2021’s last (major) roll of the data and policy dice

Markets’ focus has in the past three weeks understandably been on the Omicron variant and the reaction function, present and future, of governments and central banks.

The multiplication of social distancing restrictions and acceleration in booster jab programs in many major economies since late-November suggest that policy makers’ conviction that the Omicron variant will prove benign is still quite low.

The central bank policy meeting and in particular macro data calendar was reasonably light last week. But markets’ dovish reaction to in-line with consensus US CPI-inflation data for November are evidence, if any was needed, that macro data still matter.

In contrast, the macro data and in particular central bank policy meeting calendar is very heavy this week.

We estimate that 23 central banks will hold their last policy meetings of the year. These include all the “heavy hitters”, namely the Federal Reserve, Bank of England, ECB and Bank of Japan. A large number of Emerging Market central banks, including in Indonesia, Mexico, Russia and Turkey, also have scheduled policy meetings.

The macro data release calendar is just as heavy, particularly in the US, UK and China. Of course not all central policy meetings and macro data releases will carry the same weight, with markets perhaps more focussed on December data, however preliminary.

The bottom line is that the next four days could prove pivotal for global markets, including major currencies and interest rates, at least until the new year when financial markets could conceivably “re-set” their positions for subsequent weeks and months.

We expect the Federal Reserve to announce a faster pace of tapering for its asset purchases but the devil will be in the detail and updated FOMC “dot-chart”.

We think the Bank of England will once again keep its policy rate on hold at a record-low 0.10%, but the breakdown of the nine MPC members’ votes is up for debate.

 

Race to understand Omicron variant continues to grab headlines…

Markets’ focus has in the past three weeks understandably been on the Omicron variant of the Covid-19 virus and the reaction function, present and future, of governments and central banks. The evidence so far points to the Omicron strain being far more transmittable than the Delta strain but also far less virulent and that vaccines and booster jabs are still partly effective at protecting against severe illness or death (see Don’t forget Delta, 9th December 2021).

However, the multiplication of social distancing restrictions and acceleration in booster jab programs in many major economies since late-November suggest that policy makers’ conviction that the Omicron variant will prove benign is still quite low. Put differently, rightly or wrongly, governments on the whole have adopted a “path of least regret”, even if the powers that be in the United Kingdom and in particular the United States have taken a more laissez-faire approach than their counterparts in the European Union (EU) in our view. Moreover, many EU governments have faced a rapid rise in Covid-19 deaths in the past six weeks (i.e. before Omicron became a variant of concern) and thus introduced a number of measures, including watered-down lockdowns in Germany, the Netherlands, Austria and Belgium which remain partly in place (see Don’t forget Delta, 9th December 2021).

The Omicron variant has arguably added a layer of complexity and concern. We think that most governments will stick to risk-averse strategies until they have conclusive domestic data that the Omicron variant will not strain to breaking points health systems already under pressure at this time of the year or worse lead to a material increase in deaths, even if for a limited period of time. Importantly, we will know far more this week about major central banks’ reaction function to Omicron and the extent to which financial markets are “aligned” with policy decisions and statements.

 

….but markets face heavy calendar of tier-1 macro data and central bank policy decisions

The central bank policy meeting and in particular macro data calendar was reasonably light last week. On the policy front the highlights were arguably central bank policy meetings in Australia and Canada and a number of Emerging Market (EM) economies, including India, Poland and Brazil.

On the macro data front the release on Friday of US CPI-inflation figures for November took centre stage. US CPI-inflation data have remained very volatile this year and thus hard to predict, with CPI-inflation in October rising much faster than expected (see Macro data dog not wagging FX market tail, 22nd September 2021). Unlike in previous months core and headline consumer prices rose in line with consensus forecasts in November and yet 2-year US Treasury yields fell sharply (about 7bp) following the release – evidence, if any was needed, that macro data still matter.

 

 

In contrast with last week, the macro data and in particular central bank policy meeting calendar is very heavy this week, as it always is in the third week of December before official institutions start to wind down ahead of the Christmas holidays (see Figure 1).

We estimate that 23 central banks will this week be holding their last policy meetings of the year. These include all the “heavy hitters”, namely the Federal Reserve (15th December), Bank of England and European Central Bank (16th December) and Bank of Japan (17th December). The Swiss National Bank and Norges Bank (the first developed market central bank to hike rates since the pandemic began) will also set policy rates this week, as will a large number of EM central banks (including in Indonesia, Mexico, Russia and Turkey). Among major economies only China, Thailand and the Czech Republic will hold central bank policy meetings next week.

The macro data release calendar is just as heavy this week, particularly in the:

  • United States;
  • United Kingdom, which already released this morning labour market figures for October-November and is still due to release CPI-inflation, PMI and retail sales numbers; and
  • China, with three key data sets due out on Thursday.

