By Benjamin Picton, Senior Macro Strategist at Rabobank
Today the US markets are closed for the Juneteenth holiday, so it’s a shortened week in the beating heart of the world financial system (sorry Londoners). Happily, a reduced American presence in our audience today presents a golden opportunity for a cricket-themed daily! The timing couldn’t be better, since one of the world’s great sporting rivalries has again resumed as England and Australia face off in the latest iteration of a 140-year grudge match. The Ashes is a biennial best-of-five tournament between the two nations, with the winner claiming a coveted four-inch tall terracotta urn said to contain the eponymous ashes of English cricket, which (legend has it) died and was cremated in London in 1882 when a touring Australian side bested the Mother Country.
The first match of this year’s series is a little over halfway through (games can take up to five days). Outcomes of cricket matches are notoriously hard to predict, and one of the great beauties of the sport is that there is never a definite answer to the question of “who is winning?” Nevertheless, I will go out on a limb and predict that this particular match is headed for a very thrilling draw, which sounds oxymoronic and will no doubt be further cause for consternation amongst less-devoted followers. However, all of that to one side, what is interesting (and relevant!) about this series is the way that England is playing. England have completely re-invented themselves into an aggressive and unorthodox excitement machine. This new style of play has been dubbed ‘Bazball’, owing to the assertive combination of England’s New Zealander coach, Brendon ‘Baz’ McCullum and their New Zealander captain (sorry, couldn’t resist), Ben Stokes. Bear with me as I contort this into a metaphor for the finer points of central banking.
Of course, unorthodoxy and aggression is now the de facto policy of many central banks around the world. We should see further evidence of this later in the week when the Bank of England meets to set the official Bank Rate. A further hike is all-but guaranteed, with the only real question being: “how much do they hike by?” The Bloomberg survey of bank economists overwhelming favours a 25 bps lift, whereas market pricing shows a decent probability of the BOE adopting the Bazball approach and swinging for the fence after a bumper labour force report last week showed the unemployment rate falling back to 3.8% and wages growth accelerating to 6.5% year-on-year. OIS futures have just over 30 bps extra priced in for the June meeting, implying a 1-in-5 chance of a supersized rate hike. The same OIS curve predicts a Bank Rate of 5.85% by early February next year.
The day before the Bank of England meeting we will see UK CPI for May. Obviously, this will be important for informing the actions of policy makers. Expectations are for the headline reading to fall slightly to 8.4% y-o-y, but for the core measure to display all of the stodge of a Geoffrey Boycott in remaining unmoved at 6.4%. Like Sir Geoffrey, core inflation has proved irritatingly difficult to dismiss in several geographies around the world, and a chorus of central banks have been upping the ante (at least in terms of rhetoric) in recent times to warn us all that more needs to be done to ensure victory.
Both the Fed and the ECB struck a hawkish tone last week, and despite the ongoing lethargy in Bank of Japan policy-making, expectations are building that a hawkish pivot will come sooner or later as inflation pressures build. Even the RBA, who have compiled a watchful 400 bps worth of cumulative tightening since May 2022, now seem to be looking to up the tempo. Australia had its own bumper labour force report last week. Employment rose by more than 5x expectations in May and both the participation rate and labour to population ratio returned to all-time highs. This puts the pressure squarely back on a central bank who had signalled at their June policy meeting that they were running out of patience with Australia’s poor productivity performance and consequent growth in unit labour costs. The jobs data prompted inversion in the 3y-10y Aussie bond spread for the first time since 2008, and we are now seeing predictions in the market of an Aussie cash rate as high as 4.85% by September when just a month ago many were convinced that the RBA was ready to declare its innings closed at 3.85%.
Indeed, this morning the Australian Financial Review is reporting that more unorthodox tactics could be on the way. The AFR suggests that a reversal of pandemic-era quantitative easing could be in the offing, with the RBA exploring the possibility of selling some of the $330 billion of bonds bought over the course of 2020-21. I will risk the ire of MMT advocates here by suggesting that the QE program has been a disaster for the RBA’s balance sheet, with cumulative losses on those bonds sitting at approximately A$40 billion. That means that the already skint Australian Treasury shouldn’t expect a dividend from the central bank any time soon. The prospect of bond sales is interesting for other reasons, principally because it could cause the Aussie yield-curve to “un-invert” by pushing up longer term yields. This would then flow through to the mortgage market, where it is currently possible to find 5-year fixed rates at similar levels to prevailing variable-rate mortgages. A re-steepening of the curve would likely end this situation by causing fixed rates to command a price premium over variable rates, leaving mortgagors with nowhere to hide to avoid higher borrowing costs in the future.
There are obvious parallels in the UK, where the Telegraph reports one Tory MP catastrophizing about the state of the UK mortgage market. Rapid monetary tightening has precipitated predictable calls for government to assist over-leveraged households, but that would defeat the purpose of tightening monetary policy in the first place! So, while central bankers scratch their heads about how long the long and variable lags might be, and try their best to come out of this without looking like the next Arthur Burns, beleaguered households who borrowed on the promise of low rates from here to eternity probably feel like the current bout of monetary tightening is just not cricket. So, we’re going to have to pick our poison. For mortgagors, it’s a case of “Ashes to ashes, dust to dust. If rate hikes don’t get you, inflation must.”
