Central Bank Bonanza

[Music] Rate check, where macro meets markets, a podcast from Deutsche Bank Research. Hello and welcome to Rate Check, a brand new podcast from Deutsche Bank Research. I'm Henry Allen, macro strategist and I'm joined by my co-host, Shreya Skopal, FX strategist. Hello Henry, good to be back. It's a great time to host our second episode today, as next week we have an absolute bananza of central bank meetings. So we have in a single week the Federal Reserve, the ECB, the Bank of England and the Bank of Japan all meetings. So I'm delighted to say that we're joined by three esteemed managing directors from Deutsche Bank Research to run through those events. We have Matt Restkin, our US head of rates research. Thanks very much Henry and Shreya Skopal to be with you today. We have Mark Wall, our chief European economist. Hi guys. And we have Malika Sushdava, our global head of FX thematics. Good to be here. So to set the scene, we're recording this on Thursday the 23rd of April. The Middle East is still dominating attention in markets right now. And the concerning thing is that the US Iran talks that had shown some signs of progress do seem to be in limbo right now with no obvious signs of progress. And as a result of that oil prices which had come down significantly last week have been creeping higher again. So at time of recording, they're around $104 a barrel for Brent. And the other hopes that the straight-of-war moves might reopen have not been realized either. So the US percade is still proceeding and indeed only yesterday Iran said that they seized two commercial ships. So the very modest uptick in traffic through the straight-of-war moves has since collapsed again. So not the best macro environment right now. And it's clear that hopes from last week that this conflict might be a brief one having the materialized. So let me reassure you at this point what a client's thinking right now about the current situation. Thanks Henry. I think it's fascinating in the context of the news flow that you've just outlined that actually over the past few days, we just maybe were starting to think a little bit beyond the oil price when it comes to some other markets. That's a set a little bit of context in terms of the peak to trough range that we've seen in the front-print contract this week. It's still been quite why from the optimism we had perhaps at the end of last week to where we are now, as you mentioned, back north of $100 a barrel. That range actually compares relatively favourably in terms of the magnitude. It's just as large as we've seen on average since the start of the conflict. But if you look at other asset classes that likes of the broad dollar index, the range in the S&P, and perhaps most strikingly the 10-year yield, the ranges we've seen since we last recorded a week ago have been far far narrower. So perhaps there's a bit of headline fatigue creeping into markets, maybe getting a little bit desensitised to the back and forth headlines on talks. Or maybe it's because we're starting to think ahead to other big events that can start to shape markets, for instance, the central banks that you just mentioned. Yeah, and it's going to be a really interesting set of meetings because although market expectations at it either DB House to you, is that all four of these central banks are going to keep rates on hold. Clearly the backdrop is this big jump in inflation roads to the start of the year that we've seen. Energy prices are moving higher, and the big question of a lot of people's minds is, are these central banks going to start sounding quite a bit more hawkish? So I think that's a good segue into our first guest we're joined on the line from New York by Matt Raskin, US Head of Rates Research. It's been a big week for the Fed actually because not only obviously we've got their meeting next week, but we've also had the confirmation hearing for Kevin Walsh who Trump has nominated to be the next chair of the Federal Reserve. Matt, could you just run through us? What's going on there and how a potential Walsh chair might play into your views around the Fed? Sure. So as you noted, Kevin Walsh's confirmation hearing before the Senate Banking Committee was earlier this week, Chair Powell's turn as Chair of the Board expires in middle of next month. I think in terms of the hearing itself, there weren't really any, from my perspective, big surprises. I mean, some of this becomes Kubuki Theater. But, you know, from a more substantive perspective, I don't know that we've learned a whole lot. Walsh was quite critical of Fed policy and policy decisions over recent years and, you know, the outcomes around inflation. That's very much in line with previous comments. He emphasized that he would look to revise the committee's frameworks and communications. It's not clear exactly what that means. He wasn't committed along the policy rate path, though I wouldn't have expected him to be in this hearing. You know, he didn't really emphasize the role of the Fed's balance sheet in terms of, you know, the policy stance and inflation outcomes and reiterated his desire to see the Fed shrink its balance. He also noted that he'd like to see a shorter maturity, you know, sort of composition of its treasury holdings. I think he's really positioning that to kind of lean on expectations for a smaller balance sheet, you