GLOBAL CREDIT BULLETS | Monday, 31 July 2023

Fed – Meeting by meeting
The Federal Reserve hiked interest rates by 25bp at its July meeting, in line with expectations, bringing Fed funds to 5.25-5.50%. The statement was very similar to the June meeting: the Fed is satisfied with the progress on the inflation front but recognises that levels and risks are still elevated. As a result, the FOMC does not pre-commit to any future decision but leaves policy data-dependent, continuing with a meeting-by-meeting approach. Chair Powell recognised policy is getting tight, with credit and economic survey showing a more marked impact on the economy. We continue to see further downside to US core inflation, expecting below 4% by year end. We see the July hike as likely the last in this cycle. Markets now price some chances of another hike by November and some cuts starting in 2Q2024.

ECB – Hawks already on holidays
The ECB tone at the July meeting came across less hawkish than expected. The central bank hiked the depo rate by 25bp to 3.75%, as widely anticipated, but refused to guide explicitly for another hike in September. Lagarde comments signalled more comfort on inflation, but pointed to more work to be done potentially, depending on incoming data. The tightening bias and the very hawkish tone that permeated the past three meetings was considerably smoothed, suggesting we are approaching a more mature phase of the hiking cycle. We see chances of a last hike in September to 4% but think the ECB will stop then. The central bank also surprised markets announcing that minimum reserves will be going forward remunerated at 0% instead than at depo rate. The change in policy works as a one-off tax on banks and helps the central bank mitigate its losses. The impact on the system is small, as mandatory reserves are just 1% of banks deposits, and likely one off.

BoJ – A twist, not a turn
At its July meeting, the Bank of Japan increased the tolerance band for 10y government bond yields from 0.5% max to 1%. The yield curve control policy framework was otherwise left unchanged. We do not see this move as signalling a turn in policy. In fact, inflation forecasts for 2024 and 2025 were revised just higher. We see the move as a sign of growing discomfort on financial markets instability, particularly yen volatility and the continued inability to keep 10y yields within the band. In December, the central bank made a similar adjustment that was not followed by a policy turn. The initial strength in the Japanese Yen was quickly faded. We do not expect the central bank to loosen YCC policy any time soon, particularly as the global tightening cycle approaches its final phase.

Macro – Weak surveys vs strong data
Forward-looking survey data continues to stay weak, vs a different picture shown by realized economic data. In July, Eurozone PMIs worsened further, and manufacturing PMIs are now well in recessionary territory. The BLS lending survey showed that credit in Europe continued to tighten in the second quarter, particularly in the household sector. Hard data, instead, keep going stronger. 2Q US GDP printed at 2.4%, 0.6% above consensus and 0.4% above 1Q. Even in the US, leading indicators suggest slowdown. Overall, we think the gap between soft and hard data is now approaching unsustainable levels, and credit surveys are adding to industrial ones in showing signs of a cooldown. We thereby expect 3Q and 4Q data to become less hot. Inflation data, in the meantime, continues to point to a slowdown. Germany inflation slowed from 6.8% in June to 6.5% in July, and the US core deflator surprised on the downside too.

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Algebris Investments’ Global Credit Team