Central Bank Watch – RBA, BOC Surprise Hikes Ahead of FOMC

Week two of the world’s most influential central banks delivering policy decisions this week. Two major central banks, the Reserve Bank of Australia and the Bank of Canada surprised markets this week by resuming rate hikes to combat stubbornly high inflation, pushing up bond yields across developed markets. The Reserve Bank of India kept its key lending rate steady for a second straight policy as widely expected but gave hawkish guidance. Banco Central de Reserva del Peru and the Central Bank of Russia kept rates unchanged as expected. The Federal Reserve, ECB, Bank of Japan and PBoC will deliver rate decisions in alongside key macroeconomic reports.

The Federal Reserve’s next move is overhanging global financial markets, June FOMC is still ‘live’. The FOMC is in communications blackout ahead of the June 14th decision. We look towards the most recent data and mutterings.

Central Bank Weekly Analysis and Outlook – Banker dynamics are complex. There are myriad facets to analyze and contemplate.

Central bank monetary policy decisions and market activity interest rate decisions can have a dominant effect on financial markets, fiscal policy and geopolitics. We keep an eye on key banker developments, what they mean and what is ahead.

In the Week Ahead

It will be a busy week for central banks with policy meeting and key data dropping. In the US, the Fed interest rate decision, inflation rate, retail sales, and Michigan consumer sentiment. We also get policy decisions from the European Central Bank and Bank of Japan monetary policy meetings. The central banks of Hong Kong and Taiwan will also have rate setting meetings.

Before the rate decision on Wednesday, the Federal Reserve will get the US CPI scheduled for release at 8:30 AM on Tuesday. The expectations are for a 0.2% m/m gain and a fall to 4.1% from 4.9% y/y. The market continues to anticipate no change in FOMC rates when they meet on Wednesday. While some Fed watchers feel they will raise with the BoC and RBA moves. The no change bias was reinforced on Thursday with U.S. initial jobless claims at the highest level since October 2021. Jobless claims rose to 261K well above the 235K estimate.

The Fed is currently not expected to conclude with a rate hike, but expectations for another 25-bps increase in July remain in place. Still, Fed officials continue to signal that more rate hikes may be needed. Markets are priced for around a one-in-three chance of a 25bps hike this week and a terminal rate of 5¼% that signals market expectations that the Fed is done hiking rates. The vast majority within the consensus of over 100 forecasters also expect a hold.

To say central bankers, have issues is an understatement. Already grappling with the quickest inflation in decades they now have these decisions to make, forcefully raise borrowing costs to defend currencies and risk hurting growth, spend reserves that took years to build to intervene in foreign exchange markets, or simply stand aside and let the market play out.

Central Bank Highlights This Past Week:

Most of the G10 central banks may complete their rate hike cycles around the middle of the year or earlier, the unwinding of central bank balance sheets may continue longer, depending on the damage done.

This week’s central bank main events included:

  • The Reserve Bank of Australia again surprised consensus with another 25-bps rate hike, lifting the cash rate to 4.10% to the highest level since May 2012. The RBA similarly surprised analysts last meeting.
RBA Suprises Again Raising Rates to Ten Year High 4.10%, Australian Dollar Higher
  • Bank of Canada raised its overnight rate to 4.75% in June 2023, the market has priced in a 60% chance of a hike, the Candian dollar rallied immediately after the release.
Bank of Canada Raises Rates After Five Month Pause by 25bps to 4.75%
  • The Reserve Bank of India on Thursday made no changes to its interest rates, as expected at 6.50% during its June meeting. Guidance however remained hawkish.
Reserve Bank of India Kept its Key Repo Rate at 6.50% as Expected
  • Bundesbank & ECB’s Joachim Nagel: Not certain rates will peak this summer, Underlying price pressure remain far too high, showing little sign of abating, Several more rate hikes are still necessary. Rate must be held until there is no doubt that inflation is returning to 2% in near term. Cautiously optimistic about #German growth prospects over the rest of the year
  • ECB’s Lagarde: Underlying inflationary pressures remain high. No clear evidence that underlying inflation has peaked Price pressures remain strong It is very likely we will stop all reinvestment in APP. Wages pressures have strengthened further. Decisions will continue to be based on incoming data. Our rate hikes are being transmitted forcefully to financing conditions. Full effects of our monetary policy measures are starting to materialize. Effects of our policy can be expected to strengthen in coming years
  • ECB policymaker Knot said that second-round effects and pressures in wages are being seen and that services inflation is harder to bring down.

