Friday Feb 23 2024 13:55
12 min
No bubbles please, we’re British. Record highs for everyone – Tokyo, New York, Frankfurt, Paris... Poor old London and the FTSE 100 aren’t getting a look in. Maybe that’s a good thing! We don’t like all this froth.
~$200bn added in one day for Meta
~$270bn added in one day for Nvidia
“Can one get inflation under control with stock and crypto markets adding trillions of [dollars of] paper wealth?” — J.P. Morgan.
The answer is clear – I don’t know. Does paper wealth really translate to demand-driven inflation? I think clearly the U.S. is in a really strong position and the economy is in good shape, at least on the face of things (labour market, GDP etc). Yesterday’s jobless claims were the lowest since January – hardly seeing the labour market loosen up. Nvidia shares jumped an astonishing 16%.
How does this square with the most rapid tightening cycle in 40 years? It’s almost like it never happened. The S&P 500 index gained 2% yesterday for a fresh record, whilst the Dow rallied over 1% to close above 39k for the first time.
And if we look at the Chicago Fed financial conditions index, it’s as loose as Jan 2022. It’s like the rate hikes never happened.
The Fed has tightened, nominally, but has it had an effect? Not yet, seems to be the evidence.
"[NVDA earnings] may be a catalyst not only for the Street to get materially more bullish on US Equities but also to see a further decoupling of stocks and yields since Mag7, are proving to deliver on earnings expectations irrespective of the interest rate environment," wrote J.P. Morgan.
So, does it matter now to the market what the Fed does? Do we even care what the 10-year yield does now? Maybe not! “Watching 4.35% to hold, otherwise some will start fearing 4.5%. Will rates matter then? Rates market seems a bit soggy at the moment given the overall market bid,” wrote analysts at BofA.
Citigroup says traders should start to price at the risk of a rate hike by the Fed. If there’s any shred of truth in this then a potential increase in rates by the Reserve Bank of New Zealand (RBNZ) next week would be a major event for markets that could affect a lot more than the Kiwi.
For the first time since May 2023, an increase in the official cash rate is a real possibility.
There are two questions we should ask ourselves: what is the likelihood the RBNZ sees fit to raise rates and, secondly, what might this mean for the Fed and market expectations more widely?
Right now, another Fed hike seems like a major black swan event – but should we be wary?
ASB says it is the first RBNZ decision since May last year for which an OCR increase is a realistic possibility. Whilst analysts continue to expect the RBNZ to remain on hold, the main risk is still that OCR cuts get delayed slightly.
In a detailed commentary on the RBNZ, analysts at ABS suggest that coming after 3 months of whipsawing data releases, the decision “will have everyone on tenterhooks”. Whilst this may be the first time since May 2023 that a rate hike is on the table, ASB says Governor Orr’s latest speech showed little signs of urgency to lift rates but did reinforce the ongoing focus on the persistent elements of inflation.
ANZ has a firmer view that a hike is coming, believing that the RBNZ will hike in February and April. ANZ’s chief economist Sharon Zollner argues for 50 basis points more hikes in total, taking the official cash rate to 6.0%.
The RBNZ warned in November that “If inflation pressures were to be stronger than anticipated, the OCR would likely need to increase further.” For Zollner, there have been enough upside surprises since then to warrant further tightening. “No one piece of data is to blame but a series of small, unwelcome surprises,” she said.
Two more OCR hikes only counter the 50bps increase in the long-run neutral OCR seen in the last two monetary policy statements. Policy is “running to stand still” in that context, notes ANZ.
“We see the risks as balanced around our updated forecasts. As we’ve stated, February is a line-ball call. If they don’t hike in February, we think they will in April, unless we start to see meaningful downside surprises,” writes Zollner.
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New Zealand’s consumer price index increased 4.7 per cent in the 12 months to the December 2023 quarter, according to figures released by Stats NZ. The 4.7 per cent increase follows a 5.6 per cent increase in the 12 months to the September 2023 quarter.
“While this is the smallest annual rise in the CPI in over two years, it remains above the Reserve Bank of New Zealand’s target range of 1 to 3 per cent,” consumers prices senior manager Nicola Growden said.
It’s still too high and the higher-than-expected non-tradeable CPI, which has done a lot of the heavy lifting in getting inflation down so far, was a worry.
