The Global Week Ahead: This Isn’t the 2016 Bond Market!

Next Week's Risk Dashboard

• Intensifying political risk
• The G7 family photo could soon face a make over
• Elections threaten Eurozone unity
• Trump’s proposals face a very different bond market
• Canada won’t be an island
• BoE to stay out of the election fray
• UK CPI lands the day before the BoE
• RBA to deliver another hawkish hold
• BCCh may sound more cautious
• PBOC likely to extend its policy hold
• BCB may hit the brakes
• Norges Bank still on hold until autumn?
• A close call at the SNB
• Rupiah weakness may drive BI to hike
• BoC’s window on Governing Council
• Global PMIs may indicate France as the growth outlier
• US retail sales might face upside risk
• US markets shut Wednesday for Juneteenth holiday
• New Zealand’s flat economy

Chart of the Week

The onslaught of global central bank decisions will continue over the coming week and will be set against the backdrop of significant global data releases. Major central banks like the BoE, PBOC and RBA will weigh in alongside a slew of others totalling eight decisions all together that could well prompt global and regional market volatility.

And yet in markets it’s clearly not about just the week ahead. It’s not about the latest pontification by some central bankers somewhere when they often mess up anyway. Nor is it about merely tracking the latest inflation figures.

Central banks are entering a period of heightened uncertainty stemming from political developments that cannot be avoided or separated from the potential effects upon markets and economies. Political developments are putting renewed risk into the implications for fiscal policy, European unity, the bond market, and market stability. How these developments may net out is deeply uncertain at this phase which means how central banks may have to respond could also be highly uncertain.

Global political turmoil has to be closely monitored which we all knew coming into the year but have to start treating more seriously now. A look at the latest G7 leaders’ family photo naturally has one thinking it will probably be a very different picture within 12–18 months as most of them could well be out of their jobs if current polling proves to be accurate. Regime change on a global scale is feasible and it cannot be thought of as simply right versus left. This presents higher uncertainty around the potential for a tectonic shift in policy directions and associated effects.

UK PM Sunak may be first after the July 4th UK election with Labour’s Keir Starmer trying his best to convince markets that Jeremy Corbyn’s fiscal agenda is in the rearview mirror (chart 1). German Chancellor Scholz’s four party alliance only secured 31% support amid record participation and a 70% personal disapproval rating while the far-right AfD party is coming on stronger and posing a significant threat to European unity (chart 2). President Biden (November 5th) and PM Trudeau (no later than October 2025) are polling very poorly. This is driving pressure to call a German election as early as this summer but no later than October of next year. 

Japanese and Italian governments are inherently unstable. With the UK’s exception—where a sequence of conservative prime ministers has looked like anything but—most of these countries could turn further to the center-right unless France’s left continues to gain.

Europe’s Political Turmoil and the Bond Market

European elections present substantial market risk. Nascent signs of pressures unseen since past crises around Greek and Italian debt challenges are starting to resurface. They are nothing close to such a point yet, but the widening of French 10-year debt spreads to bunds to the widest point in many years and spillover effects upon other countries is starting to price in greater uncertainty that may intensify as the French elections on June 30^th and July 7^th draw nearer (chart 3). The outcome could well affect the ECB’s next decision and guidance on July 18^th. 

Macron’s resignation rumours could have something to them—despite denials—if his party loses as badly as current polling suggests (chart 4). The other day’s poll by Elabe showed Marine Le Pen’s National Rally (formerly National Front) party securing 31% of the vote, an alliance of left-wing parties getting 28%, and Macron’s Renaissance party getting 18%. That’s a close outcome between left and right and roughly within polling error. Macron’s approval rating sits at 24%, his lowest since 2018. The latest poll points to only 40% of Macron’s MPs qualifying on June 30th for the second-round vote on July 7th. The four French left wing political parties recently agreed to form an alliance. Losing this badly and having to potentially appoint Le Pen as prime minister could well be too much for Macron to accept with the next Presidential election not scheduled until April 2027, but he would very likely lose an election held now.

This isn’t as simple a matter as preferring left versus right or somewhere in the middle. Both the French left and right oppose the EU with uncertain effects in terms of whether that means a path toward weakening its institutions or outright withdrawal. The latter could resurrect a Eurozone break-up premium that is driving investors to seek relative safety in bunds as the German 10-year has shed about 30bps of yield in the past week. Fiscal policy is an added concern as France’s National Rally is feared to favour expansionist policies that risk ratings downgrades. The left is also a risk to fiscal policy albeit the policy mixture would differ. European unity around support for Ukraine could be shattered and give rise to more intense geopolitical risk.

