Hawkish Speeches, Weak Data

• Hawkish festival in Sintra
• The central banks may get the contraction in aggregate demand they seem to wish for quite quickly now: European surveys are turning decisively south, and the end of consumption resilience is confirmed in the US. It will take a lot to stay the central banks’ hand though.

Except for the BOJ, all central banks stroke a hawkish note last week in Sintra. Although they chose to remain evasive on the quantum and timing of the next hikes, they are sufficiently concerned by persistent inflation to warn the market against pricing rate cuts too soon after the tightening peak. Keeping monetary conditions restrictive over a long time will do some significant damage to the economy, but they have clearly reached the conclusion that there won’t be such thing as a painless landing.

They may get the contraction in aggregate demand they probably see as necessary quite quickly now. The European Commission survey released last week confirmed the message from the PMIs: services are now following the manufacturing sector in the downturn. In Germany – which we think will be the key to the ECB’s future trajectory – hiring intentions are falling, heralding a correction of the labour market which is needed to hold back future wage negotiations and convince businesses to absorb in their margins the rise in labour costs already in the pipeline. There is no “smoking gun” yet though, and the better-than-expected core inflation print for June is unlikely to stay the ECB’s hand at the July meeting. We need a clearer softening in the dataflow, and more signs core inflation is starting to land, to avoid a hike in September.

In the US, the May print for core PCE was reassuring, but the Fed is likely to focus on signs that excess demand has not yet been plugged. The upward revision in Q1 GDP was a setback from this point of view. Yet, consumption has been virtually flat since February, primarily because the savings’ ratio is rising. We don’t think this is enough though to convince the Fed to turn the current “pause” into an indefinite standby. Just like the ECB, the Fed is currently focusing on the labour market. This puts this week’s payrolls release in focus, but we suspect that even a lower-than-expected print would need to be sustained through the summer to reassure the FOMC.