Fed the #1 focus this week with dot plot set to suggest earlier first tightening

Chris Scicluna

Treasury sell-off resumes ahead of interesting Fed meeting
With investors perhaps looking ahead to the likelihood of a more upbeat Fed at this week’s FOMC meeting, selling pressure returned to the Treasury market on Friday, lifting the 10Y UST yield by 9bps to 1.62% and the 30Y UST yield by 8bps to a 14-month high of 2.38%. However, while the rise in yields and increased regulatory scrutiny of China’s tech giant Tencent weighed on the Nasdaq – which closed down 0.6% – the S&P500 still managed to eke out a modest 0.1% gain to close at a new record high. Over the weekend, Treasury Secretary Yellen sought to quell bond investors’ concerns about potential inflation risk from President Biden’s American Rescue Plan, describing the risk as both “small” and “quite manageable”. Perhaps assisted by her comments, Treasury yields initially moved a couple of basis points lower when markets reopened today but since moved back close to Friday’s close.

Turning to Asian markets, selling also returned to Chinese equities today with the CSI300 falling 2.15% and weighing somewhat on bourses elsewhere in the region. While the PBoC held the 1-year Medium-Term Lending Facility Rate at 2.95% for an 11th consecutive month, front-end Chinese repo rates lifted sharply with the CNY100bn on offer no more than offsetting tomorrow’s maturity. Meanwhile, Chinese activity data for the year to February pointed to strong growth in industrial production – driven by the earlier reported lift in exports albeit flattered by pandemic base effects – but pointed to slightly slower momentum in domestic spending indicators. Most other bourses in the region were little changed, although Japan’s TOPIX advanced 0.9% despite METI reporting a much sharper-than-expected decline in service sector activity in January. Ahead of this week’s BoJ meeting and policy review announcement, the JGB market bucked the trend with yields moving a little over 1bp lower across the curve with investors clearly giving up on their being any significant change in the Bank’s approach to Yield Curve Control.

In the Antipodes, speaking to a conference in Melbourne, RBA Governor Lowe noted that the Australian economy was doing better than most but still operating well short of its capacity. Nonetheless, reflecting Friday’s sell-off in the Treasury market, Australia’s 10Y AGCB jumped 10bps on the open and eventually closed up 9bps at 1.78%. Meanwhile, the Kiwi 10Y bond yield jumped 11bps to 1.82% despite the service sector PMI remaining below the crucial 50 level in February.

Fed the #1 focus this week with dot plot set to suggest earlier first tightening
The main focus for investors this week will be the Fed, with the FOMC meeting to review monetary policy on Wednesday and also publish revised forecasts of the economic and policy outlook. No change to the target range for the Fed Funds rate is widely expected. While some commentators have raised the possibility of the Fed leaning against the steepening of the yield curve by lifting the IOER and/or shifting QE purchases to the longer-end of the curve, on balance Daiwa America’s Mike Moran expects neither. Rather, Mike judges that Fed officials will probably be neither surprised nor alarmed by the shape of the curve, with the steepening viewed as the normal shift that occurs over the course of a business cycle during the expansion phase. Indeed, it would be more worrying if the curve was not steepening given that macroeconomic stimulus being employed. So, perhaps most interest will centre on the Fed’s new projections, which will surely portray a more positive outlook in light of the recent steep decline in new coronavirus cases, the accelerated vaccination programme and the passage of President Biden’s $1.9trn American Rescue Plan – the latter almost certainly larger than anything envisaged by Fed policymakers when they last produced forecasts in December.

Recent momentum already points to a stronger growth outlook for the current year and according to CBO estimates over a quarter of Biden’s stimulus will help boost growth in 2022. So given the likelihood that the Fed will forecast the unemployment rate to end next year below 4% – and thus already below its assumed longer-run level – Mike expects that the revised ‘dot plot’ will indicate that the median policymaker now expects the first lift in the Fed Funds rate to occur in 2023 (just 5 of 17 participants expected tightening when the last forecasts were produced in December). This could put upward pressure on Treasury yields, especially if the Fed opts not to extend in some form the current Supplementary Leverage Ratio (SLR) exemption applying to institutions’ Treasury holdings, which is due to expire at the end of this month.

