With the ECB keeping rates on hold, and the BOE and Fed expected to do the same, Blake and George explore what's really driving central bank decisions. From energy market pressures in Europe to an unexpectedly hawkish Fed backdrop, discover why holding steady is anything but straightforward in this week's policy meetings.

Participants:

• Blake Gwinn (Desk Strategy), Head of US Rates Strategy
• George Moran (Desk Strategy), European Macro Strategist

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

Speaker 1:

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:

Hello, and welcome to Macro Minutes. I'm Blake Gwinn, head of US Rates Strategy for RBC, and I'm joined today by our European macro strategist, George Moran. Today, we'll be focusing on the ECB, BOE and FOMC meetings. We're recording this on July 23rd, just after the ECB wrapped up, and we have the FOMC and BOE on deck for next week. So basically, we'll be doing a bit of a postmortem on the ECB, but then a preview of the FOMC and BOE. So George, thanks for joining. Thought we'd start with the ECB given that Lagarde legitimately just wrapped up her press conference about an hour before we started recording this. But before I get to Lagarde, let's quickly start with the statement. They obviously held rates as expected, but was there anything there that we should note?

George Moran:

Hi, Blake. Yeah, it's good to join you. It was a very short statement, which was a sign of things to come really. The ECB clearly didn't want to send a strong message. The outlook at the moment is clouded clearly by energy markets. Probably the one thing that I would take away from this statement was they didn't take the opportunity to be more hawkish where they could have been. So they said that they are still at their baseline scenario, and given that we've seen such a big rise in natural gas prices in the last couple of weeks, they probably could have leaned a little bit more hawkish here on the margin if they wanted to, but they didn't take that opportunity.

Blake Gwinn:

Okay, interesting. So let's get to the meat and talk press conference. How about we just do it this way? What are the three biggest takeaways you had from listening to Lagarde today?

George Moran:

Yeah, so the press conference is usually the more interesting part. She definitely doubled down on that baseline comment from the press statement saying that we were back to the baseline, so that was clearly something that was discussed quite a lot and they had enough confidence to say. There were also a few sprinklings of dovish comments here and there. So she did say that the underlying inflation, there was not strong evidence of second round effects just yet in that data, which was a little bit of a softening from the language at the last meeting. She also emphasized some of the more dovish data that we've had so far, like the fact that the corporate telephone survey has shown that firms expect weaker wage growth than previously. This is not often looked at as a survey, but it's something that the ECB puts quite a lot of weight on, and it's a decent survey. It surveys about 5,000 firms, so it's something quite important to look at, so it's interesting that the ECB emphasized that.

However, I don't think it's easy to be super bullish on European fixed income at this point. She did say that ultimately, the ECB's reaction function is well understood by markets, so she clearly hasn't got a big issue with the market pricing where it is at the moment, which is a fairly hawkish position.

Blake Gwinn:

Yeah, so I guess wrapping all this together, and I realize it's probably a bit too soon to really definitively be making any changes to the ECB call officially, but I guess after listening to this, how are you thinking about the risk to our current call which I think is still for a September hike, in light of everything that we learned today?

George Moran:

Yeah, we are still calling for one hike in September. Clearly, if we look at market pricing, risk is to the upside, and our September call, we changed that back when there was the memorandum of understanding and oil was much lower than it currently was, so we have to see what happens to energy markets. At the moment, we are at the mercy of energy markets. If we see a big resolution, then September and done looks pretty likely, but if we continue to see the direction of travel maintain what it's currently doing, then clearly that's going to be problematic for the ECB.

The big tension the ECB faced at the moment is between forward-looking data and backward-looking data. Actually, as I just mentioned, the backward-looking data is looking fairly decent. There's not much evidence of second round effects. A lot of the surveys are looking not particularly concerning if we look at inflation expectations, forward-looking indicators. However, the ECB has to project forward, and if energy prices maintain at the high levels that they currently are, that situation could change quite quickly. So the ECB has that tension between more positive backward-looking data and high energy prices, which make the outlook going forward potentially concerning if they make the wrong decision.

Blake Gwinn:

Interesting. Yeah, all right, let's shift gears a little bit. Lastly, hit the BOE. Can you give me a high level overview of what you guys are looking at for next week's MPC meeting?

George Moran:

So Bank of England meeting next week. We still expect a 7-2 vote split. We've had a lot of questions about the new prime minister, if that's significant for this meeting. Long story short, it's not significant. They're not going to create new monetary policy based on policies that have not been announced yet. We do get macroeconomic projections at this meeting. There are going to be downgrades to inflation, just because the previous inflation forecasts were made back in April when oil was much higher than it currently is now, but that's largely marking to market. It's not necessarily a big change in the Bank of England's worldview.

