Original insights into market moving news

Week in Focus; week commencing 27 May 2019


Core PCE is seen unchanged at 1.6% Y/Y. The April CPI data suggests a soft showing could be on the cards, though there is some risks to the upside presented by PPI inputs in the health care sector, some analysts have suggested (RBC  has noted that deviation in CPI and PCE of late is probably a function of health care, which has a larger weighting in the PCE data. There may be additional significance on this month's data, especially if there were a downward surprise, after some Fed officials have been expressing concerns regarding low inflation. The FOMC's recent meeting minutes stated that in light of recent, softer inflation readings, some viewed the downside risks to inflation as having increased. Earlier in the week, Fed's Bullard, a voting member of the Committee in 2019, said if core inflation persistently at 1.6%, he'd become more aggressive in pushing for lower rates in reaction and try to re-centre inflation expectations at 2%. The Fed's official inflation target is 2%, although it has not sustainably kept inflation at these levels since the target was adopted in 2012, and indeed, it has not been sustainably there in around quarter of a century.


The Bank of Canada is expected to leave rates unchanged at 1.75%. Recent data points suggest that the economy is performing better than the BOC had forecast in H1 2019. However, the BOC will still be cautious in the face of a number of headwinds (the Bank itself has identified trade policy, household spending, housing sector, the oil sector). The BOC might recognise the improvement on the trade front after the US agreed to drop metals tariffs, which the Canadians will reciprocate, and the government's focus has now shifted to ratifying the USMCA deal. But Canada would still not be out of the woods, in terms of global trade tensions, Capital Economics says. "The big worry is that the recent positive shift by the US towards its traditional allies is simply part of a broader strategy that will allow the US to focus solely on escalating the trade war with China, which could hit business confidence globally," CapEco writes, "ultimately, it would take a big rebound in Canadian business confidence before we reconsidered our view that investment growth will remain weak." Meanwhile, it will be interesting to see what the BOC has to say about household spending, after the recent stellar labour market report, which is likely to have supported wage growth. That said, consumer confidence remains fragile, and the outlook for the housing market remains challenging. "Overall, there have been some positives for Governor Stephen Poloz in the past month. That has been enough for market participants to revise their expectations for policy rates, with overnight index swaps now consistent with interest rates falling by just a few percentage points in the next two years," CapEco says. "We are beginning to question whether the first cut will come in September, which would be just one month before the federal election." Elsewhere, politics might play a role: given growing threats to central bank independence elsewhere in the world, Governor Poloz might be more concerned than usual about accusations of politicising interest rate decisions, particularly as he has now left the door open to taking a second term as Governor after his current term expires in January, CapEco says, "this means we may end up pushing back the timing of the first rate cut, but only to either the October or the December meeting."


RBC sees Q1 GDP coming in at 0.7% annualised in Q1, which would be the second consecutive sub-1% growth print, following the 0.4% in Q4; it sees the March monthly print at 0.2%. "We agree with the BOC's view that both quarters were impacted by transitory factors, notably lower oil production, while weather also was likely a factor in Q1," The bank says. However, RBC looks for the sub-components to show an improvement, though it flags up potential weakness in consumption, while residential investment will likely be a drag, as well net trade, on the back of lower energy exports and higher overall imports. "A sizable inventory build is expected given the discrepancies between the monthly GDP prints and the expenditure categories," it writes, and it sees GDP growth bouncing back in Q2 (at a pace of 2.2% annualized).


Finance Minister Robinson's pre-budget address has already outlined a shift in the stance of fiscal policy that will happen after the next election; Robinson said debt/GDP target of 20% would be replaced with a target range for net debt which is 15-25% between in 2021/22, and analysts say this will ultimately allow more spending. "This will give prudent scope for counter-cyclical fiscal policy, but it will be criticised as the start of a longer-term fiscal slide," UBS said, but "for short-term investors it doesn't matter much." Other analysts have also suggested keeping an eye on whether the government cuts growth forecasts given downside surprises to GDP growth in 2H18.


The BOK is expected to hold rates at 1.75%. The April meeting minutes revealed policymakers were split into dovish and hawkish camps. "The former emphasized low inflation and investments, while the latter highlighted financial imbalance risks," Citi says, "We think odds of a minority opinion for a rate cut have increased, but do not expect a cut at this meeting."