be too precise on market guidance. They did deliver their first rate cut on June 5th noting that it was reasonable to expect further cuts to the policy rate if the economy evolved as expected. They were careful to emphasize they would take decisions on a meeting by meeting basis and that upside inflation risks remained, but this was still read as a relatively clear easing bias. If nonspecific other bank communication has underlined that cuts would be gradual. A qualitative description we took to mean no more than 25 basis points at a time, but non issuing 25 basis points at every meeting. Our view has been that a soft though not terrible macro backdrop, including excess supply in product and labor markets and moderating inflation would support four consecutive 25 basis points cut that would take the overnight rate to 4% by October.

Meeting data since the June cut have included a further rise in unemployment rate to 6.4% and almost universally soft BOC business and consumer surveys released earlier this week. Labor shortages are near historical lows and forward-looking sales and price including wage indicators are all showing significant moderation from earlier levels. However, inflation data has not been what the BOC would've hoped for CPI. Trim and median measures printed at 0.33% month on month in May and follow that up with 0.24% month on month in June. These follow low prints in the first four months of the year and we think the balance of data points to another 25 basis point cut on July 24th, so do see it as a closer call about 65% confidence than market pricing is suggesting, which is closer to 85% alongside the expected cut. We see the BOC retaining flexibility and not being too prescriptive on the timing of further easing long meeting windows from April to June and then from June to July, September meeting is a more normal six weeks from July meeting.

In data terms, it's even shorter as there's essentially just one month of data, so for example, employment CPI activity releases, there will be two monthly GDP reports and also the closely watched quarterly GDP release is the week prior to the meeting, so there is some important data Still. Anything communication next week may be less established than market pricing, which is showing 65 basis points by year end is suggesting with the firmer inflation numbers impacting more on the C'S potential path than the increased pricing for fed cuts.

Peter Schaffrik:

Thank you, Simon. Last but not least, let's move back to this side of the Atlantic. We had some quite key data releases in the uk. What is the Bank of England going to do? Cathal.

Cathal Kennedy:

Thanks Peter. Well, at the top of the call and Simon just there both discussing central banks telegraphing, if you will, their next rate moves. Now I think of all the central banks we speak about here on macro minutes, possibly the one that is least keen to telegraph what it's doing is the Bank of England. Certainly under the governorship of Andrew Bailey, there's been a rowing back from providing detailed forward guidance that might telegraph the banks' next move. Indeed, at present, not only is the bank reluctant to discuss when the cycle might start, but also how much easing they may deliver. It's noticeable that the MPC refuses to be drawn into discussions on the idea of where neutral may be in the uk. Now, in a previous edition of this podcast, we did discuss the Bank of England's meeting in June and at that meeting it did open the door to Ray cuts not by giving any explicit message, but by diluting the language in the meeting minutes.

There's two no Hubble features I think kind of worked just emphasizing as part of that shift. One was downplaying the overshoot in services of CPI inflation versus the may forecast round, and the second one was a broadening of the suite of indicators that the NPC were looking at for evidence of what they describe as persistence inflation. There was an important change here from a focus on the incoming data to all of the information available, so thus diluting, if you will, any single data point, but just this morning we had the UK inflation data for June. Now, one thing that perhaps has prevented the Bank of England from signaling more strongly their intention to cut rates is that the data in the UK simply has not been playing ball. The labor market has loosened but remains relatively tight. Wage growth remains elevated and domestically inflationary pressures continue to fall only slowly.

This morning, CPI data affirmed at the last point in particular, while headline CPI inflation was at 2% the Bank of England target for a second consecutive month. It's important to point out that most of the disinflation in the UK at the moment is coming from goods and energy. Essentially what we are seeing is the external shocks that affected inflation in the UK were receding domestically generated inflation, particularly service inflation, which NPC have said they're focused on continues to fall more slowly than expected. It was 5.7% in June, unchanged from May, but well above the 5.1% at the Bank of England had forecast in its last forecast round. But again at the June meeting, the MPC downplayed the strength of that service of CPI inflation attributing it to regulated prices and more volatile components. Indeed, some of the strength in this one's data was in one of those volatile components, namely hotels and accommodation services.

Now, at that meeting in June, there were only two votes for rate cuts. It's a nine member committee, so simple mats, you need three more to switch their vote for a majority to support a rate cut. Last week, the bank's chief economist seemed to rule himself out of switching his vote, so even before today's data, the bank's decision as next meeting was touch and go. It's even more so now after this morning's data, we retain our call that the bank will deliver a red code August, and that's based on if not a quite telegraphing that at the last meeting, but just because of the very heavy lean that was in the language towards that outcome.

Peter Schaffrik:

Thank you, Cathal. That's very comprehensive as well, and thank you everyone who was on the call and thank you everyone for listening. That concludes our call and we'll hope that you join us again next time.

Speaker 5:

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