BoJ policy review outcome the main focus in Japan this week
Interest in Japan this week will also centre on the central bank, with the conclusion of the BoJ’s Board meeting on Friday set to bring the outcome of its review of the operation of monetary policy. While the winter surge in coronavirus cases has weighed on the economy over the current quarter, the outlook appears more favourable and so we certainly do not expect any change in the Bank’s policy rate (-0.1%) or the target for the 10Y JGB yield (0.0%). As far as the Bank’s monetary policy review is concerned, expectations regarding change were already fairly low given that Governor Kuroda signaled satisfaction with the monetary policy framework and the BoJ’s obvious aversion to making any change that might be interpreted as a tightening of monetary policy. Importantly, his most recent comments indicate that the permitted ±0.2% trading range for the 10Y JGB will remain unchanged, at least for as long as the economy continues to be impacted by the pandemic. While leaving the door open to an eventual widening of that range when economic conditions normalise, however, the BoJ might also emphasise that the negative policy rate might, at some point in the future, feasibly be cut further too.

At most, however, the only immediate change to the Bank’s Yield Curve Control policy to expect this week would appear to be measures to encourage greater variability of the yield within that permissible ±0.2% range, perhaps by making the Bank’s rinban purchase intentions somewhat less transparent. Regarding other changes to the operation of policy, the most obvious – indeed, well signaled by Kuroda – is a more flexible approach to purchases of ETFs. So rather than the past approach of targeting up to ¥6trn of purchases each year – presently upped to ¥12trn as part of the Bank’s pandemic response – the BoJ might set no target and instead just purchase on an as-needed basis. This is more-or-less how the Bank’s rinban purchases have operated in recent years, even before the formal target of ¥80trn was dropped as part of the pandemic response.

Japan’s core machinery orders begin New Year on a slightly softer note
This week’s Japanese economic data kicked off with the Cabinet Office releasing news on machinery orders during January – of particular interest in light of the unexpectedly strong recovery seen in Q4. Following a steep increase of over 10%M/M in December, total machine orders fell just 1.7%M/M in January and were down just 0.8%Y/Y. The closely-followed measure of core private domestic orders (which excludes volatile items such as ships and capex by electricity companies) fell by a somewhat larger 4.5%M/M. However, this decline was slightly less than consensus expectations. And coming after cumulative growth of almost 20% over the prior three months, core orders were still up a welcome 1.5%Y/Y. Moreover, the level of core orders in January is less than 1% below the average level recorded during Q4 – at this point displaying greater resilience than the 6.0%Q/Q decline that pessimistic machinery producing firms had forecast last month following the 12.9%Q/Q lift in orders in Q4. Of course, the monthly orders data can be very volatile and a very weak February could yet deliver the pullback that firms were expecting.

In the detail, orders from the manufacturing sector fell 4.2%M/M in January, with orders from the chemical sector returning to more trend-like levels and orders of electrical equipment falling almost 15%M/M to a 3-month low. As a result, annual growth in manufacturing orders slipped to 1.1%Y/Y, compared with the 3.9%Y/Y increase reported in December. Core orders from the non-manufacturing sector fell a sharper 8.9%M/M in January, although orders were still up 1.5%Y/Y. The monthly decline was due in part to the normalisation of orders from the communications industry, which in November had increased to the highest level in more than four years. Government orders, which are typically volatile, slumped 27.9%M/M in January and so were down 40.1%Y/Y. Consistent with the pickup in external demand indicated by the JMTBA’s machine tool order series, foreign orders increased 6.4%M/M and so were up a strong 15.5%Y/Y.