That is not to say of course that all central policy meetings and macro data releases will carry the same weight in the eyes of market participants, as we detail below. However, the bottom line is that the next four days could prove pivotal for global markets, including major currencies and interest rates, at least until the new year when financial markets could conceivably “re-set” their views and positions for subsequent weeks and months.

 

Federal Reserve – Devil in the detail…and updated “dot-chart”

The Federal Reserve policy statement, press conference and updated projections are likely to be the elephant in the room. While, in our view, the Federal Reserve looks set to announce a slower pace of asset purchases (i.e. faster tapering) than announced at its 3rd November policy meeting, the devil will be in the detail. Moreover, markets will pour over the Federal Reserve’s new forecasts for core PCE-inflation (its preferred measure of inflation), GDP and the unemployment rate and on the updated “dot-chart” of FOMC members’ expectations for the appropriate policy rate.

The September “dot-chart” showed that half of the 18 FOMC members thought it would be appropriate to hike the policy rate by 25bp in 2022. However, beyond 2022 FOMC members remained still very divided as to how high the policy rate should go. Our core scenario is that this week’s “dot-chart” will show that a greater number of FOMC members now think it would be appropriate to start hiking rates next year and that there will be more of a consensus as to the terminal point for the policy rate. Financial markets’ reaction to the Federal Reserve’s 22nd September policy meeting statement, press conference and “dot-chart” was mixed but ultimately un-dramatic, with the Dollar trade-weighted index remaining stuck in a narrow multi-week range. There is arguably more riding on Wednesday’s policy meeting, in our view.

 

Bank of England – MPC member vote breakdown likely to be key

The Bank of England and Monetary Policy Council (MPC) members have blown hot and cold for the past six weeks. However, we think the central bank will once again keep its policy rate on hold at a record-low 0.10%. The key question in our view is whether this week’s policy meeting results in a “dovish hold” (fewer than two MPC members vote for a hike), a “neutral hold” (once again only two MPC vote for a hike) or a “hawkish hold” (3 or 4 MPC members vote for a hike).

The most compelling argument for the Bank of England to hike rates on Thursday is that both UK core and headline CPI-inflation rose to a decade high of respectively 3.4% yoy and 4.2% yoy in October. Moreover, the consensus forecast is that data out tomorrow will show that the year-on-year rates of core and headline CPI-inflation rose further in November to respectively 3.7% and 4.7%. If correct this is likely to firm up Bank of England Governor Bailey’s concerns about keeping a lid on domestic inflation. Finally, data for October-November out this morning suggest that the UK labour market continued to strengthen, driven by strong demand for workers, and has shown little or no ill-effects from the termination of the government’s furlough program two months ago.

However, much of the rise in CPI-inflation has been due to surging international oil and in particular gas prices pushing energy and transportation costs higher rather than to strong UK consumer demand in our view. Governor Bailey has made the point, rightly in our view, that Bank of England rate hikes would do little to address cost-push pressures. The volume of retail sales, which had contracted in each of the previous five months by more than 5% in aggregate, rose only 0.8% mom in October with UK households still more prone to saving than spending. More broadly, the UK economy grew by a lacklustre 0.1% mom in October, the second slowest rate of monthly GDP growth since February.

While UK retail sales and GDP growth may have picked up slightly in November, the risk is that it will slump in December as a result of depressed consumer and business confidence, in our view. Michael Saunders, who along with Dave Ramsden is arguably the most hawkish of the nine MPC members, warned on 4th December that it was unclear to what extent the Omicron variant would impact the UK economy and suggested that it could make sense for the Bank of England to delay the start of its rate hiking cycle.

The consensus forecast, which we share, is that the Bank of England will leave its policy rate unchanged this week at 0.10%. The market is currently pricing in about 4bp of rate hikes – i.e. a roughly one in four chance that the Bank of England hikes by 15bp, which seems fair in our view (after all the Bank of England surprised markets in the other direction at its policy meeting on 4th November by keeping its policy rate unchanged at 0.10%; markets had priced in a 0.15bp rate hike to 0.25%).

 

Macro data releases will shed early light of Omicron’s impact on economic activity

Most of this week’s macro data releases are for the months of October and November and thus pre-date the official acknowledgement in late-November of the Omicron variant (see Figure 1) Therefore they will tell us little or nothing about how the Omicron variant and subsequent government measures have impacted consumers, companies and more broadly economies. Therefore financial markets may partly discount these “old” data sets.

However, these data releases will still colour policy decisions, this week and going forward, taken by governments and central banks in our view. Moreover, preliminary composite PMI figures for December (out Thursday) will give an early indication (even if imperfect) of how economic activity in the United Kingdom and Eurozone evolved in the past fortnight. In the United States, Empire State and Philadelphia Fed manufacturing indices for December will shed a (partial) light on how the manufacturing sector fared in the first half of December (although markets are likely to pay greater attention to the more informative ISM PMI data for December for the manufacturing and service sectors due to be released on respectively 4th and 6th January 2022).

Forthcoming FIRMS reports will delve into the other central bank policy decisions and key macro data due out this week.