Fundamental Macro

After a run of somewhat more upbeat economic assessments from MPC members this week (see here for David Miles speech and here for TSC hearing), Governor Carney’s speech last night (here) was even more explicit about the MPC’s (or Carney’s at least) view on the likely timing of the first rate hike, and the subsequent path.

I was surprised to see Carney got back down the path of something like time-based forward guidance, particularly following the Mansion House speech debacle of 2014 (see here for my preview of MH this year) and the terrible implementation of state-contingent forward guidance. But I guess it proved too tempting, with Carney saying:

“In my view, the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year.”

There are a few ways of interpreting that statement. The “turn of this year” would usually imply around Dec/Jan. But with the key Inflation Report meetings in Nov/Feb, it is reasonable to assume that is the window he was referring to. The second element open to interpretation is whether he means that is when they will start thinking about it more seriously, or that is when they are going to be ready to go. I think it is likely the latter, particularly based on comments earlier this week.

Following the ‘resolution’ of the Greek situation (in case interested, here is my take on that) and the more upbeat assessment from MPC members earlier in the week, the market had shifted to fully pricing a first hike by Feb 2016, with a bit less than 50% chance of a hike in November. Based on Carney’s speech, that pricing looks to be about fair now. It is a long way from where the market had been earlier this year. For those who have read my posts on the BoE this year, my long-held view has been that they would start hiking in November (eg see my post from March here and related trade idea here).

Is November still my central expectation? As ever, it depends how things pan out between now and then. I am relatively optimistic on the EZ, particularly if Greece really is out of the headlines for the rest of the year. I am also positive about the domestic growth outlook for the UK. Moreover, wage growth has already started to pick up materially (unlike in the US). But it will need to rise more quickly than productivity (which has shown a bit of life recently) for the last shoe to drop – core inflation. Finally, if sterling is going up simply because of shifts in relative rates (which it appears to be), then I am much less bothered about that being an impediment to starting the hiking cycle than if it was a big shift in risk premia. It probably matters a bit if the Fed hike in September or December too. I am still of the view they go in September (but with a big skew to December).

So if I am right about all of that (big if), then November remains my central projection, but with risks heavily skewed to February (there is almost no chance of them going in August, although I wouldn’t be surprised to see Weale/McCafferty vote for hikes). But should growth turn down again, unit labour costs fail to pick up and core inflation not rise, then the first hike will undoubtedly come later.

Based on current pricing, I think that means there is not a lot of value in being short the very front end (Dec 15/Mar 16), but instead I would look a little further along the strip for a slightly faster pace of hikes than currently priced.