Trump is a Grave Danger to the Bond Market

In the United States, both Biden and Trump present policy risks to the market outlook. Since Trump is strongly outperforming Biden in the polls (chart 5), it’s Trump policies that need to be given the most scrutiny in terms of the prospect of becoming reality unless new polling information arises.

Trump’s playbook is operating like it’s still 2016 and yet the bond market is profoundly different today. One the eve of the 2016 election, the US ten-year Treasury yield stood at 1.83% and immediately began selling off as Trump’s victory became priced. Today’s bond market is much more attuned to inflation risk and debt issuance and a cavalier fiscal plan could be met by a stronger bond market sell off that would sterilize his fiscal plans and drive business and household fixed term borrowing costs considerably higher. Expansionary fiscal policy would also potentially thwart policy easing by the Federal Reserve.

That’s because while Biden is no friend to the US bond market, Trump’s tax plans could be the apple that tips the cart right over. Everyone loves a tax cut and the immediate market reaction may be favourable, but the effects on the bond market and economy could prove very different over time. The US government has enormous advantage over others because of its reserve currency status, but there is a limit to this advantage and the bond market is willing to supply credit to the US government at a higher yield.

Trump’s plans are likely to add to the US fiscal deficit that is already running north of 6% of GDP (chart 6). US government public debt has risen by 50% since just before the pandemic struck and has risen from 107% of GDP before the pandemic to 122% now (chart 7). Sensitivity to each Treasury refunding announcement has been clearly amplified as evidenced by market volatility since last Fall.

Tax cuts don’t pay for themselves. That’s political hyperbole. We saw that in his first term when Trump inherited a deficit to GDP ratio of about 2½% and it widened to about double that after the 2018 Tax Cuts and Jobs Act but before the pandemic arrived. That raised structural deficits and issuance pressures. The pandemic’s effects were no one’s fault at first, but Trump’s crisis mismanagement and expansionary fiscal policies added to the deficits and bond market pressures. President Biden was derelict in his duty to repair the damage done to US government finances.

Trump’s proposal to permanently extend the Tax Cuts and Jobs Act provisions that are slated to expire at the end of 2025 is estimated by the Congressional Budget Office to add about US$400 billion per year to the deficit and US$4 trillion over the next decade (here).

His proposal to cut the corporate income tax rate by one percentage point to 20% would cost another over US$100 billion over the next decade (CBO estimate in reverse here).

Trump’s proposal to eliminate taxes on tips raises a host of issues that make costing it problematic. The latest data available seems to be IRS stats showing tip income at US$38 billion in 2018. Yes, six years ago. Assuming no growth since then at an assumed relatively low marginal tax rate would result in under US$10B/year of foregone revenue for Treasury. One problem is that tips have probably risen and by perhaps quite a lot since then giving how the tipping culture has shifted. Another problem is that eliminating taxes on tips could drive a shift in the sources of income away from regular pay to tips, thereby costing an unknown amount of foregone tax revenues on regular pay. It’s also not clear that data on tips income is reliable given the obvious incentive to date for workers to be paid under the table.

In summation, extending the TCJA provisions, cutting corporate income taxes, and eliminating taxes on tips could cost upward of a half trillion per year in US government revenues with no plan about how to fund it. Multiplier effects and the state of the economy at the time are difficult to estimate, but it’s reasonable to conclude that the deficit-to-GDP ratio would likely rise to at least 7–8% and perhaps higher. That would take Washington’s deficit to GDP ratio to the highest level on a sustained basis than at any other point outside of wartime or deep crisis like the GFC and pandemic. Some possibilities for how to pay for the tax cut could negatively impact finances at other levels of government, thereby shifting fiscal and issuance pressures elsewhere.

In such a scenario, US 10s presently at 4.2% may look dear. The combined inflation risk and impact upon Treasury supply could in isolation of other effects have us staring at the prospect of a 6%+ ten-year yield. If 30-year mortgage spreads of the past couple of years persist, then US mortgage holders could be left with mouths agape when the 30-year fixed mortgage rate rises toward 8–9% or potentially higher.

In short, Trump’s tax plans could wind up landing like a lead balloon in the back pockets of American debtors including consumers, homebuyers, and businesses. Tax cuts in a different bond market could go toward higher debt servicing costs except for those without debt in which case the indirect effects could be important.

Canada Is Not an Island

Canada, in turn, will not escape the consequences. A federal election by no later than October of next year is at present looking like it may be a disaster for the Federal liberals and NDP. Chart 8 shows polling, chart 9 shows that attempts to map this onto seat projections would grant a large majority to the Conservatives if a vote were held today. A lot can change in the next sixteen months or less, but governments doing this badly in the polls typically don’t spend less and yet this prospect is not factored into anyone’s forecasts. Fiscal pump priming may be in the cards in Canada either in a Fall fiscal update or next Winter’s budget. Canada’s bond market could be caught up in spillover effects from what transpires in the US plus greater domestic debt issuance pressures plus the possibility that the Bank of Canada may not be as accommodative in the face of expansionary fiscal policy. 

