Aurelia Butler

The Market Has Spoken, and it says the Federal Reserve won’t raise rates tomorrow. After the May inflation print came in a bit lighter than forecasts, Fed funds futures are priced like it’s a near certainty the US central bank will hold rates steady in their 5-5.25 per cent range.(For specifics: CME’s FedWatch shows futures markets pricing a 94-per-cent probability of US rates staying in their current range this week, compared with 79 per cent yesterday.) But how much lighter did inflation come in, exactly? While lower energy costs and a slowdown in food inflation weighed down the broad inflation figures, shelter and used-car inflation remained strong. So it was a bit of a mixed bag, which helps explain why a rally in Treasuries kicked off by the CPI report had petered out by midday. One thing the CPI (and the market reaction) shows is that it’s rather unhelpful to look at broad headline numbers without digging into the underlying drivers. So let’s take a look at a few individual sectors, with the aid of this chart from Wells Fargo:

1) Rents. US rent inflation decelerated a bit, with May shelter costs up 0.5-per-cent from the prior month (compared to April’s 0.6-per-cent rise in rent, and 0.5 for owners-equivalent rent). That’s in line with the predictions from Goldman Sachs economists earlier this week.Hotels, for their part, did see a significant jump in prices, with lodging away from home rising 1.8 per cent for the month on a seasonally adjusted basis, and 2.6 per cent unadjusted. All in, shelter inflation was the biggest contributor to the month’s increase in CPI. 2) Used cars. Inflation in used cars and trucks didn’t slow at all on a seasonally adjusted basis. Prices rose 4.4 per cent in May alone, in line with April’s 4.4-per-cent jump. Used cars and trucks were the second-biggest contributor for the month’s inflation; the recent decline in wholesale used-car prices hasn’t even started to show up for buyers. Car insurance didn’t help either! It was up a seasonally adjusted 2 per cent for the month, and 17 per cent over the year ended May. 3) Food. The cost of in groceries crept up in May after a couple of months of declines, but only rose about 0.1 per cent. Egg prices slid 13 per cent (!) for the month, as the supply pressures from earlier this year eased. Oh, and pork costs were down 0.8 per cent from the prior month. Looks like the “Summer of Pork” is indeed getting under way. Mixed data is “likely to help confirm pre-release biases in the outlook among investors”, says Jefferies economist Thomas Simons:The soft landing/”immaculate disinflation” camp can point to the deceleration in the headline, deceleration in core services, and the fact that headline would have been flat if it weren’t for used cars as signs that the Fed is getting what it wants without having to engineer a big slowdown in growth. However, the hard landing camp can point to the decline in energy prices that won’t be repeated, and the continued pressure in both shelter and core service prices as reasons to expect that consumers are going to pull back on discretionary spending as reasons to believe we are already headed for a recession.We have been in the hard landing camp for a while now, and we have no reason to change based on this data. This does not change anything for the Fed either, as they are overwhelmingly likely to pause at the meeting tomorrow, and unlikely to be forced to hike again this cycle. But really, not much has changed, says JPMorgan’s Michael Feroli:One can make a hopeful case out of today’s figures, particularly if you believe industry data on rents and supplier delivery indices portend softer rent and goods prices. However, that same argument could have been made a few months ago, and so far, it’s hard to see much improvement. By our reckoning May core PCE looks on track to increase 0.35%, or 4.7% on a year-ago basis, which would be unchanged from April.And “directional progress should not be confused with mission accomplished,” say Wells Fargo’s Sarah House and Michael Pugliese:We expect a more noticeable deceleration in core prices in the coming months. Shelter inflation appears to have peaked and should continue to slow in second half of the year. The recent jump in used autos prices is not sustainable, and we believe this category should resume its downward descent very soon. Excluding used autos, core goods inflation has shown signs of easing amid normalizing supply chains and moderating demand.[ . . . ] If, as we expect, core CPI is still growing at a 3.0%-3.5% annualized rate in the fourth quarter of this year, it should keep the FOMC from cutting rates until 2024. In the more immediate future, today’s data should lock in a pause at the June FOMC meeting, i.e. no rate hike. However, we expect Chair Powell’s press conference and the latest Summary of Economic Projections to signal that one more rate hike is still in the cards. More

