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RANsquawk Weekly G10 Central Bank Monitor - 18 June 2017

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FEDERAL RESERVE

• As expected, the FOMC hiked rates by 25bps to 1.00-1.25% – the second hike of 2017, and the fourth in the current tightening cycle. Minneapolis Fed President Neel Kashkari was the lone dissenter, once again.

• The revisions to its economic projections were mostly in-line with the market view: near-term growth was raised, but the Fed is more pessimistic than analysts in 2018-19; the unemployment rate forecasts and its NAIRU estimate was cut; near-term PCE and core PCE forecasts were slashed on what the FOMC characterises as one-off factors, but it does see a return to target in 2018 as slack is absorbed.

• The number of projected hikes over the forecast horizon was left unchanged (one more in 2017, tspanee in 2018 and tspanee in 2019). But rates traders still need convincing, given they aren’t fully pricing in the Fed’s hike trajectory, with some attributing this to the slowdown in inflation as well as forward-looking indicators casting doubt on a Q2 growth rebound.

• “Something's got to give,” say analysts at Bank of America Merrill Lynch. “Either the data vindicate the Fed's economic outlook and financial conditions tighten pushing rates higher or the data continue to disappoint and the Fed capitulates on its outlook and lowers the path of rates, keeping financial conditions loose for a bit longer.” BAML sees the alternative as the Fed continuing to hikes in absence of better data, and that “could spell disaster”, the bank says: “A weak economy and a tough Fed could ultimately stall the economy. In our view, we think the Fed would reverse course before letting this occur.”

• The FOMC has also further prepared the market for eventual balance sheet normalisation, setting an initial USD 10bln ‘cap’ (USD 6bln for Treasuries, and USD 4bln for MBS) that it would allow to ‘run-off’ from its portfolio on a monthly basis, raising that cap by USD 10bln every tspanee months over a one-year period until reaching USD 50bln. The Fed didn’t specify a start date but did hint that it could begin “relatively soon”, while also providing usual caveats that the pace of normalisation would be contingent on the economy’s progress. Some predict that the Fed will begin the process in Q4, possibly at September’s meeting.

• The upcoming week is packed with Fed speakers. Monday: NY Fed's William Dudley (voter, 1300BST); Tuesday: Chicago Fed's Charles Evans (voter, 0000BST), Fed vice chair Stanley Fischer (permanent vote, 1300BST), Boston Fed's Eric Rosengren (1315BST), Dallas Fed's Robert Kaplan (voter, 2000BST); Friday: Cleveland Fed's Loretta Mester (1715BST).

EUROPEAN CENTRAL BANK

• In recent weeks, it is clear that the ECB is placing more emphasis on wage growth as a “policy variable”. With the central bank also now looking for core inflation to rise to the 2% level too, it sets a high tspaneshold for the removal of easy policy, according to analysis by Pantheon Macroeconomics.

• The consultancy takes exception to ECB President Mario Draghi’s claim (which was echoed by Benoit Coeure too) that the so-called ‘gig economy’ is hurting workers’ negotiating power and constraining wage growth. “This link between part-time employment and wage growth in the euro area is loose, and the ECB’s argument is weaker if we look at temporary employment,” adding that temporary employment tends to be positively correlated with wage growth, given its pro-cyclical nature.

• “We are not saying that the ECB is barking up the wrong tree entirely,” Pantheon says, “if workers are pushed persistently into temporary contract work with unstable pay conditions, it will reduce overall wage pressures. But the central bank needs to come up with a better way to show this idea than referring to headline data on temporary employment.”

• Taking a Phillips curve approach, Pantheon points out that the trend in nominal wage costs has followed the trend in unemployment close since 1999. “Since the financial crisis, however, unemployment has been much higher, explaining why wage growth has declined,” and “if this relationship holds, the recent fall in unemployment sends a bullish signal for Eurozone wages.”

