Fed hikes 75bps and might do another of the same magnitude next month as it heads towards a restrictive stance
The Fed validated (revised) market expectations of a hike of 75bps, the biggest since 1994, to take the target range to 1.5-1.75%, and inevitably made clear that additional tightening is on its way over coming months. Jay Powell stated in his press conference that a hike 50 or 75bps is likely in July, while the median expectations for the fed funds rate on the FOMC’s updated dot plot rose to 3.375% and 3.75% respectively for the end of this year and next, firmly above the Fed’s long-run estimate of 2.5%, to suggestive a restrictive policy stance. The FOMC then pencilled in some easing of policy in 2024, with the median forecast for the end of that year back down to 3.375%, a step on its way back to neutral. The Fed’s updated macroeconomic projections are consistent with a soft landing, with GDP growth of 1.7% this year and next, and the unemployment rate rising only very gradually to 3.9% – still historically low – by the end of next year. But that seems a brave call, with Powell himself acknowledging that less desirable outcomes are possible. Indeed, in our view less desirable outcomes are likely, and recession next year is likely. See the note from our colleagues in Daiwa America here.)
BoE likely to hike by just 25bps as GDP weakens and external demand outlook clouds
Given the continued worsening of the inflation outlook, the BoE seems bound to raise rates again today, and we expect all MPC members to vote for tightening. But as at past meetings this cycle, the majority will probably favour a hike in Bank Rate of just 25bps – this time to 1.25% – with perhaps only three members again (all externals) likely to vote for a larger hike of 50bps. At last month’s meeting, “most” members of the Committee judged that “some degree of further tightening in monetary policy may still be appropriate in the coming months”. But the BoE’s updated projections suggested that the terminal rate would be well below levels priced into markets. Since then, the government’s fiscal policy U-turn should cushion consumer demand in Q4 and also help to reduce somewhat the peak in inflation, perhaps keeping it below 10%. But the April GDP figures raised the likelihood of a contraction in Q2 (unlike the BoE’s forecast of positive growth); the latest labour market data hinted at a slight easing of tightness; and, of course, the Fed’s more hawkish shift raises the probability of a significant weakening of external demand into next year.
Japan’s adjusted trade deficit hits series high on energy import surge
Following yesterday’s confirmation of a record euro area trade deficit, Japan followed suit today. On a seasonally adjusted basis, Japan’s trade deficit blew out to a series high in May, up almost ¥6trn to ¥1.93trn. Imports rose a much larger-than-expected 7.9%M/M (adjusted) and 48.9%Y/Y. The principal cause was a sharp increase in the value of imports of energy, with those of petroleum up almost 150%Y/Y, coal up more than 260%Y/Y, and LNG up more than 150%Y/Y. So, imports from energy and commodity exporters such as Indonesia, Australia and Malaysia were extremely strong too. But imports from China were also stronger, up 25.8%Y/Y, as pandemic restrictions eased somewhat.
Close to expectations, the value of exports rose 1.0%M/M (seasonally adjusted) and 15.8%Y/Y, roughly in line with expectations. Shipments of general machinery rose 13.3%Y/Y, with electrical machinery up 11.1%Y/Y, chemicals up 15.5%Y/Y and basic manufactured items up 35%Y/Y. But shipments of cars remained severely impeded by supply constraints, falling 11.4%Y/Y. Exports were down 0.2%Y/Y to China but up 17.5%Y/Y to Asia overall, and were also firm to the US (13.6%Y/Y). Shipments fell to both Germany and the UK.
Adjusted for price shifts on the BoJ estimates, import volume growth was still strong, up 7.4%M/M, the most since April last year. Export volumes rose 3.0%M/M, the most in six months. Given the hit to trade at the start of the quarter from events in China, however, export volumes are currently trending 1.5% below the Q1 average while import volumes are trending just 0.3% lower. So, based on today’s data, net trade looks set to subtract from GDP growth in Q2.
The focus in Japan now turns to the BoJ’s announcements tomorrow. Despite this week’s change of tack from both the Fed and ECB, our colleagues in Japan expect no change to BoJ policy tomorrow (see note here), with a re-evaluation likely to have to wait for updated projections in July. Questions in the press conference seem bound to focus on yen depreciation, and Kuroda might this time refrain from his prior suggestions that “the weak yen is generally positive.”
US data focus on housing, euro area focus on labour costs
Today’s data focus in the US will be May’s housing starts data. Given higher mortgage rates and prices, affordability is increasingly stretched, so homebuilders likely reduced single-family starts in May in an attempt to prevent an excess accumulation of inventories. And the multi-family sector is due payback from a surge in April. Our colleagues in the US expect to see a drop of 5.8%M/M in overall housing starts in May. The usual weekly jobless claims data are also due today.
In Europe, a quieter day will bring euro area labour cost figures for Q1. Expect a pickup from 1.9%Y/Y in Q4 in part reflecting special payments. But – as suggested by the recent bid from key German union IG Metall – there is certainly no sign of a wage-price spiral that will generate significant second-round effects on inflation from labour costs over coming quarters. Following yesterday’s panic ECB policy meeting, several Governing Council members will speak publicly today.