Eight of the 11 main groups in the CPI basket increased in the quarter. And whilst 2-year inflation expectations declined to 2.5%, 1-year expectations remained above the 1-3% target range at 3.22%.
According to ANZ, “...in the context of an impatient Monetary Policy Committee with no tolerance for delays in the return of inflation to target, these data certainly weren’t a ‘slam dunk’ to rule out the need for further increases to the OCR”.
The critical point is not the inflation data itself, but the reaction function of the RBNZ. In this case it seems Governor Orr and other policymakers are becoming less tolerate of any inflation shocks due to the underlying inflation pressures that persist.
“We’ve got more work to do,” Orr told the Waikato Economics Forum earlier this month.
He has stressed the importance of bringing core inflation in line with the 1-3% target range so that inflation comes back to the 2% midpoint. The language is a good deal firmer than other G10 central bankers.
Note that Bank of England governor Bailey and the chief economist, Huw Pill, stressed that inflation does not need to come back down to 2% before the Bank would feel minded to cut. This echoes comments from some Fed speakers too.
“The RBNZ is giving itself up to 3 years to have forecast inflation back to 2%, although that length of time will also depend on its tolerance for the impact of any transitory inflation shocks – tolerance which is likely to be lower at present given the persistent underlying inflation pressures,” notes ASB.
It’s worth noting that any hikes, should they be delivered, would be unwound quickly, according to the analysis. With Nomura pointing out that tightening now would increase the risk of a hard landing for the New Zealand economy.
It’s important to appreciate that the RBNZ can lead the rest of the world in terms of its sequencing and timing of monetary policy shifts. But would a hawkish shift – albeit a temporary one with cuts forecast still for later in the year – lead the Fed into something similar?
A lot has already changed in terms of the Fed. Markets have priced out two rate cuts and now just 90bps of cuts are priced in – less than four 25bps cuts.
As noted above, Orr has been sounding somewhat more hawkish than their peers, which suggests that other central banks are not in a similar position to the RBNZ, or at least are far less worried about resurgent inflation than his commentary might indicate.
The BoE and European Central Bank are seen moving around June with a cut, and recession risks are such that the risks around domestic price pressures seem skewed to the downside, helping smooth the path to perhaps earlier cuts than the market thinks right now.
For the Fed, the situation is more balanced. Strength in the labour market has not diminished and the economy is apparently in much better shape than Europe or Britain. The Fed is clearly mindful of cutting rates too soon, but so far has not indicated anything other than easing is the next phase. On Jan 31st chair Powell said, “We believe that our policy rate is likely at its peak for this tightening cycle”.
Further to this, minutes from the January meeting showed a reluctance to move too soon on cuts – obviously this is not the same as a hike, but it shows the thinking. "Most participants noted the risks of moving too quickly to ease the stance of policy,” the minutes said, whilst adding that rate cuts wouldn't be "appropriate.... until they had gained greater confidence that inflation was moving sustainably toward 2%".
But there is an undercurrent of hike chatter that is growing. Former Treasury Secretary Lawrence Summers recently stated that persistent inflationary pressures could see the Fed’s next move to hike not cut.
Indeed, U.S. core inflation was stronger than expected in January. Core CPI rose 0.39% from December, leaving the year-on-year rate steady at 3.9%. Whilst this seems innocuous enough, we have to look at what the market and the Fed are eyeing up, which is the annualised trend.
The 3-month annualised rate rose to 4% from 3.3%, whilst the 6-month annualised rate was 3.7% from 3.2%. And most worrying of all for the Fed was the so-called ‘supercore’ inflation rate.
It’s hard not to think Fed policymakers are not looking with furrowed brows at the +0.9% increase in the supercore rate of inflation, the biggest uptick since April 2022. This pushed the yearly supercore rate to 4.4% in January from 3.9% in December, an eight-month high.
“There’s a meaningful chance — maybe it’s 15% — that the next move is going to be upwards in rates, not downwards,” Summers said on Bloomberg Television. “The Fed is going to have to be very careful.”
So far, the market has been reluctant to consider a hike is next, albeit the number of cuts expected this year has fallen. But if the RBNZ hikes we could see the Treasury market sit up and take notice.
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