know, in a way that could open the door to cuts to the Fed's policy rate. You know, that might not result in lower longer term rates or easier broad financial conditions, but might kind of meet a narrow interest in in reducing the policy rate on communications and criticisms there, not really anything specific. You did make a comment about messier outcomes of meetings. I mean, maybe that's about less forward guidance, you know, from from him or the committee or more dissented meetings. But, you know, again, big big picture, no real surprises, no real hiccups outside of a whole that Senator Tom Tillis has on Worship's nomination at this point. I would say things would keep chugging from here. Actually, just to pick you up on that point, obviously you mentioned Tom Tillis. He is basically launched a decade of Fed nominees until the investigation to Powell is is over. What do you think the kind of near to applications of that? Do we still expect washed to be confirmed on time? So I think it's very unclear at this point right now the, you know, the Department of Justice has ten or so more days to appeal a ruling. You know, that basically quashed the subpoenas that had been issued to Powell. They have indicated that they intend to appeal that. I think, you know, from a legal perspective, there's questions about how all of that plays out. And, you know, Tillis has said that, you know, short of a very clear and transparent resolution to this, he will continue to hold, you know, a vote on on Kevin Worshin committee. So, you know, it's not clear how things proceed from from here, you know, the administration could choose to drop the subpoenas, but both Tillis and I think Powell have suggested that quietly dropping those isn't enough that they want to sort of full and transparent resolution of things. And again, in the absence of that, it's, you know, Senator Tillis, I think has been quite clear that he doesn't intend to advance wash out of committee short of that. So it's really unclear how things play out. Again, Powell's term as chair expires mid May, he has said his understanding, you know, he intends to continue to serve as chair of the board until his appointment is confirmed. So, there's some questions, you know, from a legal perspective about how that plays out. I think he will certainly, my understanding is he'll certainly remain chair of the committee, you know, the committee chooses its own chair. They did so at the January meeting this year. I think he will continue to serve as chair of the committee until the committee itself, you know, selects a replacement. So, and how does that play into your policy use? Where do you see the terminal right ending up ultimately? Yeah, I mean, so our official forecast is that the Fed is done cutting interest rates here. You know, that's informed by the outlook for inflation. What we've seen the labor market are kind of views around where the neutral policy rate is here. So I think you have an independent of of of, of war, and the transition in in the Fed's leadership. You know, we expect that that, you know, it's most likely the committee is done cutting interest rates from here. And so, Worsh doesn't really play into that. I mean, we've been emphasizing over recent months as we've written about this transition and leadership that it takes a majority of the committee. This that monetary policy and, you know, I think ultimately the economic fundamentals will carry the day. The labor market looks like it's, you know, stable, but in this curious equilibrium. You know, as you as you let off with with the Iran war, we've got, you know, some some impulse to inflation. And again, the committee kind of thinks it's in a neighborhood of neutral. And we think that will ultimately prove to be the case. So we think they're done cutting interest rates here. That's great. Thanks Matt. So the next week's meeting on Wednesday. What are you think is going to come out of that? So as you noted at the outset, there's no real prospect that the committee will cut rates. There's nothing on the balance sheet that's in play at this point. We don't get an updated SEP so no updated projections from the committee. I think the focus is really going to be on the post meeting statement and palace press conference. And I think the question there is really around, you know, whether the committee or chair kind of shift the balance of risks or policy bias in any way. And you know that we just mentioned the backdrop around the inflation, you know, outlook, labor market. You know what we see is the neutral policy rate. There has been this discussion over recent meetings revealed in the meeting minutes around whether the committee should adopt more explicit two sided guidance around the next policy move. policy moves. So more explicitly signal the next. move could be a hike rather than a cut. At this point, I don't think they make any change. I think they're probably comfortable with market pricing. There's basically no cuts priced in through the end of this year, only one cut priced in overall. I don't think they probably see any need to shift expectations for the policy rate or financial conditions more broadly. So I don't expect any material changes on that in this FOMC statement, though those could come at the next meeting in June. How can be a little bit more nuanced in his discussion around this