Generally, taking a step back, the Bank of England is in quite a different situation to the European Central Bank. They started from a position where they were planning to cut rates already, so just the mere fact that they have not cut rates so far has actually been quite a significant tightening in monetary policy. So the market is expecting interest rate hikes later this year. We do not think that is going to come from the Bank of England, in part because they've already, just by keeping rates on hold, done a significant degree of tightening, but it's certainly, I think, one of the more interesting central banks to be watching.

So Blake, maybe to turn it over to you, I know your team has long expected for the Fed to remain on hold this year and we have the meeting next week. It seemed like after that big CPI miss and some softer PPI and NFP data, a July hike was basically off the table, but in the last few days, market pricing's been rapidly moving back in the direction of a hike. Please help me understand as a European. How do we have a negative month-on-month to 2DP core CPI number and still be pricing, I think at the moment, nine, 10 basis points for the next meeting? So how live really is next week's meeting?

Blake Gwinn:

Yeah, that is a real conundrum, because if they were to hike in July after staying put in June, how do you explain that when the only thing that's really changed is you've gotten slightly softer NFP data and then the big CPI miss that you mentioned. So that will be a bit of a confusing statement, but I think the answer to your question about how live is the meeting, maybe it was best to just repeat the title of the FOMC preview that we published today, which is mostly dead, not all dead. We do still expect that the Fed's going to hold next week. We have that soft inflation data that you and I both mentioned, we had that softening in labor. I think that leaves just enough wiggle room for the Fed to really punt.

There's been this question of whether that softer inflation data is really just one print or the start of a softening trend, and I think this takes the pressure off of them to do something in this meeting and gives them the ability to take a look at two more months of top tier data before really making that decision to start hiking. So we do think they punt that more serious discussion to September, that they hold rates here, but the risk of a hike is certainly not zero. I think it's probably arguably higher than it really ever has been in recent history at this point into an FOMC meeting. The way these things usually work is that pricing is basically moving to the eventual decision by the time we go into the FOMC blackout period, so certainly not the case here. As you mentioned, that pricing has been swinging around.

So where does that risk come from? One, Iran. We have to at least note that those forward-looking inflation risks around the energy outlook, energy derivatives has gone up since the last time they met. There was this big discussion in June about how much those risks were really embedded into the dots, and there was this narrative after the meeting, and we were part of this, which was that the Fed was meeting at the beginning of that MOU, oil prices had continued to fall. Maybe that means they were more dovish than what we heard, or I should say slightly less hawkish than what we heard in June. Well, that's basically erased itself. Those risks are basically back to where they were ahead of the June meeting, so you can't really make that argument there.

The other thing I would point out, I do think there's an asymmetry in the hike and the hold camp. Now, we have a few hawks that are, I think, going to make pretty impassioned arguments for a hike. There's very good reasons that even I can come up with to argue for hiking at this meeting, but that camp is smaller. I think a lot more people probably come into this meeting with a base case to hold, but the argument for that case is much more lukewarm. Having inflation expectations anchored, wanting to see a few more months of data, not exactly a passionate argument.

So if you're looking at the numbers game, I think we have a handful of voters that probably come into this meeting with a base case of hold. We haven't really heard from them in a while, so it's tough to really say that they're still in the hold camp, but we assume that that base case is a hold. Now, if you get somebody influential like a Warsh, a Waller, or a Powell supporting a hike at this meeting or being convinced by those hawks' arguments to come over to the hike camp, you could easily see those dominoes starting to shift and to actually get to a majority at this meeting. So I guess subjectively, I would put the odds probably in the 15 to 20% range, certainly higher than what we typically see ahead of an FOMC meeting.

George Moran:

I'm also interested as an ECB watcher, we tend not to have meetings where we have split pricing. How comfortable do you think the Fed's going to be with that? Is there a possibility that there could be some sort of guidance in one direction or another? I know it's a blackout period, but via a leak or something like that, or do you think we go into this meeting priced pretty close to what we have at the moment?

Blake Gwinn:

Yeah, it's interesting. Into the blackout period, we were around three basis points, which I would argue is much more typical of what we see during a blackout period, that the market has basically gravitated towards the eventual outcome. But right now, we're sitting around 10 basis points. That's effectively about a 40% probability of a hike. So I guess the theory in the market would go that the closer that pricing is to fifty-fifty, the easier it's going to be for the Hawks to convince the rest of the committee to basically take what the market is giving, or at least they're not having to fight upstream against markets expecting a certain outcome.