Eyes on the Bond Market

U.S. Treasuries ended the week on the defensive with participants eyeing a flood of new supply in coming weeks and months as the Treasury works to replenish its General Account with an estimated $1 trillion of Treasury issuance as part of the latest debt-ceiling resolution. US yields moved higher this week, despite the lower dollar and expectations of no change from the Fed. The 2-yr note yield Friday rose 10 basis points to 4.62% and the 10-yr note yield rose three basis points to 3.75%. This week tightened the 2s10s spread by five basis points to -87 bps.

The 2-yr note underperformed this week ahead of next week’s FOMC meeting, which is currently not expected to conclude with a rate hike, but expectations for another 25-bps increase in July remain in place. Before the meeting, the U.S. Treasury will sell $296 bln worth of debt, starting with $123 bln worth of bills and $72 bln worth of notes on Monday with the remainder set for auction on Tuesday.

Treasury borrowings will now be playing catch up. Treasury Q1 issuance slowed to $124 billion to a record $26.956 TN. Outstanding Treasury debt surged $7.937 TN, or 41.7%, over the past 13 quarters. Since the end of 2007, Treasury debt has inflated $20.905 TN, or 345%. After ending 2007 at 41%, Treasury debt closed the quarter at 102% of GDP.

Crude oil lost $1.35, or 1.9%, this week, while the U.S. Dollar Index climbed 0.2% to 103.58 Friday, but lost 0.6% this week.

Bond Traders Weekly Outlook: Shorter Tenors Lead the Selling Ahead of Fed

Yield Watch

Friday/Week

  • 2-yr: +10 bps to 4.62% (+11 bps for the week)
  • 3-yr: +9 bps to 4.26% (+12 bps for the week)
  • 5-yr: +6 bps to 3.92% (+8 bps for the week)
  • 10-yr: +3 bps to 3.75% (+6 bps for the week)
  • 30-yr: +1 bp to 3.89% (+1 bp for the week)

Highlights – Federal Reserve

  • Federal Reserve Credit declined $26.7bn last week to $8.353 TN.
  • Fed Credit was down $548bn from the June 22nd peak.
  • Over the past 195 weeks, Fed Credit expanded $4.627 TN, or 124%.
  • Fed Credit inflated $5.542 TN, or 197%, over the past 552 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt declined $2.5bn last week to $3.407 TN.
  • “Custody holdings” were up $12.6bn, or 0.4%, y-o-y.
What is The Federal Reserve Discount Window and How it Operates

Fed 2023 Bank Stress Tests.

Update: This got more interesting with the three bank failures in a week. Silicon Valley Bank (SVB) was the largest failure since Washington Mutual’s September 2008 collapse. It was also the second largest in U.S. history.

SVB is the dominant financier for Silicon Valley startups. SVB ended 2022 with a $120 billion securities portfolio, the vast majority mortgage securities (MBS and CMOs). SVB’s spectacular collapse will have a major negative impact on its $74 billion loan portfolio.

Silvergate Capital Corp. plans to wind down operations and liquidate its bank after the crypto industry’s meltdown. Silvergate collapsed amid scrutiny from regulators and a criminal investigation by the Justice Department’s fraud unit into dealings with fallen crypto giants FTX and Alameda Research. Silvergate’s woes deepened as the bank sold off assets at a loss and shut its flagship payments network, which it called “the heart” of its group of services for crypto clients.

The Federal Reserve last month released the hypothetical scenarios for its annual bank stress tests. This year, 23 banks will be tested against a severe global recession with heightened stress in both commercial and residential real estate markets, as well as in corporate debt markets. Last year the Fed found all 34 large banks tested remained well above their risk-based minimum capital requirements, and the Fed announced no restrictions relating to dividends and buybacks.