in the press conference? So there we may learn more about the extent to which there is a growing chorus in favor of adopting more explicit two-sided guidance. Of course, the rest of the policy issues that the committee is confronting at this point. Well, thanks a lot, Matt. That's something nicely for that meeting. Actually, that brings us to some of the things that Trest writes about that FX and the dollar. What is it that you are looking out for this week, Trest? Well, I think actually in the context of some of the things that Matt mentioned, most notably the policy bias of the Fed and the scope potentially to cut through neutral or maybe not, depending on how the guidance changes. One of the things that we in the FX team have put a lot of emphasis on with regards to our dollar view is the shape of the US curve without getting into too much of the specifics. One of the key determinants that we found in the past is that curvature of the US rates market and how that feeds into the broad dollar view. If there is a bias on the committee to cut through neutral and in doing so has less of an effect on the 10-year point of the curve as Matt's pieces have alluded to, that is generally a more bearish signal for the broad dollar. Now, I explicitly used it words generally and broad dollar because in FX there's always a lot of exceptions. Perhaps the most common exception on exceptional place is Japan and the bank of Japan meeting next week is one of the other ones on the counter. So speaking of the bank account, we're of course joined by Malikah, our head of FX thematics and for those who don't follow the bank of Japan, just rise through this because they seem to operate a little bit differently to the ECB or the Fed say, they have a comparatively low policy rate but of course, if relations above target we've got some physical stimulus coming, just run us through some of the dynamics that are why are they hiking as aggressively as those other simple banks? Shortenery, that's a great place to start. So, you know, Japan has had core inflation above 2% now for the last four years also, wages are rising about 5% a year over the last three years and Japan has been running a positive output gap. And so, if you looked at this data and you didn't know that the country we were talking about was Japan, you would think that policy rates in this country should be 1.5% to 2%. Japan is running policy rates of 75 basis points. They have been lifting rates over the last two years but much more slowly and cautiously than perhaps some of their peers would do. And so, I think the big question that we have as a team and that a lot of market participants have is why is the B.O.J. keeping policy rates this easy and is that going to change? I would say there's two big interpretations. The first interpretation around why the B.O.J. has been more cautious and this feeds into our view next week because we expect them to hold rates and that is a change versus where we were before the Iran war, where we were forecasting a rate hike and actually the market was pricing about a 60% chance that the B.O.J. would raise rates in April before the war started. So, again, the market and our own forecasts have gotten more dovish for the B.O.J. So, we come back to the line of argument around why has the B.O.J. tended to be so cautious? I think the first interpretation is that they're worried about upsetting the Apple cut. And I think to understand Japanese policy today, you have to frame it in the history of Japan. After the 1990 asset bubble burst, Japan had decades of very stagnant nominal GDP growth, very low inflation. Every time they tried to lift rates, they were either too early, inflation hadn't been entrenched. Japan has actually not had policy rates above 50 basis points this entire century. So, another way of looking at 75 basis points is, Japan is running the tightest policy they run in a very, very long time. And I think one can say that, in this point, some caution might be warranted. Japan is unusually exposed to the energy shock that the Iran war is introduced. Japan is a pretty manufacturing and industrial economy. Two-thirds of the economy depends on oil and gas. Almost all of that is imported and a lot of the crude comes from the Middle East. So, from an energy security and even a growth perspective, if this war really drags on, Japan could face a growth shock. In addition to the inflation shock that every other central bank has been really focused on. So, that's the first kind of line of argument, which is there is some warranted caution that's informed by history. The second line of argument where maybe market participants have a little bit more concern is that the government may favor a higher inflation regime in Japan because it creates fiscal space. And we've written a lot about the fiscal inflation trade off in Japan. Very simply, high inflation creates fiscal space. It flatters the nominal GDP denominator, brings debt on a downward path, allows a country to run larger fiscal deficits. And for a government that wants to be able to spend more on defense or energy or AI, fiscal space is important. So, there's two ways of looking at it. One, genuine economic caution around ensuring the recovery is in a good place. The second, which is a bit more worrying for market participants, is that the government might favor kind of a high