Personally, I don't really think the Fed works that way. I don't think they think about market pricing as much as maybe the market thinks they do. It certainly, I don't think, has really moved Fed outcomes in the past. I think the Fed is much more likely to go out and try to shift market pricing towards the outcome rather than moving their outcome to where markets are pricing, so I just don't really think the Fed operates that way. But under Warsh, there is an interesting shift because I think we have to consider that he may be much more willing to be offsides into a meeting, to do something that is not priced to surprise markets, if you will.

Now, I don't necessarily think that leans hawkish or dovish for July. I don't think the ability or the willingness to surprise markets really means, "Hey, we should expect a hike." To me, it just really means that that market pricing is not really going to be an input or a constraint on what the Fed does, and that is a little bit different, I think, than what we saw under Powell where the Fed almost always delivered on what was priced ahead of the meeting, even if that required them to push market pricing in line with what they expected to do at the meeting.

George Moran:

Okay. So the decision itself is going to be interesting, which is exciting for us as central bank watchers because there's not many meetings that come around where it is genuinely interesting what the result is going to be, but apart from that, setting that aside, what else might surprise markets from this meeting?

Blake Gwinn:

There's not really a ton. We don't get dots. This isn't an SEP meeting so we won't get any update to those hawkish dots that we saw in June, which really did drive, I think, most of the reaction to that meeting and the hawkish sentiment that came out of it. The statement was heavily pared down last meeting. We clipped a lot of dead weight there, so it really doesn't seem like there's much left in there that could be changed in a way that would have a major market impact. And Warsh, we've seen him four times now since the FOMC, including the FOMC press conference at Centra, and then two days on the Hill. He steadfastly rejects to provide any forward guidance, and the problem is that what Warsh considers forwards guidance is a very, very wide umbrella that really seems to incorporate anything on any outlook around the economy or the path of policy or the reaction function.

So I think probably what we get from Warsh, he just keeps recommitting to the inflation target. That's basically what he's been doing, but he's still not really providing any tangible plans or a framework or potential actions that he would take to achieve that inflation target, so just don't really think there's a lot there to continue to move markets.

Now, one thing that I think will be interesting, I do think it's possible we get dissents from Hammack and Logan, maybe even Kashkari, which I don't think would surprise anyone, but that could certainly set a bit of a hawkish tone to the market reaction immediately following the statement.

George Moran:

Okay, that's very clear. Thanks, Blake. Just looking beyond this meeting, I have to be honest, setting aside that weak core CPI number, your call for the Fed to remain on hold is looking increasingly difficult to justify with a continued hawkish shift in Fed rhetoric and where we see market pricing at the moment. You mentioned just then, you expect a few voters to dissent for a hike, and there's probably now renewed inflationary risks around energy from the situation in Iran. So I guess the question is how is your conviction in that hold call right now and where do you see the risks of a hike this year, even if not at this meeting?

Blake Gwinn:

We already saw that with July, right? We got this softer inflation data and they said, okay, well, assuming they hold this week, that's saying, "All right, well, let's take a look at two more months of data until September." I think we get enough signs of improvement in that data where then in September, they say, "Okay, well maybe let's just hold off till the October meeting," and that process just keeps playing out. We keep kicking the can down the road until at some point, we see enough of a trend that they're more comfortable going back onto an extended hold. So that's really how we're viewing that hold, not really the Fed abandoning hikes or giving up on a hawkish bias, abandoning the inflation target or something. It's that they're getting just enough improvement every time to keep punting that decision.

George Moran:

Right. I see. And last question, and potentially a very quick one. Are we going to hear anything new on balance sheet or communication from Warsh this week? I know we've got these ongoing task forces going on. Do you think this meeting could provide us with any clarity?

Blake Gwinn:

I don't think so. You basically hit on it right there. We've got these task forces now in place. I expect any questions that Warsh gets in the press conference around communication policy changes, balance sheet changes, those are all going to result in Warsh just punting to these task forces and saying, "Hey, the process is ongoing. We'll hear more from them by December," so really don't expect any developments or any kind of news there.

All right. Well, thanks, George. I'm going to go ahead and blow the final whistle here, and that's all the time we have today. Thanks to all of you for listening, and please remember to join us for future editions of Macro Minutes.

Speaker 4:

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