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Three Questions: Week of August 1

CalendarJuly 30, 2022

Good morning, and welcome to Three Questions - a look at the big uncertainties facing currency markets in the week ahead.

Here are some of the things we'll be watching:

Question 1: How aggressively might the Reserve Bank of Australia move to tamp down inflation?

Markets overwhelmingly expect Australia’s central bank to lift its cash rate from 1.35 to 1.85 percent at Tuesday’s meeting. Swaps trading suggests hikes will continue until the benchmark hits 3.25 percent by year end - slightly above Governor Lowe’s “neutral rate” estimate at 2.5 percent.

Bitter medicine is needed: Data released last week showed consumer prices rising 6.1 percent year-over-year in the second quarter. Trimmed-mean, a core measure preferred by central bankers, climbed 4.9 percent - well above the central bank’s target - as pressures broadened across the economy. Treasurer Jim Chalmers told parliament the government expects inflation to reach 7.75 percent in the fourth quarter of this year, nearly double the forecast published in May.

The Bank can’t yet afford to follow its global counterparts in moving away from its “shock and awe” tactics. In Tuesday’s decision and Friday’s Statement on Monetary Policy, we expect officials to lift inflation forecasts and signal further tightening to come. Another 50 basis-point hike is likely to come at the September meeting, with 25 basis-point moves coming at consecutive meetings thereafter.

But the Lucky Country’s domestic outlook is darkening as high inflation rates and soaring debt service costs - exacerbated by spectacular levels of household leverage - demolish consumer confidence. Retail sales grew just 0.2 percent in June as rising living costs cut spending.

The export outlook is growing more uncertain as global growth slows. Raw materials prices are tumbling, and evidence of a turnaround in the Chinese economy remains elusive, at best.

And inflation is showing signs of peaking as - mostly imported - food and energy prices decline.

Rate expectations for 2023 are coming under pressure, and the Australian dollar is likely to remain on the defensive until traders are fully prepared for a reversal in the central bank's stance. The Reserve Bank of Australia is doomed to play catch-up - on both ends of this monetary policy cycle.


2. Will Brazil’s central bank surprise markets?

Most market participants expect the Brazilian central bank to lift its benchmark SELIC rate on Wednesday by 50 basis points to 13.75 percent. The statement accompanying last month’s decision said the bank, “foresees a new adjustment, of the same or lower magnitude” at this meeting.

The move could represent the final hike in this cycle: The futures curve currently sees just one more 25 basis-point move before year-end, and policymakers have described the policy trajectory as “advanced” with rates currently in “restrictive territory”.

Inflation is moderating. The most recent data showed prices rising 11.29 percent year-over-year, and the bank’s latest market survey sees it ending 2022 at 7.3 percent.

But survey data also shows expectations for 2023 holding at 5.2 percent, well above the bank’s 4.5 percent tolerance band. A deepening global downturn could see money flooding out of emerging markets, putting upward pressure on Brazilian prices. And an election is coming in October, adding both near-term government pump-priming and longer-term fiscal uncertainty to the mix.

We think policymakers could choose to prolong the hiking cycle by raising rates in smaller increments over time, or by abandoning forward guidance altogether - playing coy about whether their tightening campaign has peaked. If global market conditions don’t take a turn for the worse, Brazil’s central bankers might lend the real a surprising degree of support.


3: Will the Bank of England go big?

Markets are split on whether the Bank of England will tighten by 25 or 50 basis points from the current 1.25 percent. Two in three polled economists think the bank will opt for a larger hike, but a deteriorating global growth backdrop has led futures markets to put equal odds on both potential outcomes.

In their last outing, policymakers voted six-to-three for a 25 basis-point move alongside a promise to “act forcefully” in the event of “more persistent inflationary pressures”. Economist Huw Pill has suggested he thinks those conditions have now been met, as has Governor Andrew Bailey (albeit with less gusto).

The Bank’s doves argue that the economy is likely to slow, and they have a good case: income gains are lagging prices, retail sales are falling, the global economy is losing steam, and Britain’s largest trading partner—the Eurozone—could fall into a deep recession.

But the hawks may have a stronger hand: Inflation is at 9.4 percent and projected to reach double digits this fall. Unemployment is almost at pre-Covid lows amid labor shortages exacerbated by Brexit.

Politics also argue for a bigger jump - unions are threatening strikes as real wages fall; the bank is under fire for falling behind the curve; and Tory contenders to succeed Boris Johnson are pushing tax cuts.

On balance, we believe the majority will back a 50 basis-point hike. But the statement will likely also detail growing downside risks, raising doubts as to whether the bank has the stomach to get to 2.65 percent by year end. Market risks are somewhat asymmetric: if the doves carry the day, the pound will sell off immediately, while a hawkish move is unlikely to deliver sustained momentum.




EUR Unemployment Rate

USD ISM Employment, Prices Paid, July


AUD Reserve Bank of Australia Rate Decision

USD Job Openings and Labor Turnover Survey, June


USD Durable Goods Orders, June (Final)

USD Department of Energy Weekly Inventories

BRL Central Bank of Brazil, Rate Decision


INR Reserve Bank of India, Rate Decision

GBP Bank of England, Rate Decision

USD Trade Balance, June

USD Weekly Jobless Claims

AUD Reserve Bank of Australia, Statement on Monetary Policy

CNY Current Account Balance, Q2


USD Non-Farm Payrolls, July

CAD Employment, July

USD Baker Hughes Weekly Rig Count


Some of this week's most interesting and informative reads on the state of the global economy:

“Some of you may still be hoping that economics makes good by Christmas and somehow delivers the world a new train set. But Macro Santa isn’t coming this year. And Macro Santa isn’t coming next year either. Because Macro Santa is dead.” Financial Times: There’s No Such Thing as R-Star

“The market’s eagerness to price in a dovish Fed pivot early next year is worsening the situation by effectively easing financial conditions before inflation has even peaked. This post reviews the strength of household purchasing power along the three sources and suggests a dovish Fed pivot is far away.” Fed Guy: The Money Still Flows

“Overall, Russia needs world markets far more than the world needs Russian supplies; Europe received 83 percent of Russian gas exports but drew only 46 percent of its own supply from Russia in 2021. With limited pipeline connectivity to Asia, more Russian gas stays in the ground; indeed, the Russian state energy company Gazprom’s published data shows production is already down more than 35 percent year-on-year this month. For all Putin’s energy blackmail of Europe, he is doing so at significant financial cost to his own coffers." Foreign Policy: Actually, the Russian Economy Is Imploding

"Most signs suggest that people still believe that inflation will fade with time. But interpreting inflation expectations is more art than science: Economists disagree about which metrics matter, how to measure them and what could make them change. And after more than a year of rapid price increases, central bank officials are increasingly worried that it’s foolish to take the stability of price expectations for granted." NY Times: How Bacon and Costco Fish Shape America’s View of Inflation

“For whatever reason, the HMI (Housing Market Index) has an excellent track record of forecasting the unemployment rate 18 months. It has guided me to the right unemployment mark through several cycles (Chart 1), including the most recent. There is no reason to believe its prescient powers have evaporated. A simple regression forecasts a 5.5% unemployment rate by the end of next year. Odds are this level is broached sooner than that.” TS Lombard: How High For Unemployment In The Coming US Recession

“For decades, US households bailed out the global economy when it needed a consumer of last resort. America’s latest spending spree has come with a sting in the tail.” Bloomberg: The US Is Exporting Inflation, and Fed Hikes Will Make It Worse