In all of this, how should global central banks respond? That’s highly unclear at this point. Should market turmoil risk instability and systemic risk then they could be forced to respond in dovish fashion. Should it be more of a slow grind toward more expansionary fiscal policy and consequences for inflation and bond markets then this could thwart prospects for at least some of the policy easing they might have otherwise considered. Should fiscal issuance intensify, will central banks allow markets to engage in price discovery while continuing to tip toe away from bond markets?

I’m not saying that all of this is a base case or even close to being one at this point, but one has got to keep a part of one’s mind open to the possibility that central bank plans could be thrown into a state of upheaval toward greater easing pressures if market turmoil intensifies over the summer and beyond. Political risk and consequences for market stability and policies are front and center.

With that, the round of global central banks that are tasked with delivering this week’s decisions should approach them in a highly circumspect manner.

CENTRAL BANKS—EIGHT IS ENOUGH!!

Eight central banks will weigh in with updated decisions this week. Brief highlights are offered below in chronological order of the pending decisions. More will be offered in regular notes throughout the week.

RBA—Another Hawkish Hold

No ones expects Australia’s central bank to change its policy rate on Tuesday. Markets are priced for a hold and are not pricing a full quarter-point cut until early 2025. The prior meeting on May 7^th delivered a higher-for-longer message. Since, then, 77k jobs have been created if which roughly half have been full-time. Wage growth remains high (chart 10). Inflation also remains high (chart 11) and driven by domestic non tradeable prices that matter more to the RBA.

BCCh—More Cautious?

Chile’s central bank decision on Tuesday faces a somewhat divided and lightly populated consensus. Four out of seven expect a 25bps cut, 2 expect -50bps including our Santiago-based economists, and one expects a hold. We may hear a more cautious sounding central bank toward the pace of easing either now or in future not least of which because of 525bps of cuts to date since they began last July.

Since the 50bps cut on May 23^rd, inflation has been a little hotter than expected and at 3% y/y remains above target. The peso has appreciated more than other crosses given higher copper prices (chart 12) and the unemployment rate fell. GDP is tracking two consecutive months of decline, however, which could tip the balance toward a larger cut. The surprise hold by Peru’s central bank and the FOMC’s dot plot that is on the fence between 25bps and 50bps of cuts this year may also weigh on the decision.

PBOC—Likely to Extend a Hold

A minority of forecasters mainly comprised of the usual suspects think that China’s central bank could cut its 1-year Medium-Term Lending Facility Rate from 2.5% by 10bps on Wednesday. Sixteen of 21 in Bloomberg’s poll think it will hold.

Several factors may lean more closely toward a hold. For one, recent financing figures accelerated somewhat, suggesting that the lagging effects of prior reductions in required reserve ratios may be driving credit easing. The yuan has been weakening from about 7.1 to the dollar at the start of the year to 7¼. Cutting now could further destabilize the currency (chart 13) given that the Federal Reserve is in no rush to ease. Inflation remains very low at just 0.3% y/y with core CPI at 0.6% compared to a 3% headline target, but China’s central bank has been persistently more indifferent toward achieving its inflation target than would be the case across other central banks. 

BCB—Hitting the Brakes

Brazil’s central bank is expected to hold its Selic rate at 10.5% on Wednesday. This would be a natural progression from having downshifted the prior 50bps per meeting cut pace to 25bs in early May that reflected a more divided committee. A small recent increase in inflation expectations is a key concern (chart 14), headline inflation appears to be stuck at just under 4% y/y, and potentially expansionary fiscal stimulus is being carefully monitored. 

BoC’s Summary of Deliberations—Consensus?

The Bank of Canada issues its Summary of Deliberations on Wednesday. These cover the process leading up to the June 5^th decision to cut the policy rate. Watch for discussion that reflects the degree of consensus on Governing Council and possible indications on next moves.

Norges Bank—Still On Hold Until Autumn?

Norway’s central bank is unanimously expected to hold its deposit rate unchanged at 4.5% on Thursday. Markets are priced for no change and all nine within consensus expect a hold.

The prior meeting on May 8^th stated no change for “some time ahead.” This is a central bank that tends to prefer providing explicit forward guidance and sticking to it barring unusual circumstances. Forecasts will be refreshed at this meeting and watch for updated forward guidance that in the last round saw no changes until autumn and modest easing in 2025 (chart 15).

SNB—A Close Call?