Japan’s service sector activity contracts sharply in January, suggesting GDP pullback in Q1
In today’s other Japanese economic news, METI released the results of its survey of service sector activity for January. Sadly, thanks to the winter surge in coronavirus cases and associated restrictions on activity, the aggregate Tertiary Industry Activity Index fell 1.7%M/M – much worse than the consensus forecast of a 0.6%M/M decline, with no solace provided by a 0.1ppt upward revision to the reading in December (which now reports a 0.3%M/M decline). As a result, service sector activity was down 6.1%Y/Y. And with activity having peaked in October, the level of activity in January was 2.2% below the average through Q4, with next month’s release of data for February unlikely to improve the arithmetic for the current quarter. So even with manufacturing activity presently on track for a modest rate of positive growth, today’s report suggests that much of the 2.8%Q/Q lift in overall economic activity reported in Q4 will likely have been erased, albeit temporarily, in Q1.

In the detail, unsurprisingly, much of the weak result in January owed to non-essential personal services, with the relevant index slumping 6.9%M/M to be down more than 16%Y/Y. Thanks to early closing times for restaurants and bars, activity in the living and amusement industry fell almost 12%M/M. Moreover, with this slump following a near 6%M/M decline in December, activity in this sector was down around 30%Y/Y. As suggested by other indicators, retail trade fell 2.9%M/M and was down 1.6%Y/Y. Activity related to essential personal services fell a much less severe 0.6%M/M – nonetheless the third consecutive decline – and so was modestly below year-earlier levels. Activity related to medical, healthcare and welfare fell 3.9%M/M, making the second largest downward contribution to the aggregate index. In contrast to the weakness seen in personal services, the business services index increased 1.9%M/M in January, more than erasing a 0.8%M/M decline in December. Nonetheless this index was down 3.5%Y/Y, driven by weaker demand for services from the non-manufacturing sector.

Looking ahead on the Japanese data front, following tomorrow’s release of final IP data for January – which should more-or-less confirm the 4.2%M/M leap in output indicated by the preliminary report – attention will turn to Wednesday’s release of merchandise trade data for February and the Reuters Tankan for March. The only other economic report this week is Friday’s national CPI for February. As indicated by advance data from the Tokyo area, a combination of higher energy prices and base effects should cause the deflation indicated by the headline CPI to further moderate, while the core inflation is likely to be little changed.

China’s IP starts New Year on strong note, but retail sales and capex momentum softer
Following last weekend’s news on international trade, today brought the release of the remainder of China’s key activity indicators for the combined January/February period, which predictably reported some very flattering growth rates due to base effects associated with last year’s coronavirus-driven slump in activity. Looking through that volatility, the production data was undeniably strong – clearly benefitting from the strength of export-related demand – but the retail sales and capex data pointed to some slowdown in domestic demand from the rates of growth reported at the end of last year.

Beginning with the factory sector, IP increased a whopping 35.1%Y/YTD in February. While this was flattered by base effects – it followed a 13.5% slump over the same period last year – the outcome was somewhat firmer than the market had expected and suggested that underlying growth had picked up from the 7.3%Y/Y pace reported at the end of last year. Growth in manufacturing output was an even more impressive 39.5%Y/YTD, with output of machinery rising 69.4%Y/YTD, auto production up 70.9%Y/YTD, general equipment up 62.4%Y/YTD and metal products up 59.5%Y/YTD. By contrast, mining output was up a relatively subdued 17.5%Y/YTD and power generation increased 19.8%Y/YTD.

Turning to the major expenditures, retail sales increased 33.8%Y/YTD following a 20.5%Y/YTD slump in the same period last year. This outcome was also somewhat ahead of market expectations. Nonetheless, this suggests an underlying pace of growth over the period was slightly weaker than the 4.6%Y/Y achieved at the end of last year – perhaps not surprising given the isolated re-emergence of coronavirus cases and constraints placed on travel during the LNY period. Not surprisingly, spending on catering services increased a huge 68.9%Y/YTD while spending on garments increased 47.6%Y/YTD and spending on autos rebounded 77.6%Y/YTD.

