ECB – Substantial progress, but more to go
Last week, the ECB delivered the widely expected second 75bp hike but flagged that it has now made “substantial progress in withdrawing monetary policy accommodation.” Markets took the press conference as a welcome pivot message given Lagarde’s references to substantial progress, reducing support for demand, heightened recession risks, and the lagged impact of tightening. QT does not seem up for discussion imminently. We read the new tone as a relaxation about the core inflation outlook and think the range of terminal rate in 2023 will be 2.5-3%, not far from where it’s priced. The ECB is likely to slow down the pace to 50bp hikes at the December meeting.
October inflation data surprised on the upside with Spain being the only exception of the big 4 economies. France saw harmonized EU CPI YoY at 7.1% (previously, 6.2%), Italy saw harmonized EU CPI YoY at 12.8% (previously, 9.4%) – impacted by a change in indexation for energy, from quarterly to monthly, Germany saw harmonized EU CPI YoY at 11.6% (previously, 10.9%). Most of the upside surprises were driven by the lagged effects of energy prices, therefore core inflation doesn’t look as bad. With the lagged effects of energy prices in mind, we think the ECB can stick to her dovish rhetoric from last week, also considering the next set of macroeconomic projections are set to come out at the December meeting. However, if November CPI numbers continue following this trajectory, the recently changed rhetoric may be at risk.
Fed and BoE – Searching for pivot
A fourth consecutive 75bp hike for the Fed this week seems to be fully priced in by markets. Focus will be on the press conference where Powell could acknowledge a debate on the merits of a downshift in the pace of hikes at some future date. Recent data show a slowdown of economic momentum and less booming labour markets when compared to August. Leading indicators on inflation show a marked drop is in the cards for October and November. Fed speakers’ rhetoric has recently softened, including from more hawkish members. As a result, the Fed is likely to adopt a more accommodative tone, in line with the ECB. The balance of inflation risks will remain skewed on the upside, and communication won’t suggest a lower terminal rate, but rates markets are likely to consolidate around the 4.5-5% for end-2023.
The BoE is also set to meet this week. Post recent stabilization in the politics, the choice is between a 50bp and 75bp hike. We still think the BoE will go with the higher hike, as FX remains volatile and inflation remains in the rising phase. The budget has been recently moved from October 31st to November 17th, adding an element of uncertainty to the BoE projections, and assumptions on the fiscal side will remain loose for now. We think the terminal rate for the Bank of England will be close to 5%, in line with what the market is pricing.
Algebris Investments’ Global Credit Team
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