Pro Perspectives 6/10/24



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June 10, 2024

Last week, we discussed the easing cycle that is underway in developed market economies.

And as we’ve discussed, we should expect the easing cycle to be coordinated among the major central banks (excluding Japan), just as it has been in the post-global financial crisis era.

If we needed any clues, just look at the shared language they use to describe policy decisions.  The most recent has been the need for more “confidence” that inflation is coming down.

The Fed started using this “confidence” condition in its policy statement in January of this year:  “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

The Bank of Canada cut last week.  And said, “If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate.”

The European Central Bank cut, on the condition of “confidence.”  Here’s what ECB President (Lagarde) said about it in the press conference last week:  “What we wanted before making that decision was collectively to increase our confidence level that the path ahead was on its disinflationary rhythm that we needed in order to make our decision.”

What else looks carefully coordinated?

The way both the BOC and ECB described the rate cut last week.

As we discussed in my Thursday note, Lagarde made a clear effort to shape opinion on the cut, as “moderating restriction” on the economy, rather than stimulating the economy. So, she wanted everyone to know that they are still in an inflation fighting stance.

The Bank of Canada Governor, similarly, focused on removing restriction:  “We don’t want monetary policy to be more restrictive than it needs to be to get inflation back to target.”

So, with all of this in mind, we’ll hear from the Fed on Wednesday.  And also on Wednesday, we’ll get May CPI.

The market is now pricing in just one cut by end of year, and CPI is being propped up by two components that restrictive interest rate policy is powerless to bring down (for at least a few more months).

With that, when the Fed presents its update projections on Wednesday, the market will be prepared to see ticks higher in the inflation forecast for this year, and a higher Fed funds rate projection by year end (adjustments UP in the highlighted areas below).  

So, given that set of expectations, a negative surprise for markets on Wednesday seems unlikely.  And given the actions taken last week by the Fed’s counterparts, there’s a better chance that they (the Fed) telegraph more and sooner cuts than the market is expecting, of course, just to “remove some restriction.”

We will see.

On CPI, remember we looked at this chart last month on what CPI would look like if we stripped out auto insurance and owners’ equivalent rent?

Both auto insurance and owners’ equivalent rent make up about 30% of the CPI.  And both of these CPI components are lagging features of an asset price boom.