• Elsewhere, the team at CreditSights have been looking at the performance of the ECB’s corporate bond purchases, and note that since the programme was announced last March, the ECB’s purchases have delivered excess returns of 4.22% versus 4.55% from the rest of the eligible Euro investment grade index. CreditSights also notes that spreads on ECB CSPP bonds have tightened more than the non-purchased portfolio since the beginning of the year.

• Interestingly, the spreads between French and German corporate bonds has continued to narrow: “while that was driven initially by tightening in French corporates following the French Presidential election, over the past few weeks it has been driven by a widening of German corporate spreads potentially reflecting an unwinding of the search for safety in European credit,” CreditSights says.

BANK OF JAPAN

• In a week loaded with central bank risk, the BOJ’s policy meeting last week was a benign affair; the BOJ maintained rates at -0.10%, the 10-year yield target at ‘around’ 0%, and kept the pace of its asset purchases unchanged. Once again Policy Board members Takehiro Sato and Takahide Kiuchi dissented, calling for asset purchases to be scaled back.

• However, as economic indicators point towards firming expansion, the BOJ amended its view of the growth profile, replacing characterisation of the economy as “continuing to recover” to “is turning toward expansion”.

• In his post-meeting press conference, Governor Haruhiko Kuroda pushed back on any pressure to tighten policy, saying that “achieving and maintaining stable prices and avoiding a return to deflation are far more important than the problems of the prolonged period of easing.”

• But Kuroda was pressed on the pace of the BOJ’s buying operations, which have eased to JPY 7.2trln in May versus the JPY 11.6trln in April, which therefore takes the annual pace increase to below JPY 70trln. The BOJ governor chose to highlight the guidance which suggested a purchase rate of “about JPY 80trln”.

• “The BOJ will probably remove ‘80 trillion yen’ from the statement when the reduction of the JGBs purchase has become so-widely accepted that the deletion would be considered long overdue,” write analysts at Japan Macro Advisers. “However, we did find it meaningful that Mr Kuroda did offer his view that as the liquidity in the JGB market becomes scarce, the BOJ will need to buy less to control the long-term interest rates.”

• Kuroda was also quizzed on the on-going ‘policy exit’ theme and the potential losses incurred from its purchases, but he largely brushed-off the questions suggesting it was too early to talk of tapering, and that only losses will be offset by previous gains the BOJ has made.

• “While the BOJ prefers not to admit it, it is becoming clearer that it is intending to reduce the size of its JGB purchases,” says JMA, “in our assessment, the pace of reduction could fit somewhere between our ‘slow taper’ scenario and ‘medium taper scenario’.” Under the latter, the central bank’s holdings would satbilise around JPY 460trln to JPY 465trln by mid-2019, or under the former, it might even rise to JPY 560trln by 2022, JMA believes.

BANK OF ENGLAND

• Although the BOE stood pat on policy last week, the bulk of focus was on the vote split, which favoured maintaining status-quo by a margin of five-to-tspanee. The vote split perhaps flatters the hawkish contingent on the MPC given it was operating with eight members instead of nine (on account of Charlotte Hogg’s early departure) as well as the fact that the outgoing Kristin Forbes was always seen voting for a hike, as she has done previously. But with that said, there appears to be a signal from some of the MPC’s external members that there is less tolerance to above-target inflation amid tight labour market conditions.

• “For members voting for a hike, the rationale is that now that last year’s rate cut had delivered stabilisation in the economy it was time to reverse it, in order to mitigate risks of a persistent inflation overshoot,” says Barclays, “that reasoning makes the assumption that the bank has the ability to fine tune its stance by moving the interest rates without having to commit to an interest rate cycle.” Ultimately, Barc argues that this wouldn’t be wise, and that central banks operate more effectively when adjusting policy in cycles.

• Some are also perplexed by the timing of the call for higher rates. Commerzbank notes that FX-induced inflation is only problematic if inflation expectations markedly rise, and “the evidence points to slower rather than faster wage inflation of late, suggesting no indication of rising inflation expectation.” Additionally, the impact of GBP’s fall last year will begin to fade, pushing down inflation in the months ahead.