China unexpectedly cut a key interest rate on Tuesday and announced tax breaks for businesses, as weakening credit growth added to signs a post-Covid recovery in the world’s second-largest economy is losing steam.The People’s Bank of China cut the seven-day reverse repo rate, used to manage short-term liquidity in the banking system, in a move analysts said probably signalled more substantial monetary easing and stimulus measures to come.Following the rate cut, the government released credit growth figures for May that analysts said fell well short of forecasts as a weak property market weighed on consumer sentiment.China’s economy staged a comeback in the first quarter after the lifting of draconian Covid controls, but it has begun to falter in recent weeks as export growth has slowed and the real estate market has struggled to re-emerge from a long slump.While the services sector is strong, with restaurants and other businesses reopening, factory activity is weak and construction has been constrained by the property market downturn.The government sought to help address this on Tuesday by cutting the seven-day reverse repo rate by 10 basis points to 1.9 per cent in order to “maintain reasonably sufficient liquidity in the banking system”.It was the first cut in nine months to the rate, which sets the cost of seven-day lending by the central bank. Lowering the rate pulls down the cost of short-term loans and boosts liquidity in China’s financial system.On Tuesday, the government also announced 22 measures to lower costs for companies this year, including tax breaks and measures to reduce interest rates and to channel loans to certain sectors.Analysts believe the reverse repo rate reduction could presage cuts to the PBoC’s other policy rates — the medium-term lending facility rate (MLF) and the benchmark loan prime rate (LPR). “We expect more monetary policy easing measures to be announced, including MLF rate and LPR cuts over the next few days,” Goldman Sachs said in a note. New bank lending was Rmb1.36tn ($190bn) in May, well short of Rmb1.6tn forecast by a Reuters poll of analysts. If the government wanted to stimulate a recovery in loan demand, it would need more aggressive rate cuts, said Julian Evans-Pritchard, head of China economics at Capital Economics. But Beijing was reluctant to follow the example of central banks in developed countries, which aggressively eased monetary policy during the pandemic only to have to rapidly tighten afterwards. “Obviously, the way to boost credit demand is to cut interest rates, but 10 basis points are not enough to have much impact on credit demand,” Evans-Pritchard said.With demand for credit low, many analysts argue easing monetary policy on its own will do little to boost the economy. More substantial steps could include providing developers with extra help to complete unfinished real estate projects. While China’s consumers are sitting on large piles of savings and property prices are affordable by historical standards, many developers lack the funds to complete projects after a prolonged downturn.“The main problem is that households don’t have confidence that developers will deliver the units that they buy. The government’s efforts should be focused on that,” said Evans-Pritchard. More

