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By GEOFFREY SMITH
| SNEAK PEEK |
— The Fed is ready to pause, if May’s payrolls data will just let it.
— Euro inflation falls, but the top brass isn’t convinced.
— Defaults are in the air, and you probably won’t see the one that hits you.
| POLICY TICKER |
ECB 3.75% ⇡ — BOE 4.5% ⇡ — FED 5.35% ⇡— SNB 1.5% ⇡— BOJ -0.10% ⇣— RBA 3.85% ⇡— PBOC 3.65%⇣— CBR 7.5% ⇣ — SARB 8.25% ⇡
Good morning, and congratulations to making it to the end of a long short week. It’s been heavy on numbers, and the numbers have been heavy with implications. Across Europe, we’ve seen inflation coming down, and in the U.S., there are suddenly clear signs of the Federal Reserve taking a breather from rate hikes. Today’s payrolls and earnings numbers could have a decisive influence on what the Fed does with rates the week after next. Meanwhile in Europe, the half-yearly round of financial stability reviews have all echoed recent credit and bank-focused research in transmitting a sense of deep unease, as if the authorities are struggling to believe their own shtik about how much stronger the financial system is this time. I mean, it’s the job of FSRs to sound concerned and all that, but still. There may be some long weekends ahead this summer, but that shouldn’t stop you enjoying the coming one.
Send tips to bmunster@politico.eu, jtreeck@politico.eu, Gsmith@politico.eu, ikaminska@politico.eu. Tweet us, too: @Geoffreytsmith, @JohannaTreeck, @Ben_Munster, @izakaminska
| DRIVING THE DAY |
— French April industrial production, 8:45 a.m.
— U.S. May employment report, 2:30 p.m.
FED BLINKS: A surprise, but nonetheless clear, shift in the Federal Reserve’s messaging means there’s a lot resting on the U.S. labor market report for May, due at 2:30 p.m. Governor Philip Jefferson — nominated for the Fed’s vice-presidency — hinted on Wednesday that the Washington-based board now thinks it can afford to skip a hike on June 14. His comments were echoed by Philadelphia Fed president Patrick Harker, one of the regionals who is a voting member on the Federal Open Markets Committee this year.
Slowdown too obvious to ignore: Reasons to pause abound: the ISM manufacturing survey has been miserable for months, job growth does appear to have settled in a lower range and average hourly earnings have slowed from a clip above 5.5 percent last year to less than 4.5 percent now. The Fed also appears to have killed the pandemic housing boom, although governor Michelle Bowman still seems willing to channel her inner Johnny Caspar and put one in the brain.
WHO’LL BREAK COVER? The change in the Fed’s signalling, and the sharp drop in Eurozone inflation last month, are likely to embolden ECB doves to start pressing their case more forcefully and lead its hawks to soft-pedal their arguments. As Johanna’s story here points out, dovish momentum was already building quite nicely at the May policy meeting.
President Christine Lagarde seemed on Thursday to be trying to hold the line, saying there was “no clear evidence that core inflation has peaked.” Who will be the first to dare to disagree with her in public?
PIVOTING POLES: Blink and you may have missed it, but the disinflation winds were blowing eastward in Europe too. Headline CPI fell more than expected to 13 percent year-on-year in May, according to the Polish stats agency. That was down from 14.7 percent last month and the lowest since April 2022. This follows a striking campaign from the National Bank of Poland, which put up a not too subtle banner on its HQ in May blaming all the out of control prices on, you’ve guessed it, Russia.
The NBP meets at the start of next week and expectations for a cut are rising, with ING’s econ team putting the odds at 30-40 percent in the second half of the year. However, IMF staff might be unimpressed, having warned stiffly that the government’s use of untargeted mortgage holidays to keep the financial system ticking over was “inefficient, costly, weaken monetary policy transmission, and should not be extended.” Almost half a million Poles took advantage of the opportunity to suspend repayments, when the scheme — enacted into Polish law — began in August 2022.
| CREDIT CONDITIONS |
BEWARE OF BOOM-BUST It’s not only the ECB that’s celebrating its 25th anniversary. Deutsche Bank’s annual default study has also made it to age 25 and this year’s edition is forecasting the return of the boom-bust cycle. Buckle up, it tells us, the next credit default cycle has arrived.
Default wave imminent … The collision of the tightest Fed and ECB policy in 15 years with high leverage built upon stretched margins has created the perfect storm, says Deutsche’s Jim Reid. “Our US credit cycle gauge is producing its highest non-pandemic warning signal to investors, since before the GFC,” he noted. The good news? It’s going to be more boom-bust than full blown GFC (global financial crisis for those who have blocked it out of their memories).
A wall of LBO loans. Defaults are set to peak in the fourth quarter of 2024, with the magnitude of defaults determined by maturity walls, highly leveraged LBOs last seen during the 2007 private equity party and policy measures. Deutsche is predicting that investors will be sorely disappointed by the lack of central bank support this time round. On the bright side for Europe, the U.S. will likely be worse off as loans are more skewed towards the frothy tech, healthcare and business services sectors.
TOLD YOU SO: Sweden’s Riksbank doesn’t need to read anyone else’s research to know this. It’s been shouting about the exposure of the country’s banking system to a highly-leveraged real estate sector for well over a year, and amped up the volume its Financial Stability Report on Thursday.