By contrast, while spending on non-rural capital goods increased 35.0%Y/YTD, this was a somewhat disappointing increase considering that such spending had slumped 24.5%Y/YTD in the same period last year. Spending by state-owned corporates increased 32.9%Y/YTD following a 23.1%Y/YTD slump last year, whereas spending by private firms grew 36.4%Y/YTD following a 26.4%Y/YTD slump last year. In the manufacturing sector, growth of 37.3%Y/YTD was less than stellar considering that spending had fallen 31.5%Y/YTD last year. By contrast, last year’s strong momentum in the healthcare sector continued with capex rising 57.2%Y/YTD following a relatively modest 12.8%Y/YTD decline a year earlier. Spending in the education sector also increased more than 50%Y/YTD. Meanwhile, spending on property development increased 38.3%Y/YTD following a 16.3%Y/YTD decline last year.

According to the NBS, the urban unemployment rate increased 0.3ppts to 5.5% in February. Based on the limited history of this series, this increase – which was not expected by the market – appears to reflect mainly seasonal effects associated with the LNY holiday. In any case, the latest rate is still consistent with the Government’s just-announced target for this year.

In other news, today there were further signs that Chinese home prices have begun this year on a firmer note. New home prices across 70 cities increased 0.4%M/M – the most since August – causing annual growth to lift 0.4ppts to 4.1%Y/Y. Existing home prices increased 0.3%M/M causing annual growth to lift 0.4ppts to 2.9%Y/Y. Price movements were largest in first-tier cities, with new home prices rising 0.6%M/M and 4.8%Y/Y and existing home prices rising 1.1%M/M and 10.8%Y/Y. There are no further Chinese economic data scheduled over the remainder of the week.

BoE monetary policy announcement the focus in the UK this week, but no policy change likely
The main event in the UK in the coming week will be the BoE’s latest monetary policy announcement on Thursday. But unlike the meetings at the Fed and BoJ, this should be a relatively low-key affair. Since the BoE published forecasts following its previous MPC meeting on 4 February, economic activity appears to have been somewhat firmer than it expected. But inflation at the start of the year was broadly in line with the Bank’s expectation. And while Gilt yields are up significantly since then – with the 10Y yield today about 40bps higher from just before the MPC’s February announcement – the near-term path for fiscal policy will be materially more supportive than the BoE had assumed in its forecast. So, the unemployment profile will also likely undershoot the path set out in the BoE’s projection. And while Governor Bailey recently emphasised the significant uncertainty surrounding the economic outlook, the overall shape of the BoE’s forecasts for the coming couple of years – with GDP rising above the pre-Covid level early in 2022 and inflation returning close to the 2.0%Y/Y target this year and remaining thereabouts – still appears valid.

So, there will certainly be no change to policy this week. And while markets will no doubt watch closely any commentary about bond market developments, the MPC’s forward guidance seems likely to be left unchanged too, i.e. stating that “If the outlook for inflation weakens the Committee stands ready to take whatever additional action is necessary to achieve its remit” and that the “Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.”

Data-wise, the coming week will be very quiet in the UK with no show-stopping releases scheduled. Indeed, the calendar is empty until Friday when the GfK consumer confidence survey for March will be published, along with public finances data for February. A modest improvement in the headline consumer confidence indicator is expected, to -20 in March, albeit leaving it some way off the level recorded in the same month last year as the pandemic built up steam (-9). Meanwhile, public sector net borrowing (excluding banks) is expected to come in at £23.0bn in February, up from just £1.4bn a year earlier but down from the high of £47.2bn in April last year.

