US – Upside risks to CPI
On Tuesday we’ll see January’s US CPI print, which consensus sees at 6.2% YoY for headline versus 6.5% prior, and core at 5.4% vs 5.7% prior.
Inflation swaps agree, but see upside risks to the headline figure MoM, pricing 0.6% vs 0.5% consensus. The Cleveland Fed Nowcasting-Tool even sees 6.4%, but this has been overstating inflation prints recently and therefore no longer serves as the best indicator. Nonetheless, we agree that risks lie to the upside for the upcoming print, as gasoline prices rose in January, inflation tends to be higher to the begin of the year, and it’s unclear yet again how quickly the rent component falls in the official data.
In addition, the Mainheim Used Vehicle Index reaccelerated in January and rose by 2.5% MoM. Following the very strong NFP jobs report, we believe that an upside surprise to inflation can drive bets on a higher Fed terminal rate, which Powell mentioned as possible if inflation does not abate, and can fuel speculation that the Fed may revise their 2023 dot even higher in the next March projections, beyond the 5.125% it had signalled in December. Markets are pricing close to 5.2%, and have trimmed bets for rate cuts in 2023 from -60bp to -32bp since the NFP print.
Eurozone – Stay bearish duration
European economic data has been generally holding up very well over the past weeks, as the Eurozone defied fears of a bad recession amid energy shortages. Citi’s Economic Surprise Index stands at 93, near the highs of the past 20 years when excluding post-Covid, thereby signalling just how well European data has performed against very poor expectations recently.
Nonetheless data is slowing, as last week’s retail sales at -2.8% YoY showed. Nonetheless, ECB speakers continued to caution on upside risks to inflation. We follow Isabel Schnabel in particular, as we see her leading the narrative among the Governing Council. In a German webinar held last Wednesday, she pointed to continued rises in underlying components, high inflation momentum and rising nominal wage growth in the Eurozone.
While Germany’s delayed HICP publication came in at 9.2%, below consensus of 10%, this was still above Eurostat’s initial estimate of ca. 8.6-8.7% and means January’s Eurozone CPI of 8.5% may be revised 0.1-0.2% higher. Market pricing now sees the ECB terminal rate at 3.5%, which corresponds to expectations for 50/25/25 steps over the next three meetings. We agree with this pricing, but even see upside risks, as our inflation models show Eurozone core inflation staying sticky around 5% until mid Summer.
In such a scenario, we don’t think the ECB can afford to slow down and may signal further increases beyond that. Accordingly, we remain cautious on European duration.
Central Banks – No pivots in smaller economies
Last week saw the RBA, the Riksbank and Banxico surprising markets hawkishly, despite wider anticipations of monetary policy slowdowns in the leading economies of US, EU and UK.
The RBA hiked 25bps to 3.35%, and guided the market that further hikes will be necessary in the following months, as underlying price pressures continue to accelerate. The Riksbank hiked by 50bp to 3% and signalled a higher terminal rate of 3.3%, despite only guiding for a 25bp in their last meeting in November.
Both the Australian and Swedish economies are particularly vulnerable to higher rates due to the highly geared housing market with largely floating or short-term mortgages, but both decided nonetheless that more forceful hikes were necessary to tame inflation.
While the hike increments for both the RBA and Riksbank had been anticipated by markets, Banxico delivered a real surprise by hiking 50bp to 11%, versus market expectations of only 25bp. Policymakers noted that the economic recovery has lost momentum in the recent months, but inflation expectations were revised higher, opening the door to a potential 25bp hike next month. Taken together, we note a rising divergence among central banks, between those who started earlier and more forcefully (e.g. Fed, BoE, RBNZ), versus those who started later and are fighting stickier inflation (e.g. RBA but also ECB).
We think investors need to be nimble when picking their interest rate exposure across geographies carefully.
Algebris Investments’ Global Credit Team
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