Fund managers have cut commodities allocations to their lowest levels for three years in a shift that illustrates declining confidence in the outlook for Chinese demand for raw materials and fears that the global economy will enter recession.Bank of America’s monthly global fund manager survey showed that a net 3 per cent of managers held an “underweight” position in commodities in May after canvassing the views of 247 institutional investors that together oversee $708bn of assets.Investor sentiment towards commodities has weakened markedly, dropping 17 percentage points over the past two months, the steepest deterioration since August 2015, according to BofA.Most major commodity prices, apart from gold, sugar and beef, have fallen over the past 12 months. The S&P Goldman Sachs Commodity total return index, the most widely followed commodities benchmark, has dropped 27 per cent since reaching a near eight-year high in June 2022Francisco Blanch, BofA’s top commodity strategist, said commodity declines had been driven by a combination of rapid increases in US interest rates and the lenient economic sanctions imposed in response to Russia’s war in Ukraine which had allowed Moscow to minimise revenue losses from oil and gas exports.“This combination of lax commodity sanctions on Russia and less money in the [global financial] system has contributed to a major commodity price pullback,” said Blanch.Sentiment towards commodities has also been dented by evidence that the bounce in Chinese economic activity following the easing in November of coronavirus lockdown restrictions has fizzled out, with official purchasing managers surveys indicating that manufacturing activity shrank in both April and May.“Growth is stalling in key China sectors, most notably the property sector,” said Duncan Wrigley, chief China economist at the consultancy Pantheon Macroeconomics.Wrigley said he expected the Chinese government to introduce limited new measures to support economic growth but he cautioned that policymakers in Beijing remained wary of the risk of creating another debt hangover if they pursued another major stimulus programme on the same scale as the response to the 2007-08 global financial crisis.Iron ore prices and some Chinese real estate stocks have rallied on expectations of a large property-related stimulus but Aakash Doshi, a senior commodities strategist at Citigroup in New York, cautioned that Beijing would aim “to prop up but not to pump up” domestic economic activity.“Real Chinese commodities consumption appears weak for metals, energy, and grains, and is unlikely to rebound in the short-term,” he said. Ricardo Leiman, a commodity trading veteran who is now chief investment officer at KLI Asset Management, said a decline in investor activity, driven in part by the growth of algorithmic trading, had resulted in structural changes in commodity markets.“The participation of investors has been severely reduced. If you look at the positioning in the market relative to open interest [active derivative contracts], then it is one of the lowest in the past 20 years,” said Leiman, a former chief executive of two commodity trading houses, Noble Group and Engelhart. More

Traders of futures tied to the Fed’s policy rate now see about a 95% chance the U.S. central bank will decide to forgo an 11th straight interest-rate hike and keep the benchmark rate at 5.00% to 5.25% on Wednesday. Before the report, traders saw about a one-in-four chance of a June rate hike. Traders also trimmed bets on a Fed rate hike in July, overwhelmingly expected in markets before the report, which showed consumer prices rose 4% in May from a year earlier. That was the smallest annual gain in more than two years. “The data ever so slightly tilts things towards this not just being a skip, but a full-blown hold,” said Brian Jacobsen, chief economist at Annex Wealth Management. More

President Recep Tayyip Erdogan, re-elected last month, has just appointed former U.S. banker Hafize Gaye Erkan as the new central bank governor. She is his fifth since 2019. He has also picked Mehmet Simsek, a former deputy prime minister respected by international investors, as finance minister. Turkey has a long track record of yo-yoing its interest rates, cutting them sharply and then raising them even faster every time a currency market crisis strikes. Erdogan, a lifelong critic of high borrowing costs, pushed the central bank to cut its rates from 19% two years ago to 8.5% in the run up to last month’s elections. The central bank will meet next Thursday. Below is what some of the big investment banks expect to see:J.P.MORGAN “We think that a policy rate hike to 25%, from the current level of 8.5%, for the June 22 MPC meeting is on the table along with forward guidance suggesting smaller rate hikes if needed.””We maintain our year-end policy rate forecast at 30%, with risks on the upside. We forecast a recession in 2H23 on the back of a tightening in credit conditions.””The lira depreciated by 10.5% against the dollar last week as a signal of a policy pivot to orthodoxy. The lira depreciation and a slowdown in domestic demand should improve the current account balance in 2H23. That said, inflation is likely to rise.” DEUTSCHE BANK “It is difficult to assess the precise reaction function at this point in time, but we would argue that the recent fast depreciation of the currency requires a credible first hike.””We would expect levels slightly below the current lira deposit rates (27%) as adequate for the time being. This could be achieved via a one-off hike to 25% or two consecutive hikes in June & July.” “In the second scenario, we would expect an immediate hike close to 18%-20%, most likely closer to the upper-end of this, followed by another hike in July to 25%.””We would not rule out the need for slightly higher rates in this cycle, but would not expect rates above 30%. In any case.””In our view, a near term clearing level for the exchange rate of around 25 (lira to the dollar) is reasonable. Should USD/TRY reach this level, and authorities deliver a sizeable interest rate hike… we could see the possibility of a tactical period of lira outperformance.”GOLDMAN SACHS”We think a currency adjustment will be accompanied by a large front-loaded hike to the TCMB’s (central bank) marginal lending rate.””Turkish lira interest rates on deposits without FX protection have already repriced towards around 40% and have largely de-linked from policy rates.” “We think the incoming team will want to re-establish its marginal lending rate as the anchor for interest rates in the economy, and hence will raise it upfront towards deposit rates.” “We are, however, sceptical that the marginal rate will be the repo rate, or that the repo rate will be used to help limit the shock of the repricing for banks and the corporate sector.””Once the exchange rate stabilises, we think the marginal rate can fall fairly quickly, and we expect it to fall to 25% by end-year, although this requires a stabilisation of inflation expectations.”MORGAN STANLEY”With Mehmet Simsek’s appointment as Finance Minister and his initial remarks, we expect more conventional policies, including faster currency depreciation and higher policy rates.” “We expect rates to reach 20% in June and 25% in August. Uncertainty remains very high as more policy guidance can be expected.””We might see smaller moves in the currency (compared to June 7 slump) until the authorities have their plans in place on monetary policy and other aspects of the economic programme – our strategists see USD/TRY around 28 at year-end.” “Given Turkey’s past experience with relatively short-lived u-turns in interest rate policy, enhancing credibility will likely take time, but this pivot should rule out risk scenarios related to reliance on more unconventional measures, including stricter regulations on FX transactions, to sustain extremely low rates.” More

