Douglas Porter

July 28, 2023

The one common theme to this week’s slew of central bank pronouncements is that policymakers are keeping the door open to further tightening moves, depending on how the inflation and economic data unfold in the coming months. While central bankers may not all be using the buzzwords “data dependent”, that’s how the entire financial community now views them. One could argue that it was ever thus—that is, when are central banks not guided by the economic data? Still, bond markets were not amused, having perhaps anticipated a clearer message that the end of rate hikes was nigh. Adding to the bearish tone in Treasuries, which saw 10s briefly top 4%, was that this week’s slate of U.S. indicators—the data we’re all depending on—was almost a royal flush of strength. And, the cascade of Q2 earnings reports were generally positive, suggesting that the economy is not buckling and modestly boosting equities yet again.

The Federal Reserve surprised no one with its 25 bp hike to 5.25%-to-5.50%, renewing its tightening campaign after a one-meeting pit stop. The accompanying statement and Powell’s press conference played it as close to the vest as possible, with minimal changes in wording and almost no guidance from the Chair. The Fed’s description of the economy was upgraded from ‘modest’ to ‘moderate’ growth, but that was about the extent of the messaging. One very slight hint—and we’re getting into Kremlinology terrain here—Powell said it was “certainly possible” that rates could rise again in September, but only “possible” that they could be held steady. While our official call is for no more moves, the Fed’s body language and the weight of solid U.S. data keep the risks of one more hike high.

Perhaps the two most interesting wrinkles in the press conference were: a) Powell said that the Fed could indeed be cutting rates and engaging in QT at the same time (surprising), and b) a young reporter’s question on whether the roaring success of the Barbie movie and Taylor Swift’s concert tour were signs of a robust economy. We say “nah” on Barbie (movies can be hot in any economy), but “perhaps yes” on four-digit ticket prices for concerts. Chiming in, real consumer spending was reported up 0.4% in June, and is up at a 2.9% annualized rate in the past three months—actually accelerating into summer.

The ECB didn’t face the same curious issues, but also delivered a totally foreseen 25 bp rate hike, taking its refi rate to 4.25%. That brings cumulative rate hikes since the start of the campaign a year ago to 425 bps, compared with 525 bps from the Fed. In her press conference, President Lagarde pointedly did not give direct guidance on the September meeting, and expressed some concerns about a softening Euro Area economy. In contrast to solid U.S. data, European PMIs were weak in July, with Germany’s manufacturing index dropping to a low 38.8. While that economy was flat in Q2, this followed two quarters of mild declines in GDP, also known as a technical recession. Other regional economies are faring much better, with France’s GDP up 0.5% (2.2% a.r.), but the overall tone is softer than stateside. The problem is that core inflation at 5.5% is higher in the Euro Area—that compares with 4.8% in the U.S., and just 4.1% on the core PCE, while U.S. employment costs have importantly calmed to 4.5%. Still, like the Fed, we suspect that the ECB may be done hiking, as inflation is cooling just enough and the economy is struggling.

At the other end of the spectrum, the Bank of Japan has barely even begun on the tightening trail. Its key interest rate has yet to budge at all, although Friday’s highly anticipated meeting resulted in a nod in the direction of higher rates. Its yield curve control policy was loosened, such that the BoJ won’t step in to hold down 10-year yields until they hit 1%—they previously defended the 0.5% level, although the Bank continues to suggest that this is the “reference” rate. Markets paid little heed to that nicety and promptly took 10s above 0.5%. While not as aggressive as may have been possible, the yen strengthened a bit on net for the week, but moved back above ¥140 by Friday.

While the Bank of Canada didn’t have a rate decision this week, their summary of deliberations from the July 12 exercise was published minutes before the FOMC decision. The main takeaway from the BoC is that each meeting will be taken “one at a time”, and the decision will be “based on the available evidence”, also known as data-dependent. Our view is that the case for the Bank being done with hiking is a bit more straightforward than for the Fed. First, inflation has been consistently lower, with core inflation below 4% and headline now tucked below 3%. (Presumably, the absence of any Taylor Swift concerts on this side of the border has helped dampen the inflation fires.) Moreover, growth looks somewhat soggier, despite being pumped up by a surging population. The flash estimate on Q2 GDP growth pegs it in the low 1% annualized range, or about half the 2.4% U.S. rise.

The overall message is that most major central banks are now at, or close to, the end of the tightening cycle, and will let the data dictate the next moves. Our best guess is that the rate hikes are done for most of these banks (although the BoE still has work to do). The risks to that call are different for each economy (Chart 1). For example, the ECB is dealing with higher inflation than most others, and hasn’t done as much as some of the more aggressive hikers, but also is looking at a chillier economy than most. On the flip side, the U.S. is arguably dealing with the firmest underlying economy, but has done as much as any bank and is seeing inflation coming down nicely. The Bank of Canada is somewhere in between on growth and the amount of tightening, but has the mildest inflation and highly indebted households, and thus probably the strongest argument for now staying put. The Bank of Japan is on its own island, and can afford to be extremely patient, as a bit of inflation is exactly what that economy has been seeking for the past 30 years.

When the Dow reels off a 13-day winning streak, one of the longest ever, one gets the sense the market is telling us something. Bears would counter that a deeply inverted yield curve has been telling us something else for the past year. But in the spirit of the title above, we will listen to the data, and it’s sending a positive message. The high side surprise in Q2 GDP, alongside a rebound in consumer confidence, solid spending trends, falling jobless claims, rising home prices, and, yes, buoyant equity markets have prompted an upgrade in our U.S. economic forecast. As Sal details below, we are dropping our call of two negative quarters, as we now see Q4 posting modest growth. For all of this year, we now look for GDP growth of roughly 2% and 1% in 2024. That’s not robust, but it’s a long way from the recession that markets and economists were bracing for at the start of 2023.

Because of Canada’s vulnerability on the household debt side, as well as the sluggish GDP performance heading into Q3, we are not significantly changing our Canada call yet. In addition, Canada has not had as powerful a push from fiscal policy—appropriately so, we may add—which has triggered a surge in U.S. factory construction. The contours are broadly similar to the U.S., with 1.6% growth overall this year and 0.8% next, but with a slightly softer tone as borrowers deal with the renewed back-up in rates.

Douglas Porter is chief economist and managing director, BMO Financial Group. His weekly Talking Points memo is published by Policy Online with permission from BMO.