pressure strategy. And in terms of high pressure and favoring higher inflation is another side of that coin favoring a week again. We've seen the Japanese yen in trade-weighted terms make new lows this week, even as maybe there's some persistent view that intervention is on the cards. What is your take on how the government is viewing the yen and potentially what it could use to turn the tide if it were to reverse its policy choices? So, I mean, we do know that the Japanese government does have a significant amount of foreign assets invested outside. The government pension fund has about a trillion dollars invested in across foreign bond and foreign equity markets. Japanese companies are large exporters. So, there are big pockets of the country that have benefited from a weaker yen environment. However, like you mentioned, the yen is at historic lows on a kind of a trade-weighted basis. The yen is the cheapest currency on our valuation models. And so, there is a question of is this now going too far? We do know that the government has been quite explicit with verbal intervention and arguably quite successful as well. Back in January, there was a rate check that was reported to have been done by the US Treasury. And the market has kind of since been wary of testing the kind of conviction of the government to defend the yen. If the government fully wants to turn the tide on the yen, I think the one kind of crucial thing in their arsenal that they haven't really tapped till now is the fact that Japan has an enormous amount of money outside that could return home. And I would say there's two big groups of investors that can be encouraged by the government to repatriate their money. The first is the pension fund. And the second is the Japanese retail community that has a lot of foreign equity money outside. The pension fund could be encouraged to start hedging on their existing asset portfolio, or potentially reallocate some of the foreign bonds back into the domestic bond market. And they currently don't hedge at all? That's right. So, there are, you know, the GPIF or the government pension fund has about 500 billion or so foreign bonds entirely unhanged. They do not need to sell those bonds and bring them home in order to help the currency. They simply need to start to hedge on them. And we have seen a precedent for this in Korea where the National Pension Fund that also has a lot of foreign assets has begun to raise their strategic hedging ratios explicitly to try and defend and support the Korean one. Indeed, that's one of the currencies that our colleagues in Asia have turned more constructive on this week with, as you mentioned, changes around the National Pension Service and also potentially some bond inflows that, if that were to repeat in Japan, could be a potential game changer in terms of the year? Yes, absolutely. I mean, I think the dolly end is sort of the last holdout in this kind of dollar cycle. But if you think, you know, the dollar sort of peaked, say, back in January of last year, against global effects, the dollar is down about 13% or average of currencies. Dolley end is still within 1% of its ice. And for the cheapest currency in the world, kind of the largest holder of US treasuries, a country that is very long dollars. There is an irony that in a broadly weaker dollar cycle, Japan has not been participating till now. Well, then that brings us to the meeting on Thursday for the European Central Bank and delighted to have Mark Wall, our chief European economist, joined us for this. Now, Mark, the market pricing is saying that June hype is likely and you're in agreement with that. So just for us to be going thinking on that and why shouldn't the ECB look through this oil? shock. Yes, we are, thank you very much. We are looking for the ECB to hike. We have 50 base points in our call. We have 25 hikes in June, September. Ultimately, it's a call on the persistence of inflation. But you pick up on this point about looking through the shock, right? Everyone understands that in the context of a supply side shock, the basic and prescription against this is to look through it. I think it's important to understand that the ECB is not against that. If you listen to what Christine Lagarde said in her speech to the ECB watchers conference several weeks ago, she laid out a graduated response function. And the first option is for the ECB to look through. But it can look through only if there is a small and transitory inflation shock. But if there is a larger shock to inflation, albeit not too persistent, BCB is saying that maybe a measured tightening of policy would be more appropriate. At the further end of the spectrum, and again, it's not too much of a surprise if there is a strongly sustained overshoot of the inflation target, then what the ECB would recommend would be something more forceful and persistent. So really, it's all about gauging the energy shock, how large it's going to be and how persistent it's going to be. But I'd go back and just focus on that measured tightening option that the ECB mentioned, because that just requires a large and not necessarily a persistent shock to inflation. Because if it's large enough this summer, then that itself could, on more inflation expectations, if it's large enough that still could create demands from a labor perspective to reclaim that hits to relinquen. So