“Continuity With Change”

By Benjamin Picton, senior macro strategist at Rabobank

Continuity with Change

“Continuity with Change” was the comically vapid election slogan of Julia Louis-Dreyfus’ Selina Meyer in the hit TV show ‘Veep’. It’s appropriate for this week in markets, which may have marked an inflection point in some respects, but there was also a strong hint of sameness in some of the ‘variation on a theme’ central bank moves.

Wednesday’s CPI inflation report for the USA was received as a harbinger of welcome change by jubilant equity markets. The softer than expected read for both core and headline inflation also added momentum to a rally in bonds that was sparked earlier in the week by the Mannheim report that showed a fall in used car prices of 4.2% from May to June. 10-year Treasury yields retreated from the year-to-date high of 4.07% as at market close last Friday.

Lower than expected inflation obviously raises some questions on the policy path for central banks. San Francisco Fed President Mary Daly said overnight that the inflation report was “very positive”, but that it was too early to declare victory on inflation. Christopher Waller seemed to hedge his bets by suggesting that two more rate rises are appropriate, but that another two soft inflation reports would justify a pause in the hiking cycle. So, continuity with change?

Both Daly and Waller are considered to be hawks, but talk of a pausing from Waller is particularly interesting because (unlike Daly) he is a voting member of the FOMC this year. Another well-known Fed hawk, James Bullard, announced this week that he will be departing the St Louis Fed to take up a role in academia. Bullard has formed something of a double-act with Loretta Mester in the vanguard of the PR assault on inflation by regularly frontrunning policy decisions with public comments about the need for the Fed to go harder. Bullard and Mester have been well placed to play the Devil’s advocate this year because neither are voting members, but with that poised to change in 2024, the timing of Bullard’s exit is certainly curious. Has he sniffed the wind on a change in the inflation outlook?

News of James Bullard’s departure came shortly before an announcement today that Philip Lowe would not be re-appointed as RBA Governor. Markets had certainly been expecting Treasurer Jim Chalmers to draw a line under the Lowe years, but the appointment of current deputy Michele Bullock as the new Governor from the 18th of September came as a bit of a surprise. Finance Department Secretary Jenny Wilkinson had been considered the favourite for the role given the government’s indicated preference for a female candidate, Wilkinson’s strong academic credentials, a decade of previous experience at the RBA and a reputation for no-nonsense competence. It seems that her chances may have been stymied by Opposition Leader Peter Dutton, who suggested that appointing a serving department head (who has been responsible for implementing the government’s policy agenda) would unduly politicise the central bank.

So, Michele Bullock has been given the nod and will become the first female Governor in the Bank’s history. She will now oversee the implementation of the 51 recommendations of the RBA Review, including the shift from 11 meetings a year to 8 meetings a year from February onwards. Aussie 10-year bonds have underperformed Treasuries this morning as rates traders digest the news. The fact that Bullock was a voting member of the RBA Board for the 12 rate hikes delivered since May last year, along with her past comments about needing to get the unemployment rate up to 4.5% to see inflation sustainably back in the 2-3% target band, seems to have convinced traders that she will delivered on Philip Lowe’s “deadly serious” commitment on bringing inflation to heel. A change in leadership (and structure), but continuity of approach.

Elsewhere this week we saw policy rate decisions from both the Reserve Bank of New Zealand and the Bank of Canada. The RBNZ left their policy rate unchanged at 5.5%, effectively confirming the end of the aggressive hiking cycle that had seen the OCR increase at 12 consecutive meetings from October 2021 onwards. Despite the hold in rates, the RBNZ noted that credit conditions will continue to tighten as a large number of Kiwi mortgages reset from pandemic-era fixed rates to much higher variable rates in the weeks ahead. This coincides with sharp slowdowns in new housing construction, business investment and consumer spending that have already seen the economy tip into a technical recession, despite labor market indicators remaining historically strong. Nevertheless, markets scented a slight hawkish bias in the Monetary Policy Statement and we saw a bit of a lift in NZDUSD upon its release.

The Bank of Canada delivered another 25bps to take the policy rate up to 5%. Governor Tiff Macklem singled out surprisingly resilient food price inflation in justifying the further policy tightening, but also noted that household consumption and labour markets have remained stronger than previously expected. The BOC’s forecast on inflation returning to the 2% target was pushed back two quarters to mid-2025, despite warnings of slowing growth. Our resident expert on the Canadian economy, Christian Lawrence, expects no further rate hikes from the BOC, which is also our expectation for the RBNZ. The two economies show remarkable similarity, with policy rates now at a peak (we think), economic growth under pressure and inflation moving lower (albeit not as fast as policy makers might like). As with the EU, USA, UK and Australia, tight labour markets remain a concern as elevated wage claims pose upside risks to services price inflation and keep some possibility of further tightening alive, even as headline inflation figures fall back towards target.

Signs of labor cost pressures are not difficult to find. The Bureau of Labor Statistics this week reported that US real average hourly earnings increased by 1.2% in the year to June, while UK public servants have been offered pay increases of at least 5%. The American Screen Actors Guild (Ronald Reagan’s old shop) has decided to join Hollywood writers in taking strike action on Friday after failing to reach agreement with studio heads over new labour contract conditions. SAG President Fran Drescher said that “The entire business model has been changed by streaming, digital, artificial intelligence… If we don’t stand tall right now, we are all going to be in trouble. We are all going to be in jeopardy of being replaced by machines and big business.” That would be quite the change indeed, but Hollywood might find it hard to elicit much sympathy for their situation from “deplorables” in flyover states who were similarly disrupted into structural unemployment 30 years or more ago.

And finally, in Vilnius this week there was some change with a lot of continuity. Chronic holdout Turkey finally agreed to back Sweden’s application for NATO membership, but there was less enthusiasm for Ukraine to join the alliance. Existing members expressed concern that accepting Ukraine’s application could lead to escalation in the war with Russia. There are signs that Ukraine’s Western allies may be growing war-weary, but for now hostilities continue to grind on.