Stuffed full: Refinancing risk is at the heart of its concerns: the problems of SBB, a fallen star in the Nordic property sector, are likely to make it harder for peers to refinance their bonds as they fall due, forcing them to turn to local banks for support. But the banks’ loan books are already fairly full of property risk (over 40 percent of corporate lending, at the last count). And the Riksbank clearly doesn’t believe that asset sales will be enough to get the sector through the coming months. It’s urging banks to lean on their debtors to bolster their balance sheets now, and not wait until it’s too late, as SBB did. SBB was forced to abandon a planned equity raise this week and is now exploring the dreaded “strategic alternatives” …
Everything, everywhere, all at once: The Riksbank echoed the foreboding that was also palpable in the ECB’s FSR earlier this week, signing off with this cheery little valediction:
“Current events show that it may be difficult to identify in advance all of the vulnerabilities that may come to light when the economic situation changes as rapidly as it has done now. The sequence of events may moreover be rapid and turbulent, and problems may spread between agents and markets.”
For more on how banks are coping with liquidity and interest-rate mismatches, see Izzy’s story on the phenomenon of “deposit beta” here.
| SPEAKER’S CORNER |
CRUISING ALTITUDE: Unfasten your seatbelts, stretch your legs and help yourselves to some salted peanuts from the catering trolley, but don’t throw yourself from the emergency exits of INFLATION AIRLINES 2023 just yet — it’s still a long way down.
Ease off the throttle: Christine Lagarde’s speech at a conference in Hanover on Thursday went heavy on airplane metaphors, urging participants to “think of an airplane climbing to cruising altitude” while noting that rates still have to be hiked, but at a steadier, more reasonable pace.
Dubious evidence: Lagarde added there was “no evidence” that underlying inflation — the price increases that persist medium-term — has yet peaked. The chunky wage rises around the region may yet prove her right, but Eurostat’s core figure fell for a second straight month in May, to 5.3 percent from 5.6 percent the previous month, a sharper drop than expected.
KEEP IT UP, BANKS! The largely contagion-free fallout of the Credit Suisse implosion is a sign Europe’s banking union is arriving at the “end stage of a difficult and lengthy transition that started in the aftermath of the global financial crisis,” ECB supervisory board head Andrea Enria said.
Not to take all the Credit, but … Enria pointed to a number of ECB-led initiatives that have improved banks’ standing since 2009, among them the Single Resolution Framework, which requires banks to build up hefty reserves to forestall runs; the reduction in European banks’ portfolios of non-performing loans — i.e., those likely doomed to default — from around €1 trillion to a mere €340 billion by 2022; and a sharpening of banks’ business models that has already led to a higher return on equity. (At the same time, as our colleague Hannah Brenton reports, Enria also blamed said banks for causing the chaos in the first place.)
GOOD COP, BAD COP: Enria also argued that the latest dramatic episode is evidence that supervisors, rather than regulators, are the best placed to hold banks accountable and prevent future crises. Supervisors — who, unlike regulators, which make and enforce rules, monitor banks in a looser, more agile fashion — are less dogmatic and better able to help lenders on a case by case basis, Enria said.
That’ll be news to SVB investors, but still …
Balance sheet perspective: Since hikes began markets have started to perceive banks’ health in terms of their balance sheets rather than the mark-to-market value of their assets and liabilities. “This can be understood as a kind of Gestalt shift, in which the market suddenly moves from one way of understanding reality to another, without any change in the underlying fundamentals,” Enria said.
| GREENFLATION |
YOUR PLANET NEEDS YOU: Some bold predictions from ex-cbanker Mark Carney, now the UN envoy for climate change.
“Climate change is macro critical,” Carney told the BIS’s Green Swan conference. “Climate policy and the pace of the transition directly impact the efficacy of fiscal and monetary policy … it will heavily influence … the fundamentals for central banks of price and financial stability.”
Well, yes, but what about inflation? Carney conceded that investing in energy infrastructure and clean energy technologies would push it up in the near term, but argued that if everyone gets with the plan, it will only last the first decade of the transition and then will help in lowering inflation and increasing growth.
He was arguably on stronger ground when he argued that: “high and volatile inflation can at least be vanquished. It need not be a permanent condition … But the same is not the case with climate change … Central banks have a duty to prepare for this possibility and do what they can. It’s part of the job of a central banker to prepare for failure.”
| QUOTED |
“There is no clear evidence that underlying inflation has peaked,” said ECB President Christine Lagarde on Thursday.
“Financial markets are already pricing in interest-rate cuts for next year. If they have to adjust this expectation, which is not unlikely, this could lead to new corrections,” Dutch central bank governor Klaas Knot told an international banking summit in Brussels.
“The increases in interest rates that we still have to do are relatively marginal, most of the work has been done,” said Bank of France governor François Villeroy de Galhau.
| WHAT WE’RE READING |
— After SVB downfall, EBA stress test seeks out unrealised losses. (Risk.net)
— Sri Lanka cuts rate for first time in three years as inflation cools. (Bloomberg)
— Japan PM Kishida: To issue special bonds aimed at supporting child care. (Nasdaq)
— The macroeconomics of artificial intelligence. (OMFIF)
— Fed official says rate pause doesn’t signal end to hikes. (WSJ)
THANKS TO: Izabella Kaminska, Ben Munster, Johanna Treeck, Anjuli Davies and Hannah Brenton.
| WHAT’S ON |
(Editor’s note: this is intended as a selective list, giving precedence to European events)
FRIDAY June 2
— French April industrial production, 8:45 a.m.
— Spanish unemployment, 9:00 a.m.
— ECB publishes quarterly insurance statistics, 10 a.m.
— U.S. May employment report, 2:30 p.m.
All times CET, unless otherwise noted.
