LA Private

Highway to the monetary policy danger zone

The return of the hawks in Australia and Canada last week has reminded investors that inflation hasn’t evaporated from the risk landscape nor have the dangers of aggressive central banks.

As we have pointed out the US May consumer inflation report tonight and then the Fed’s rate decision early Thursday (Sydney time) carry with them dangers to the bull market and to the belief that inflation is going to go on falling and interest rates will remain on hold for at least a few weeks.

US consumer price inflation is forecast to ease to around 4.3% from 4.9%, with core inflation down to 5.3% from 5.5% in April. If that happens, then US markets should be happy.

But any move up in either or both measures and it will be back to the worry beads and hair shirts as the bears re-emerge to have a little snack at the expense of the bulls.

The prospects for change mean a nervy week for markets everywhere with the world’s two other important central banks – the European Central Bank, and the Bank of Japan, joining the Fed in discussing policy settings and interest rates.

There is one final consideration – the US consumer price data to be released early Tuesday, Washington time, just as the 19 members of the Open Markets Committee and staff are sitting down for coffee and buns.

The market sees a small easing in the headline CPI to 4.6% (annual) from April’s 4.9%). If the headline figure is 4.6% then the growth in the CPI. Core inflation is forecast at 5.4%, down from 5.5% in April (and perhaps as low as 5.3%). No change in the core rate and the chance of a 0.25% lift rises.

While most in the market don’t really see an increase, the Fed could lift its federal funds rate by 0.25% on Thursday, Sydney time and economists at Moody’s haven’t ruled out such a rise.

“In our view, this picture of a slowing economy but enduring demand and high inflation keeps open the possibility of a rate hike for the June meeting,” Moody’s wrote in their Monday monetary policy round up.

“An important consideration will be the May core CPI inflation data scheduled for release on 13 June. As Fed Chair Jerome Powell explained in his 19 May press conference, having raised interest rates substantially, the Fed could pause this month to assess the effect on the economy.

“But the ultimate choice would depend on incoming data. If the FOMC leaves the federal funds rate unchanged, we expect the decision will be accompanied by hawkish forward guidance suggesting a strong possibility of more rate hikes if data continues to surprise to the upside.”

The ECB is widely tipped to boost its key rate by 0.25% on Thursday despite clear signs of a slowing economy and weakening inflation.

The Australian and Canadian central banks both raised their key rates by a quarter-point, whereas the majority of economist-analysts were betting on a pause. India’s central bank left its key rate steady at 6.5%.

RBA rates are now 4.1% and BOC rates 4.75%. Comments from the two central banks were again very hawkish, and are considering further rate hikes because of sticky inflation and have no other option to get rid of it.

So far there’s no sign of the rate rise infection spreading to the Fed – futures contracts tracked in real time by the CME’s (Chicago Mercantile Exchange) FedWatch still give a 73.6% probability of a pause.

But this percentage was close to 80% before the double decision in Australia and Canada, a sign that investors are not entirely comfortable. This means around a quarter of the market thinks the Fed will raise rates to the 5.25% to 5.50% range.

The futures market also adjusted for the July meeting: a rate hike is now clearly on the cards, with a probability of 65% late last week.

No second thoughts about the ECB – it seems to be a case of Not if, but when.