This one is a close call. Consensus is evenly divided between a policy rate hold at 1.5% and a 25bps cut on Thursday. Markets have about 70% of a cut priced in. SNB enjoys a good surprise, as evidenced by its 25bps cut on March 21^st well ahead of the ECB. Recent inflation has been a smidge warmer than usual months of May but at 1.5% y/y and core CPI at 1.2%, there is ample justification to continue front-running the ECB especially given recent strength in the Swiss franc.

BoE—Watch the Guidance

The Bank of England is universally expected to hold Bank Rate unchanged at 5.25% on Thursday. Key will be guidance that could inform market pricing that is half way toward pricing a 25bps cut at the August 1^st meeting.

The BoE may wish to stay out of the fray ahead of the July 4^th general election. After all, it cancelled all public communications during the election campaign. That could also add to reasons to be guarded on forward guidance. Wage growth remains hot (chart 16), but job growth is cooling. UK CPI is poised to be updated the day before the decision and could be impactful to the meeting’s bias. No new projections are due at this meeting and so that may be added reason for not expecting much from this meeting.

BI—Could Rupiah Weakness Drive a Hike?

Bank Indonesia Thursday is widely expected to hold its policy rate at 6.25% with a small minority thinking that it could hike. That minority might be an understated risk.

Key is that the rupiah has been weakening and currency stability matters a lot to this central bank given the implications for imported inflation and overall market and economic stability. Since early March, the rupiah has been among Asia’s weaker currencies to the dollar, having lost about 5% of its value as the Federal Reserve’s easing gets pushed out and more intensified uncertainty is creeping back into global markets (chart 17). If BI decides to hold, it is very likely to have a hawkish feel to it.

GLOBAL MACRO—A LITTLE SOMETHING FOR EVERYONE

Central banks will dominate market attention this week, but there will also be a solid line-up of key macro releases spread across major markets.

Global PMIs Show Solid Growth—Except in France

A fresh round of global purchasing managers’ indices for June starts to arrive halfway through the week. Australia (Wednesday), Japan (Thursday) and then each of the US, Eurozone, UK, Germany, France and India releases on Friday. All regions except France are signalling growth through above-50 composite PMI readings. India has reasonably balanced growth between services and manufacturing, but all other regions are being led by services.

UK Inflation Arrives Before the BoE

The main highlight on Europe’s data calendar will be UK CPI on Wednesday. The Bank of England delivers its policy decision the day after. Markets are expecting a hold, but inflation may influence forward guidance for subsequent meetings. Markets are pricing most of a first cut by the September meeting and a decent chance at one in August.

Core inflation has been ebbing from a peak of just over 8% y/y in May 2023 to just under 4% in April. The last three months have, however, registered somewhat firmer than seasonally normal m/m increases with just April shown in chart 18). Still, headline inflation is expected to land at around 2% y/y this summer and at 2.3% it isn’t far off. Key will be signals from core inflation along this path.

The UK also updates retail sales for May that may bounce back from the sharp decline during the prior month.

US Releases Focused on Consumer Spending

The main US release will be retail sales for May (Tuesday). At best a modest gain is expected given what we know so far about auto sales and gasoline prices. Guidance from the National Retail Federation nevertheless points to a solid rise (chart 19). Household sector releases will also include housing starts for May (Thursday) that are expected to post a small rise, and existing home sales for the same month (Friday) that are likely to fall based upon tracking of pending home sales. Industrial sector releases will include the kick-off to the month’s regional manufacturing gauges with the Empire measure for June (Monday) and then an expected small gain in industrial output during May (Tuesday).

Canada to Focus Upon Housing Updates

Canadian markets will face a light calendar over the coming week. Housing starts during May could have slipped before a surge in permits for new dwellings to the highest level since early 2021 may give them a boost (Monday). Home resales during May (Monday) will merely tee up the first tee of rate sensitivity ahead of the June numbers that may reflect the BoC’s rate cut. The base 5-year Canadian government bond yield has dropped by about a half percentage point since the recent peak in late April. Then on Friday, the retail sales figures for April with guidance for May will arrive; Statcan had guided that nominal sales were up 0.7% m/m SA in April pending revisions and details like volumes.

Conflicting Readings on Japanese Inflation

With the Bank of Japan not due to deliver another decision until July 31^st, Thursday’s CPI figures for May should just be a placeholder between steps and a modest acceleration in year-over-year terms is expected to follow the already known Tokyo CPI gauge. Trend pressures in core inflation at the margin have nevertheless been in steady decline (chart 20).

New Zealand’s Flat Economy

Asia-Pacific markets face a light schedule beyond central bank decisions. New Zealand’s Q1 GDP (Wednesday ET) is expected to post little to no growth after a pair of mild quarterly contractions. What is holding back the RBNZ from easing and why markets don’t see a solid chance at cutting until November is the fact that domestic, non tradeable CPI inflation is still running hot (chart 21).