what does the ECB worry to that here? It's worried about a few things. It's worried about non-linearities. What they saw in 2022 was a rapid reset of prices within the economy and that allowed a much larger, much stronger pass-through of rising costs into inflation. It doesn't want that to happen again. It's worried about memory. It's worried about the fact that or the fear that firms might remember, it was easy to reset prices or households might remember that it was easy to ask for a pay rise. So these are the things that the ECB is somewhat troubled by. And if you look at the data that's actually coming in and we've just had the April PMI, I would say there was some warning signs of the March PMI in terms of the pricing balances, but it was even more dramatic in the April numbers. We're getting strong increases in input costs. We're getting strong increases in input prices. And in fact, in Germany, there's a larger increase in composite output prices than there was an increase in input costs. So they're trying to factor margins go beyond the increase in prices. We have our own DVDs survey. I'll just give that a bit of a plug for a moment because we survey 2000 households, of course, the year area every single month. You can see long-term inflation expectations go up. We can see a fattening in the right hand tail of the distribution of inflation expectations. That happened in 22, that bothered the ECB. And we can also see that households are thinking about or increasing the probability of asking for pay increases. So is there a risk of a larger and more persistent price impact or inflation impact? Yes. And that's why it's not so obvious that the ECB would just be able to look through this. That's super interesting. And I know you obviously are mentioning that 2022 parallel because another parallel that some people are worried about is the 2011 parallel when the ECB did hike rates, but that was going right into the sovereign debt crisis. And many perceived that as a mistake in retrospect, and some people are using that parallel to war against rate hikes today. Do you think that that caution is barred? Could the ECB be making a mistake if they do hunt? I mean, the way I think about it is like this. We're calling for 50 basis points of hikes. That takes the ECB rates from 2% to 2.5%. That to me is a good risk management because they're sending a signal in the context of this risk of inflation persistence. They're sending a signal of their commitment to price stability. But in raising rates only to 2.5%. Because 2.5% is at the upper end of the range of neutral, you're not overly burdening economic growth by doing that. And when you adopted this call, whenever it was a month ago, we said there were two silent risks around this. We said that if the crisis in the Middle East dissipates quickly, then maybe the ECB would have to hike interest rates at all. But we said on the other side that if the crisis was to escalate further, there's always the possibility that the ECB would have to go into genuine, restrictive territory and go beyond 2.5%. Over the course of the last month, we spent a lot more time analyzing, in particular, we've been analyzing growth and the risk to growth. And there are clearly downside risks to growth. You can think of fuel shortages and the risks of ration, for example. And they're talking about jet fuel availability only for the next six weeks. In Europe, that could be clear downside risks. That was to materialize. There's a risk of a weaker labor market. There's a risk of tighter financial conditions. So today, I'd be more asymmetric in terms of how I describe the outlook for ECB policy. There is still, even though we have this kind of a elongated ceasefire, this kind of indefinite blockade, there is still the chance that if this crisis, geopolitical crisis comes to an end more quickly, the ECB can avoid hiking interest rates at all. But if you have this growing sense of downside risk to economic activity, we saw that in the PMI, activity is a level that's consistent with a contraction in GUP. I think it's more difficult now for the ECB to get that forceful or persistent tightening of mantra policy. So from my perspective, it feels more like a measured tightening at most. Thanks, Bob. That's a really interesting point. And one thing that we have written about is actually this habit of central banks almost fighting the last war, as it were. You've seen that in a lot of shocks to history in some ways. You know, not just the reacting for hawkish in today, and they did initially in 2022, but actually what happened in 2020 with the pandemic in response to perhaps the insufficiently doubtful response in 2008. And even in the oil shocks of the 1970s, if you look at the oil shock, the second shock in 1979, Paul Volker and other central bankers were actually much more hawkishly in response to that recognizing that in the first oil shock in 1973, they probably haven't done enough with hindsight. So that's a thing we've seen at several points in history, as you mentioned. I'm Treyas. Let's bring it back to you again. Obviously, we've got all these central bank meetings happening next week. Are there any others we might be keeping on or other things in markets we need to be looking out for? There's just no escape, there is more and more central banks. Until the next time that we plan on recording