• This week, BOE-watchers will be keeping an ear out for comments from BOE Governor Mark Carney (Tuesday 0830BST), which he was originally due to make at the Mansion House annual merchants dinner last Thursday, before that event was cancelled in sympathy for those affected by tragic London tower block fire.

SWISS NATIONAL BANK

• There were no surprises from the SNB last week; the sight deposit rate was maintained at -0.75%, while the 3-month Libor target was held between -1.25% and -0.25%. President Thomas Jordan repeated that expansionary policy was necessary as inflation remains elusive amid the recent economic momentum. The updated forecasts saw the SNB’s 2017 inflation view unchanged, though the profile was lowered for 2018 and 2019, but its growth forecasts were firmed slightly.

• Jordan also repeated that the franc remains “significantly overvalued”, and the SNB has intervened heavily to make franc investments “less attractive”. Analysis by ING suggests that in the first four months of the year, foreign currency asset investments have risen by CHF 34bln – totalling CHF 730bln as of April; for comparison, the rise in the whole of 2016 was CHF103bln, and was CHF 83bln in 2015.

• “For the SNB, there is more than enough reason not to move its stance and to remain careful: the ECB’s sluggish normalisation path, the effectiveness of the exchange rate policy or international politics,” ING writes. “Indeed, both Italian and global politics remain risks and it remains easy to imagine a political accident triggering a stronger demand for safe havens like the CHF.”

• Analysts generally don’t see the SNB shifting policy before the ECB does, which would alleviate pressure on EURCHF, which is likely seen in 2018 at the earliest. However, there is always the risk that bouts of uncertainty will contribute to franc strength, which would keep SNB active in terms of intervention.

BANK OF CANADA

• The BOC appears to have signalled that tighter monetary policy lies ahead after comments by its Deputy Governor Carolyn Wilkins, and afterwards, Governor Stephen Poloz seemed to suggest that Canada’s economy fundamentals were “pretty impressive” (Wilkins), and earlier rate cuts had “largely done their work” (Poloz). Wilkins also suggested that the BOC’s Governing Council “will be assessing whether all of the considerable monetary policy stimulus presently in place is still required” in the meetings ahead.

• However, before we can expect the BOC to reverse the two rate cuts fired in 2015 (the so-called “insurance policy” to cushion the economic slowdown caused by the collapse in oil prices), Poloz suggested that there are two missing ingredients: stronger exports, which are being held back by challenges to Canadian competitiveness, and further evidence that investment levels have recovered.

• “The signal here is that timing the first hike may remain significantly conditional upon considerable evidence of improvement on both fronts,” says Scotiabank – which expects traction on both fronts over the next two years. However, Scotia also wants to see discussion on other areas first: “Granted that his audience was general and not specific to financial markets, but the absence of any discussion on inflation drivers and the inflation outlook was notable.”

• The debate, therefore, shifts to whether the BOC is shifting its policy bias prematurely, according to Scotia, particularly so with core inflation lingering at the lowest since Q4 2013, Trump-induced trade risks, export growth which is struggling for traction, a potential peak in the housing market, as well as only nascent recovery in investment.

• It was also interesting that such comments were made by two senior officials outside of a policy meeting. Deputy Governor Lynn Patterson is on the slate to speak towards the end of June and there will, no doubt, be added attention on her speech.

• While the Canadian dollar strengthened against its US counterpart after Poloz’ and Wilkins’ comments, the short-end rate market remains to be convinced. CPI data due this week will be the immediate data point which adds to, or detracts, from the twos’ arguments.

RESERVE BANK OF AUSTRALIA

• This week, minutes from the RBA’s latest policy meeting, where it held the cash rate at 1.50%, are seen reflecting the dovish tone of the post-meeting statement, which flagged slowing household income growth as a key factor constraining consumption.

• It will also be interesting to see what the central bank has to say about the weakness seen in Q1 GDP, which it characterised as reflecting quarterly variations. Meanwhile, the RBA is likely to sound upbeat on the labour market, however, as the statement did note stronger employment growth (though noted the average hours worked had slipped).

