Week ahead – ECB, BoC and BoJ meetings in the spotlight
It’s a huge week ahead, with three central bank meetings and a storm of data releases that will reveal how major economies are performing amid crippled supply chains. The Bank of Canada could signal that sharp rate hikes are coming, while the European Central Bank could push back speculation of early tightening as Europe grapples with the energy shock. Likewise, investors may have gone too far in setting prices for aggressive rate hikes in the UK and Australia.
BoC – Prepare for take off
The Canadian economy is absolutely roaring. Growth is coming back in line, inflation is soaring, businesses are bullish, the real estate market is on fire and oil prices continue to rise. Better yet, the recovery in the labor market has been spectacular, with employment already returning to pre-crisis levels. This suggests that wage growth may soon pick up to keep inflation momentum going.
It will all be music to the ears of the Bank of Canada, which is meeting on Wednesday. Another reduction in weekly asset purchases seems almost certain, before the full end of the QE program in December. The real question is how the central bank will react to investors who expect big rate hikes.
Money markets are forecasting three rate hikes for next year, the first around April. But given the strength of the economy, that might be too conservative. The energy industry could rampage on investment if oil prices hold, turbo-fueling an economy that is already operating near full capacity. This is exactly when a central bank needs to put the brakes on to avoid overheating, especially with the potential for home bubbling.
If the BoC did indeed recalibrate its language to signal that the bullish cycle could begin earlier, it would likely fuel the recent rally in the Canadian dollar. The main risk factor is that the BoC does not want to get too far ahead of the Fed for fear that the loonie will appreciate too quickly. But with the things going so well, there isn’t much to choose from.
The ECB will play a bit in defense
In the euro zone, the situation is not so encouraging. Stagflation fears dominate as supply disruptions threaten to slow growth while soaring energy prices keep inflation high. There is also the risk of a slowdown in China. The housing market there is experiencing a painful hangover as the huge construction sector deleverages, and with China being the Eurozone’s largest trading partner, some collateral damage seems inevitable.
With this in mind, the European Central Bank, which will meet on Thursday, will not be comfortable with the fact that investors are banking on the first minor rate hike (10 basis points) for next year. The only positive point is that inflation expectations are finally rising, but only because of the energy spiral – growth prospects remain bleak.
This implies that the ECB could push back market prices, downplaying the scenario of a rate hike next year and therefore dealing a minor blow to the euro. President Lagarde recently reaffirmed her position that inflation is transitory, so the risk of a change in tone seems low.
There’s also a heavy dose of data releases, including the preliminary reading of GDP for the third quarter and inflation numbers for October, both on Friday.
US GDP disappointment?
In the United States, the first estimate of third-quarter GDP will be released on Thursday. There is a clear disconnect between the market forecast and the Fed’s models on it. While the consensus among economists is 3.2% annualized growth, the Atlanta Fed’s GDPNow model estimate stands at just 0.5%.
The funny thing is that GDPNow’s estimate started the quarter above 6%, but has steadily declined as economic data continues to disappoint. This heralds some downside risks around the next GDP figure.
This could put pressure on the dollar, but any weakness should be short lived. America is currently the most resilient of the major economies thanks to its energy independence and Congress willing to spend more to stimulate growth. In contrast, energy shortages are likely to hit Europe and China harder, without impressive government spending either.
Along with the GDP report, durable goods orders will hit markets on Wednesday, while Friday will bring a barrage of publications including income and personal spending statistics alongside the Fed’s preferred inflation measure – the all for September.
Reunion BoJ – another snoozer
In Japan, the central bank concludes its own meeting early Thursday. We don’t expect much. The economy barely managed to escape deflation despite the inflationary supernova in the rest of the world. This implies that demand is quite fragile and that the Bank of Japan will not be joining the global rate hike party anytime soon.
Precisely because there is no expectation of real policy change, the yen no longer responds to BoJ decisions or economic data releases. Instead, the currency is almost entirely determined by the movement of foreign yields. When global yields rise as investors anticipate higher inflation, Japanese yields cannot participate as the BoJ maintains a cap on the country’s bond yields so that credit spreads widen at the expense of the yen.
This is exactly what has crippled the currency lately. As long as the market trades on inflation fears and rate hikes from foreign central banks, the yen will likely continue to suffer.
UK budget and Australian inflation
In the UK, Finance Minister Rishi Sunak will present his latest budget on Wednesday. It looks like government spending will be cut further to limit debt levels now that the economy is healthier. There is also a fear that a sharp increase in spending will fuel inflation further and force the Bank of England to raise rates faster, thus increasing the debt burden.
As for the pound, the outlook does not look so bright. The BoE will soon raise rates in a slowing economy, to fight rising inflation expectations. This risks stifling the recovery and may ultimately be a policy error. Indeed, market prices are already super aggressive. The first rate hike is scheduled for December of this year, with three more to follow next year. There are a lot disappointment here, because the UK economy is not really running at full speed.
Finally in Australia, inflation statistics for the third quarter are due on Wednesday. Markets are playing ‘chicken’ with the RBA, fixing the first rate hike for August 2022 while the central bank itself insists that won’t happen until 2024. Therefore, the RBA also seems too aggressive , especially with China grappling with an economic downturn and struggling iron ore prices.