Influential member of ECB signals that tightening is imminent

Chris Scicluna
Emily Nicol

Fed to raise rates, most likely by 50bps; signal intention to get stance at least back to neutral; and announce QT plan too
All eyes on the Fed today, with the FOMC set to take a further, bigger step towards its apparent goal of shifting its monetary policy stance to neutral (a Fed Funds Rate of about 2.25-2.50%), and probably eventually a contractionary setting. Chair Jay Powell has already made clear that a 50bps rate hike – to take the Fed Funds Rate target range to 0.75-1.00% - will be on the agenda, and our colleagues in Daiwa America suspect that the possibility of a hike of 75bps will also be up for discussion. On balance, they think the 50bps option will get the nod. But undoubtedly some members of the Committee would prefer the larger increment. And, despite last week’s negative print for US GDP growth in Q1, in his press conference Jay Powell will surely leave no doubt that a series of successive hikes – probably including another of at least 50bps – will come between now and the end of the year so that the Fed is back at least to neutral by year-end.

The Fed will also provide new information on the plans for its balance sheet today. The minutes from the March FOMC meeting already provided plenty of information about what to expect in this respect. In particular, they already made it clear that QT would start soon (and probably later this month), with redemptions to be ramped up quickly to $60bn per month for USTs and $35bn for MBS. In months when fewer than $60bn of USTs mature, the Fed will also redeem some of its holdings of Treasury bills to make up the difference. And once QT is well underway, the Fed is also open to active sales of MBS to maintain the desired pace. What is not clear yet, however, is how far the Fed will want to shrink its balance sheet. Our colleagues in NYC suggest that the volume of reserves in the banking system will be the key consideration in deciding when to stop QT. But while the Fed ultimately wants to maintain an “ample” volume of reserves, it’s not yet made it clear what that will mean in practice. Should it aim to return the stock of reserves as a share of GDP to the pre-pandemic level, then total redemptions of up to $2trn could eventually be in order, which at the pace indicated in the March minutes would take between 1½- 2 years to achieve.

ECB’s Schnabel argues that “We need to act”, validating expectations for end to net purchases in June, first rate hike in July and further tightening thereafter
In an interview with Handelsblatt published this morning, highly influential ECB Executive Board member Isabel Schnabel – who arguably reflects the current mainstream thinking on the Governing Council – seemingly validated market expectations that monetary tightening in the euro area is imminent. With inflation continuing to exceed expectations and becoming increasingly broad-based, strikingly she argued that “Talking is no longer enough, we need to act” to prevent high inflation from becoming entrenched in expectations. Among other things, she stated that the ECB will be able to end net asset purchases at the end of June. And – while insisting that everything’s still data dependent – she agreed that a rate increase in July is “possible”, with the tone of her remarks suggesting that it is probable too. She also appeared keen to press on with a series of hikes, noting that real interest rates are still deeply negative and “quite far off” from neutral levels, some estimates of which are now “well on the positive side”.

German goods exports drop in March as shipments to Russia fall more than 60%; trade surplus smallest since 2000
While the flash German goods trades numbers for March had already suggested a marked decline in the value of exports to non-EU countries (-7.2%M/M), today’s full goods trade report suggested a somewhat smaller drop in total exports that month, albeit by a still-sizeable 3.3%M/M. Unsurprisingly, the weakness was driven by a slump in shipments to Russia, down a whopping 62.3%M/M as sanctions took their toll. In addition, the value of exports to China fell by more than 4%M/M as renewed lockdowns in that countries likely constrained trade, while shipments to the UK were also down around 4%M/M. These negative impacts were offset to some extent by a solid rise in exports to the US (3.2%M/M) as well as EU countries outside the euro area (0.9%M/M). But with the value of imports up 3.4%M/M, Germany’s trade surplus narrowed by €7.9bn to €3.2bn, the lowest since 2000.

Of course, the value of trade shipments continues to be boosted by higher prices. So, when adjusting for such effects, export volumes fell a more substantive 6.8%M/M in March, the most since April 2020, to leave them down 2.8%3M/3M. But with import volumes down 3.5%3M/3M, today’s release suggested that net goods trade provided a modest boost to GDP growth in Q1. When also including services, however, net trade was probably a modest drag.

Prices on the UK high street up the most since 2011 despite strong competition on every-day essentials; BRC signals further price hikes to come
Despite an apparent weakening of demand amid the increasing squeeze on household budgets, today’s BRC shop price index suggested that UK retailers continue to pass on a share of their higher cost burdens to consumers. Indeed, the BRC’s measure of shop price inflation jumped 0.6ppt to 2.7%Y/Y in April, the highest since September 2011. According to the survey, there was a slight moderation in fresh food inflation on the High Street due to strong competition among supermarkets on everyday essentials. But overall food price inflation edged up, by 0.2ppt to 3.5%Y/Y, the most since the start of 2013, as global food prices reached a record high last month. And with supply bottlenecks exacerbated by the war in Ukraine and renewed lockdowns in China, there were also signs of more intense inflationary pressures elsewhere, with the survey’s measure of non-food inflation up 0.7ppt to 2.2%Y/Y, the highest since the series began in 2006. The BRC also warned of more price rises ahead, with cost pressures likely to be increasingly passed on to consumers of a wider range of goods over coming months. However, not least due to the exclusion of prices of energy, cars and services, the BRC survey measure of shop price inflation will continue to track well below CPI inflation, which stood at 7.0%Y/Y in March and is likely to rise to above 8½%Y/Y in April.

March trade, April services ISM and ADP jobs figures on today’s US data calendar
Ahead of the Fed, the US data-flow brings final March trade figures, the April services ISM indices and ADP jobs numbers for the same month. With respect to the former, the widening of $19.0bn in the goods trade deficit to a record high of $125.3bn will surely dominate the overall trade report in March. The surplus in service trade narrowed in the previous two months after a jump in December, and so a renewed improvement might be in order in March. However, that will likely be relatively modest – Daiwa America’s team expects the overall trade deficit to widen some $18.3bn to a hefty $107.5bn, helping to explain the large negative contribution from net trade (of 3.2ppts Q/Q annualised) to the contraction in GDP in Q1. Meanwhile, having softened in Q1 from the elevated levels in Q4 (average 65.8), our colleagues in NYC expect the headline ISM services index to edge down 0.8pt to 57.5 in April with a drop in the employment component too. As ever, finally, the ADP survey might be taken with a pinch of salt in terms of what it suggests for Friday’s nonfarm payroll report. 

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