• “RBA appears comfortable with a neutral stance for now,” Barclays’ analysts write. “The current weakness in household consumption and wages will continue to keep RBA watchful, despite the improvement in business conditions,” and Barclays believes that, “more than headline growth, if the trend of improvement in the labour market continues and wages start to rise at the margin, it may create conditions for RBA to normalize policy, but not before those trends are firmly established.”

RESERVE BANK OF NEW ZEALAND

• The RBNZ is unanimously seen keeping the Official Cash Rate unchanged at 1.75% in June, with the tone of its statement mirroring the May Monetary Policy Statement, which noted global risks remained tilted to the downside, though commodity prices, consumer sentiment, household spending and net migration were solid.

• Analysts at TD Securities aren’t expecting a BOC-esque hawkish tilt, and say that unlike the BOC, the RBNZ is taking on a more cautious view on offshore developments. “The RBNZ is likely to reiterate its neutral stance on monetary policy at next week’s meeting,” TD writes, “the weaker Q1 GDP print (+0.5% cf mkt +0.7% and RBNZ +0.9%) buys the Bank some breathing space, as RBNZ Governor Wheeler is determined to remain neutral until his contract expires in late September.”

• TD also notes that, the trade-weighted currency is some 3% higher than the May MPS, but oil is around 5% lower, leaving little to change to inflationary profile in the immediate term. Currently, OIS look for the first RBNZ hike to come in Q3 2018.

NORGES BANK

• The Norges Bank is seen maintaining rates at 50bps, though there will be a lot of attention on the rate path going forward.

• The Bank meets amid a firming in domestic activity – as indicated by the Regional Survey released last week – with many indicators coming in above the central bank’s own forecasts; inflation, however, has been surprising to the downside.

• Meanwhile, the NOK is around 3% softer than March MPR, while oil prices have dropped by around 7%. “On balance, we expect no major changes to Norges Bank's policy rate path (published alongside an updated June MPR),” says Goldman Sachs, “we expect Norges Bank to revise its forecast for mainland GDP growth higher, while lowering its inflation forecast,” and GS sees the Bank on hold in the quarters ahead.

• It is also worth keeping in mind that, for the first time, the Norges Bank will publish its meeting minutes alongside its rate decision.

RIKSBANK

• The latest batch of consumer prices data from Sweden shows inflation is quickly returning towards target. The Riksbank recently re-instituted its 2% inflation target, with a plus/minus tolerance of 1%, while switching its inflation benchmark to CPIF.

• Last week, CPIF Y/Y came in above forecast at 1.90%, and given this gauge has been on sawtoothing but steady upward march since 2014, the need for ultra-loose monetary policy must surely come into question. “With inflation firming in recent months and economic output running near full potential, the Riksbank’s justifications for its ultra-loose monetary policy are starting to wear thin,” Oxford Economics writes, arguing that markets will begin pricing in a tighter policy route, which would ultimately see SEK strengthen versus the EUR. “While the ECB has also been ultra-expansionary, the Riksbank’s policy activism has been at a totally different level, and the impact of its policy easing has been disproportionate on Swedish rates and the krona.”

• The consultancy argues that downside risks to inflation have eased, while core inflation is firming, leaving the Riksbank in reach of its inflation target in Q3. Additionally, a likely softening of Eurozone growth – as has been indicated by some survey data will erode the euro yield advantage.

• “The likely announcement of ECB QE tapering in autumn is will probably provide a boost for the euro,” Oxford Economics writes, “nonetheless, the Riksbank will soon find itself ready to claim victory against deflation. That means it will exit its ultra-loose policy and start hiking rates before the ECB,” which will likely steepen the Swedish short-end and boost the SEK.

• This week, labour market data will likely show the jobless rate edging down by 0.1ppts to 7.10%. We will be keeping an eye on both consumer and manufacturing confidence; the former expected to slip a touch albeit from the best levels since 2010.

(Write to Yogesh Chandarana: Yogesh.Chandarana@RANsquawk.com)
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