in a couple of weeks, there really is no escaping the theme. I think interestingly Matt earlier mentioned about Kevin Warf maybe trying to open up more dissents on the FOMC. Perhaps the G10 poster child for dissenting views in terms of the central bank has been the Bank of England. I think we've written that that is likely to resume next week's meeting, even though a hold is widely expected. That is certainly what is priced by the market. We're expecting divisions to essentially start to return amongst the MPC without a raft of data this week, where there's been a little bit of something for everyone. Perhaps most-worryingly similar trend of input prices and output prices rising sharply in the PMI data. But we're just overall less convinced that in the UK, we're going to see the scale of tightening that's currently priced into markets. So at the time of recording, we have a similar amount of tightening price for the Bank of England as we do for the ECB this year. At the starting point, at least as we're assessing the rate of the policy rates in the UK in terms of that restrictiveness, it's not quite as close to that neutral rate as it might be for the ECB. That's something that's feeding into our FX views, definitely, on our forecast for a little bit of sterling underperformance. But elsewhere across the G10 landscape, as I mentioned more and more central banks, just very, very briefly, the markets as this currently price will be less surprised by further tightening in the likes of Australia with Norway already high yielders, but would set to go further. But by contrast, I don't think there's very much expectation of action from the likes of the Bank of Canada next week or the Riksbank the week after. Is there anything else you've been reading lately that you'd like to share with Arlesnir's that might be of interest? Well, one thing away from this very topic, I thought there was interesting in the financial times anyone who studied undergraduate economics in the UK will probably have read Tim Huffert's book The Undercover Economist. His column in the FT on risk, history of insurance markets and how that ties into the rise of prediction markets I thought was particularly fascinating, especially in the context of these forthcoming against central bank meetings where you're starting to see a little bit of divergence between what their signaling at times and say the front end of the money market curve. What about your self, Henry? So, as you also had a Koseh Indian FT article this time on the Ghibliical theme though, it was Gideon Rackman who read I thought a really interesting piece on how the US Iran conflict could still escalate further. Of course, I'm being able to get some markets if it did because markets don't price in a temporary conflict. You can see that from the energy futures curve for oil for instance, break free futures are in backwardation, i.e. they are downward sloping people expecting that in six, 12 months time, oil price can be lower than they are today. And Rackman's ultimate was that even though both sides might ostentibly want a peace deal from this conflict. They still distrust each other and they still remain far apart on a lot of crucial issues. So actually, if there's difficulty closing that gap, we've already seen that to some extent with the breakdown of the talks that might have been expected, actually that opens up more distillation scenarios and for markets critically, it all hinges on what's going with all of it. Indeed, we've seen the correlations between how oil is trading and how other assets like equities and bonds are trading in terms. So it really does all hinge on the geopolitics right now, can the Stravelled Moose get reacting to oil start flowing or are we starting to look at some of the more negative risk scenarios with implications across the board? Well, thank you very much to our guests for joining us today. So thank you to Mark. Thank you very much, Robby Meak. Thank you to Melika. Thank you to Be here. And thank you to Matt. Absolutely, thanks again for having me. So we've heard plenty on central banks, clearly a lot going on, although interestingly in each of those cases a decision to keep rates on hold is expected, but of course it'll be fascinating to hear what each of them have to say in terms of the outlook, how they're thinking about where the policy might need tightening. And of course, as Mark said in the ECB case, and indeed, as Mark at pricing is suggesting, are they going to tee up a hike as soon as the meeting after this in June? So lots of themes to keep an eye out over the coming days and weeks. Thank you for listening and I'll see you next time. Thank you very much. This is Rate Check, where macro meets markets, a podcast from Deutsche Bank Research, to ensure you never miss an episode. Subscribe now. This podcast has been produced by Deutsche Bank and may contain research as defined in method 2. The information discussed is believed to be reliable and has been obtained from public sources believed to be reliable, although Deutsche Bank makes no representation as to its accuracy or completeness. Opinions, estimates and projections discussed constitute the current judgement of the speaker at the time of recording. They do not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice. For further important information, please visit research.db.com.