Eurogroup to discuss fiscal policy today, but few market-moving economic data ahead in the euro area this week
Euro area finance ministers will this evening review the sectoral impact of the pandemic on the region’s economy and also discuss the appropriate fiscal policy response. Expect the ministers to pledge to maintain a supportive fiscal stance for another couple of years, albeit nothing compared to the fiscal support coming from the US. Meanwhile, this week will be relatively quiet on the euro area economic data front, with little in the way of market-moving releases. After a very quiet start to the week today, French and Italian final CPI data are due for release tomorrow followed by the aggregate euro area numbers on Wednesday. The flash estimate of euro area headline inflation was unchanged at January’s eleven-month high of 0.9%Y/Y, as upwards pressure from higher energy prices offset the reversal of certain other temporary factors. So, core inflation fell back 0.3ppt from January’s five-year high to 1.1%Y/Y. The final German and Spanish data released on Friday aligned with the flash estimates and so we expect the euro area numbers to do likewise. Meanwhile, the ZEW investor sentiment survey for March (also out tomorrow) is expected to report further improvement in the current assessment and expectations balances as the German government edges towards a gradual easing of lockdown measures. The Bank of France will also publish its retail sales survey results for February tomorrow, while Wednesday brings the release of EU-27 new car registrations data for February and euro area construction output figures for January. On Thursday, euro area trade data for January will reveal the extent to which weakness in imports from and exports to the UK has been offset by flows to and from elsewhere.

Retail sales and IP data due from the US this week
Aside from the FOMC meeting, there are a number of US economic reports that will also be watched closely by investors this week. Following today’s New York Fed manufacturing survey for March, tomorrow will bring the IP and retail sales reports for February. Difficult weather conditions will likely have boosted utility output during the month, but Mike Moran expects the same factors to have weighed on manufacturing output so that overall IP likely rose just 0.4%M/M. Meanwhile, following the huge rebound in retail sales reported in January – not least due to the arrival of stimulus payments – Mike expects that headline spending was likely flat in February, with the impact of poor weather on general retail providing an offset to price-driven higher spending on fuel. News on import prices, business inventories and the NAHB’s Housing Market Index will also be released on Tuesday. The following day, just ahead of the FOMC announcement we will receive housing starts and building permit data for February. On Thursday, the Philadelphia Fed will release its manufacturing survey for March while the Conference Board’s leading indicator for February will wrap up this week’s data flow.

Labour market and retail sales reports the key focus in Australia this week
Given the RBA’s focus, most interest in Australia this week will clearly centre on Thursday’s Labour Force survey for February. The various labour market indicators have remained positive over the past month and so Bloomberg’s survey indicates that the market consensus is that employment will increase a further 30k – similar to last month and leaving it only around 30k below the pre-pandemic peak. As a result, the unemployment rate is forecast to have edged down to 6.3% – still 1.2ppts above the pre-pandemic peak and perhaps still 2ppts north of what the RBA would like to see in order to generate the desired upswing in wages growth and consumer price inflation. The other important release this week is Friday’s preliminary retail spending data for February, which should reveal growth settling down into moderate uptrend following the very wild swings caused last year by the pandemic. This week’s other diary entries include tomorrow’s ABS House Price Index for Q4 – which will clearly confirm an upswing in prices – and minutes from this month’s RBA Board meeting. RBA Assistant Governor Kent, who has responsibility for financial market issues, will speak on both Wednesday and Thursday.

Kiwi services PMI edges up in February; Q4 GDP the main NZ focus this week
The BNZ-Business NZ services PMI increased 1.1pts to 49.1 in February. In the detail, despite the pandemic-driven restrictions on retail activity that were in place on two occasions over the month, the activity index increased 3.9pts to 50.8 and the employment index increased 4.3pts to 50.9. However, the new orders index fell 3.0pts to a 6-month low of 50.3 and the supplier deliveries index fell 0.8pts to just 40.8. With all restrictions on activity removed last week, we would expect to see a much stronger survey for March. Looking at the week ahead, most attention will centre on Thursday’s belated publication of the national accounts for Q4. Bloomberg’s survey indicates that the median analyst expects a modest 0.3%Q/Q gain, leaving output up 0.6%Y/Y. However, understandably, following a currently-estimated 14%Q/Q rebound in Q3 – which could be subject to greater-than-usual potential revision – the dispersion of forecasts is quite large and a small decline in output would not be surprising given the pull-back in output suggested by some sectoral indicators. 

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