The Markets
It’s a big week ahead in terms of central bank meetings, economic data, geopolitics and supply. Starting with the central banks, the Bank of Japan (Tuesday), the Fed (Wednesday) and the Bank of England (Thursday) meet. Last week’s temporary break of the USD/JPY above the 150 level suggests that the BoJ will meet with guns blazing. Ahead of the meeting, rumors of upward revisions to inflation forecasts (>=2% for fiscal years 2023 & 2024) and further easing of its yield curve control policy underline expectations that a next step in policy normalization should/will be taken. If not, the Japanese Yen risks sliding at a pace that no FX intervention can immediately stop.
The Japanese 10-year bond yield touched 0.9% this morning for the first time in over a decade, just shy of the current maximum deviation (100 bps) from the 0% yield target. The US Federal Reserve will hold off on raising its key interest rate for the second meeting in a row. The US economic data since the Fed’s September meeting has been crying out for the last (flagged) hike on the back of much better than expected growth data, but the Fed governors have joined forces to downplay such a move as the rise in yields at the long end of the curve (tightening financial conditions) is a substitute for such a move. We believe that Fed Chair Powell will keep the option open for December (currently 20% market implied probability) or risk a further rise in inflation expectations, which have risen to a year-to-date high of 2.5% since the same Fed speech (March).
The US 2-year yield is at risk of losing the 5% level in the event of a dovish hike (not our preferred scenario). The Bank of England is expected to be dovish, with its new monetary policy report likely to paint a very gloomy economic outlook (high risk of recession; rising unemployment). The central bank tends to err on the soft, growth-supportive side. Given that inflation dynamics in the UK are still worse than in the EMU or the US, this combination risks backfiring via GBP weakness. Last week, EUR/GBP found its first resistance at 0.87.
We see further upside potential towards 0.90 by the end of the year. The economic calendar starts light today with only EC confidence data, but quickly heats up: EMU CPI inflation, Q3 GDP and US consumer confidence (tomorrow), US ADP employment, JOLTS job openings and manufacturing ISM on Wednesday, US weekly jobless claims and Q3 unit labor costs on Thursday and payrolls and services ISM on Friday.
Amid this complex of central bankers, numbers and the intensifying Israeli-Hamas conflict, the US Treasury releases its quarterly refunding statement on Wednesday. It serves as the biggest wild card of the week. At the last announcement in August, the Treasury stepped up issuance for the first time in more than two years (to $103 billion in refundings). A new increase is expected this time around, with additional focus on how the Treasury wants to use the funds (more bills or more long-term funding).
News and Views
The IMF‘s first managing director, Gita Gopinath, in an op-ed for the Financial Times, called on governments to rein in their fiscal spending. They have acted as “insurers of first resort” in response to the Covidien and energy crises, but this has added a heavy burden to already high debt levels. Many challenges lie ahead, including large age-related spending needs in advanced economies and large public investment needs in developing countries. Combined with an increase in defense spending, the resurgence of costly industrial policies (i.e. deglobalization and subsidies), and climate-related investments, it estimates that additional spending above current levels could exceed 7-8% by 2030.
“With record-high debt levels, higher interest rates for longer, and the weakest growth outlook in two decades, restraint is needed.” At the center of global finance, Gopinath singled out the U.S. for getting its fiscal house in order, but others should heed the IMF’s advice as well. In what we call “The Fiscal Reset,” Gopinath said governments can no longer be the insurer of first resort for all shocks.
Depleted fiscal buffers need to be rebuilt and expanded. Any future response to shocks should be better targeted and temporary. Second, revenues must keep pace with expenditures. A minimum corporate tax is advisable, while tax loopholes need to be closed. Carbon pricing must also be on the table, both to catalyze and finance the climate transition.
Finally, Gopinath said, fiscal frameworks need to be strengthened. Many countries have rules, but deviations are the rule rather than the exception. Debt containment requires credible plans that are better aligned with annual budgets and anchored in spending targets.