BENGALURU (Reuters) – The Bank of Canada will raise interest rates again in July to 5.00% after a surprise 25 basis point increase last week, according to economists polled by Reuters, who unanimously said the main risk was the central bank might have to do more. In the run-up to the BoC’s shock move on June 7, most economists said there would be no further hikes this year, underscoring a sharp turnaround in sentiment rooted in widespread concerns inflation is not coming down fast enough.After raising the overnight rate to a 22-year high of 4.75%last week, the BoC noted “monetary policy was not sufficiently restrictive” and showed concerns inflation “could get stuck materially above the 2% target.”Inflation unexpectedly rose for the first time in 10 months to 4.4% in May and activity in the normally interest-rate-sensitive housing market has rebounded, suggesting rates still aren’t quite high enough. The BoC will hike its overnight rate by 25 basis points to 5.00% at next month’s meeting, according to 20 of 25 economists in a snap June 8-13 Reuters poll. The remaining five expected the bank to hold at 4.75%.”When you resume hiking, you don’t resume for one 25 basis point hike. Otherwise, it’s better to do nothing,” said Sebastien Lavoie at Laurentian Bank, one of the few economists who correctly predicted a hike last week.Also the only economist who now expects two more quarter-point moves at the next two meetings, Lavoie said “a 25 basis point hike as they did last week doesn’t buy much conviction that inflation will be at 2% at some point in 2024.”All but three of 25 economists forecast the overnight rate to peak at 5.00% or higher, 50 basis points more than was predicted in the last survey published on June 2.All 21 respondents who replied to a separate question said the bigger risk to their terminal rate forecast was that it would be higher than they now expect.”At the core, the view is that the labour market is still very tight, and now even the housing market is starting to improve…(and) that really does raise questions whether policy is tight enough at this point,” said Doug Porter, chief economist at BMO Capital Markets.”The bigger risk to the outlook is we all get surprised at how persistent underlying inflation is.”House prices, a major component of the inflation basket, have already started rising again and are set to recover further on the back of still-resilient demand, according to a separate Reuters survey taken before the surprise move.The economy grew at a much faster-than-expected 3.1% annualized pace in January-March after a contraction in the quarter before, beating the central bank’s projection, one reason why the central bank resumed hiking. Only one of 25 economists expected a rate cut this year, compared with five in the last poll. There was no clear consensus on where rates would be by end-Q1 2024, partly because fewer economists have settled on a policy outlook for next year.(For other stories from the Reuters global economic poll:) More