Federal Reserve Hypotheticals For 2023 Bank Stress Tests have Unemployment at 10%

Central Bank Week Ahead:

  • FOMC: Markets are priced for around a one-in-three chance of a 25bps hike this week and a terminal rate of 5¼% that signals market expectations that the Fed is done hiking rates. The vast majority within the consensus of over 100 forecasters of various ilk also expect a hold. A lot may depend on Tuesday morning’s CPI update. If core CPI is hot again then it may tip the balance toward a hike particularly in the wake of the strong payrolls report.
  • ECB: Markets are priced for a 25bps hike from the European Central Bank on Thursday (8:15amET). They are expecting another 25bps hike at the following meeting on July 27th and for a terminal rate that is about cumulatively 50bps higher from here. The consensus of economists is unanimous toward a 25bps hike this week. President Lagarde’s comment at the start of this month on the further “ground to cover” in raising rates.
  • BOJ: No policy changes are expected when the Bank of Japan delivers its decisions on Friday. The policy balance rate is expected to stay at -0.1% and the 10-year yield target of 0% with +/-50bps bands is very likely to remain intact.
  • PBOC: A minority within consensus thinks the People’s Bank of China may respond to weakening momentum by cutting its key 1-year Medium-Term Lending Facility Rate by 10bps on Thursday evening (ET). Most expect no change. Recent comments from Governor Yi Gang lean in the direction of the no change camp, despite very soft core CPI inflation

This Week’s Interest Rate Announcements (Time E.T.)

Wednesday, June 14, 2023

  • 14:00 FOMC Statement & Fed Interest Rate Decision
  • 22:30 Hong Kong Interest Rate Decision

Thursday, June 15, 2023

  • 04:00 Taiwan Interest Rate Decision
  • 08:15 ECB Monetary Policy Statement & Interest Rate Decision
  • 23:00 BoJ Monetary Policy Statement & Interest Rate Decision

This Week’s Central Bank Speeches, Meetings (Time E.T.)

Monday, June 12, 2023

  • 10:00 BoE MPC Member Mann

Tuesday, June 13, 2023

  • 10:00 BoE Gov Bailey Speaks

Wednesday, June 14, 2023

  • 14:00 FOMC Statement & Fed Interest Rate Decision
  • 14:30 FOMC Press Conference
  • 21:30 RBA Bulletin
  • 22:30 Hong Kong Interest Rate Decision

Thursday, June 15, 2023

  • 03:00 German Buba President Nagel Speaks
  • 04:00 Taiwan Interest Rate Decision
  • 08:15 ECB Monetary Policy Statement & Interest Rate Decision
  • 08:45 ECB Press Conference
  • 09:15 German Buba Balz Speaks
  • 11:35 BoE MPC Member Cunliffe Speaks
  • 22:00 China NBS Press Conference
  • 23:00 BoJ Monetary Policy Statement & Interest Rate Decision

Friday, June 16, 2023

  • 02:30 BoJ Press Conference
  • 03:00 German Buba President Nagel Speaks
  • 07:45 Fed Waller Speaks

Federal Reserve FOMC Schedule 2023

The Fed with a Strong US Dollar

The strong dollar is likely to negatively affect the US economic outlook and could alter the Federal Reserve terminal interest rate, economists surveyed by Bloomberg said. Just 28% saw the currency strength as unlikely to have any impact.

The survey of 40 economists was conducted Oct. 21-26.

  • 44% said they believed the Fed could fully complete its aggressive rate tightening despite possible stresses.
  • 38% said the policy makers would be forced to cut rates earlier than expected and
  • 18% said the Fed would not be able to raise rates as much as planned.
  • Survey respondents expect rates to peak at 5% early next year and a majority of the economists now expect a US and global recession.

The Fed as expected raised another 50 basis-points last meeting. The median estimate for the terminal rate in 2023 had been raised to 5.10% versus the September projection of 4.60%. The value of the dollar is an important component to lowering inflation. A stronger dollar tends to dampen inflation by reducing the costs of imports and lowering domestic production as it raises export prices.

“Usually the trade deficit would balloon when the dollar appreciated as much as we had seen since last year. But that effect has been curiously absent so far, even as we are already about five quarters into the appreciation process. One possible explanation is that US is increasing its exports in energy products. The fact that this tightening channel of dollar is absent means that the dollar appreciation is less contractionary to the economy than historically.”

Anna Wong (Bloomberg chief US economist)
Federal Reserve Gives All Banks a Pass in Annual Bank Stress Test

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Sources: TC WSJ Bloomberg Scotia Bank

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