The is having a good month. Against the and , it is appreciating for the fourth consecutive month. Rising rates continue to appear to be the main driver. The divergence of monetary policy is palpable. At the same time, it is not simply a positive news story in the US but also less constructive developments in Japan and the euro area.
The euro, trading around its lowest level in two years, may initially tick higher if Macron is re-elected president. Yet it should not be exaggerated. Le Pen never ran ahead in the polls, but the proximity spooked some market participants. One of the key reasons the race was tight was that Le Pen tapped into a concern with broad appeal and may strike a responsive chord elsewhere. Between the rising cost of living from inflation and higher taxes (in many countries), households are squeezed. This potent political issue taps into a vein of anger and frustration that arguably were simmering below the surface.
However, Europe is more exposed to the stagflationary forces emerging in the post-COVID period and from the war in Ukraine. The IMF’s updated World Economic Outlook recognizes this and cut its forecast for eurozone growth this year to 2.8% from 3.9%. This is now in line with the market’s forecast (the median forecast in Bloomberg’s survey is 2.9%). However, this may still seem a bit elevated unless the war ends quickly. In addition, another energy shock may be around the corner. The stand-off between Russia’s payment scheme now that it cannot spend the euros due to the sanctions and Europe’s reluctance to play ball will likely come to a head in the coming weeks. The eurozone will publish its first estimate of on April 29. It is expected to have risen by 0.3% quarter-over-quarter.
will be reported an hour before the eurozone estimate. Remember, Europe’s largest economy contracted by 0.3% before the war began. It may have eked out 0.2% growth in the first three months of 2022. The French economy continues to fare better than Germany. It will report its a few hours before Germany. After growing by 0.7% in Q4 21, Q1 22 activity appears to have slowed to around half that pace.
reports its Q1 22 GDP estimate that will be released at the same time as Germany. For the second consecutive quarter, Italy appears to have outperformed Germany. While Germany contracted in Q4 21, the Italian economy expanded by 0.6%. In Q1 22, it may have contracted by 0.3%, according to the median forecast in Bloomberg’s survey. The Bank of Italy warned of a deeper contraction. Specifically, earlier this month, the Director-General of the central bank cautioned that Italy’s economy may have contracted by 0.55 in Q1. Signorini cited two drivers: the surge in COVID cases during the few several weeks of the quarter and the jump in energy prices.
To round out the top four largest eurozone economies, may surprise many observers by likely being the best performer. The Spanish economy probably expanded by around 0.6% in Q1 22 after a 2.2% bump in Q4 22. Spain is among the least dependent EMU members on Russian energy. After shaving its growth forecast one percentage point to 4.8%, this year, the IMF has Spain growing faster than China (4.4%).
At the same time that the eurozone’s Q1 GDP report will be published, Eurostat will also announce its preliminary estimate of the region’s CPI. German and Spanish national figures the day before will help solidify forecasts. French figures are due a few hours before the aggregate figure. Italy offers no lead time whatsoever. Its estimate is made at the same time as the eurozone as a whole. Given COVID-related distortions, there may not be much that can be said about it with confidence.
However, two things seem likely. First, March’s 2.4% surge (month-over-month) is unlikely to be repeated. Energy prices were a key driver and appeared to account for a little more than half of the monthly rise. After the Dutch wholesale benchmark for jumped more than 24% in March, it has nearly fully retraced it in April. Wholesale costs are passed on to consumers with variable lags, making it difficult to estimate when it hits. Also, several countries have cut taxes on energy purchases to relieve the squeeze on households.
Second, last April’s 0.6% increase is the bogey. If the Eurostat estimate comes above it, the year-over-year pace will accelerate from March’s 7.5%. The median forecast in Bloomberg’s survey is for a 0.5% month-over-month increase. Higher input costs and supply chain disruptions could see the core rate continue to accelerate. It rose 2.6% in 2021, and March’s 2.9% is unlikely to be the peak.
The Bank of Japan is in the proverbial hot seat. It meets on April 27-28. will be updated. It will likely boost this year’s CPI forecast of zero made a few months ago. It is also likely to reduce its growth projections. Previously, the BOJ’s forecast stood at 2.8%. The IMF cut its forecast to 2.3% from 3.2%. The BOJ will probably boost its inflation forecast from 1.1% in January to something closer to 1.7%. However, Governor Kuroda will likely reiterate that the price pressures coming from food and energy and the statistical quirk with the mobile phone charges are not the kinds of things that make for sustain inflation.
The yen has been on a historic depreciation course that has seen it depreciate by 10.5% this year, with more than half of which has taken place here in April. The of is the key driver, and the rise of roughly 140 bp increase in the US yield can be explained by the nearly 200 bp increase in the anticipated increase in the Fed funds rate this year.
Many observers believe that if the BOJ were to abandon the 10-year cap of 0.25%, the yen would strengthen. We are less sanguine. The key, we think, is the divergence of monetary policy, not the cap on the 10-year bond. Japan’s 30-year bond yield is not capped, and pays 1%. The US premium on this tenor briefly exceeded 200 bp last week for the first time in nearly three years. The IMF has suggested that the BOJ target the five-year yield, which is around three basis points, but not now during the challenge of the existing 10-year cap. After selling off for a record 13 consecutive sessions and extending the losses into a 14th session (reaching JPY129.40), the yen bounced strongly after the BOJ defended the 10-year cap.
On April 28, the US reports Q1 22 . As recently as early March, the Atlanta Fed’s GDP tracker warned that the economy may be contracting. However, last week’s update now sees it at 1.3% at an annualized rate. That is slightly firmer than the median forecast in Bloomberg’s survey (1.1%). This would still be well below the 6.9% pace in Q4 21, but that had been bolstered by a surge in inventory accumulation. , which still drives the economy, is expected to have strengthened from the 2.5% Q1 rate to 3.4% (median, Bloomberg survey). and the March will be reported days before the GDP estimate and may prompt last-minute tweaks to forecasts.
The GDP deflator may have stabilized around 7%, but the March deflator, which the Fed targets, is likely to have accelerated from 6.4% in February to near 6.7%. The median forecast in Bloomberg’s survey looks for the to ease slightly to 5.3% (from 5.4%). The actual spending figures will have been incorporated into the GDP estimate.
With inflation running the highest in a generation, the important differences between and the PCE deflator seem somewhat less significant. The point is that the market has become convinced that the Federal Reserve may have been slow to respond, but it has begun what will be very aggressive. Outside of some bolt-from-the-blue as it were, or a black swan, if you prefer, the Federal Reserve will likely by 50 bp at each of the next three meetings (May, June, and July). The market is almost sure that it will hike another half a point at the September meeting too. The Fed funds futures strip now implies a year-end rate of almost 3.0%
The hawkishness of the recent rhetoric from Fed officials means that the tightening cycle will continue into next year. Last month’s Summary of Economic Projections showed six of the 14 “dots” were above 2.75% in 2023. Eight were above it in 2024. The swaps market now sees the peak in Q2 23, moving toward 3.50%. One of the implications is that the note yielding less than 2.70% is still rich. It should be expected to rise above 3%. Long-term yields are a different story. We will see the appetite for 10- and bonds when yields rise above 3%. Arguably, there is value there, especially if is near a peak. Food and energy are excluded from the core rate, not just because they are volatile, but because over time the headline rate seems to converge with the core rate, not the other way around.
