COVID Easing Versus Policy Tightening

Markets were muted and sentiment subdued Tuesday, as news of incremental easing in China’s COVID restrictions was largely offset by worries about additional tightening in developed market monetary policy.

Beijing did away with testing requirements for most public venues, joining a hodgepodge of other key cities in relaxing measures blamed for widespread protests. Negative tests are still mandatory for restaurants and nursing homes in the capital, but it’s clear the leadership would rather pacify a restive populace than risk a violent crackdown on demonstrators at a delicate geopolitical juncture.

Nationally, cases in China fell an eighth day, and are around 11,000 below the peak seen late last month. Less testing means fewer reported cases, and China isn’t exactly famous for being forthright about matters related to the virus. But it’ll be difficult to mask (no pun intended) an overrun health care system. That’s the next challenge.

Meanwhile, the RBA delivered a third consecutive 25bps rate hike on Tuesday. It was the eighth straight hike overall. The cash rate now sits at a decade high (figure below).

Not since 1989 has the monetary authority hiked rates by 300bps in a year.

Initially, Philip Lowe was reluctant to countenance the idea of any rate hikes in 2022 after the market forced the RBA out of its yield-curve control regime 13 months ago. He came around, though. Questions linger as to the reputational damage the bank suffered from the YCC fiasco and the ensuing about-face on rates.

Recall that Lowe was first to downshift, opting for a 25bps hike in October after a string of half-point moves. “A further increase in inflation is expected over the months ahead, with inflation forecast to peak at around 8% over the year to the December quarter,” Lowe said Tuesday, flagging a “very tight” labor market and expressing some concern about a wage-price spiral.

The RBA is, of course, sitting atop a housing bubble, something policymakers are compelled to acknowledge as they ratchet rates higher. “The Board recognizes that monetary policy operates with a lag and that the full effect of the increase in interest rates is yet to be felt in mortgage payments,” Lowe remarked.

Although the RBA “expects to increase interest rates further over the period ahead,” Lowe emphasized that policy “is not on a pre-set course.” The “pre-set course” talking point is a favorite among central bankers seeking to quell angst during periods of tightening. Powell employed that language in his infamous January 2019 pivot.

“Since the RBA has policy meetings approximately every month, it can continue to hold a very straightforward meeting-by-meeting, data-dependent approach, and there was unsurprisingly very little forward guidance in today’s statement except for the vague reference to more tightening ahead,” ING said. They expect another 50bps of cumulative tightening.

Back in the US, the search for terminal continues. Monday’s robust ISM services print was bad news for risk assets, but frankly, the reaction felt a bit overdone or, perhaps it’s more accurate to say the price action wasn’t explainable solely by one (anecdotal) data point.

“It’s hard to see the Fed backing down from the idea that the market doesn’t see terminal rates quite high enough,” SocGen’s Kit Juckes said. Market pricing has settled right at 5% (updated figure below).

That’s probably not high enough for the Fed’s liking. Even if the updated dots suggest it’s “right,” I imagine officials would rather market pricing err on the side of more tightening or, at the least, cease and desist from pricing cuts for the back half of 2023.

“Friction between the Fed and market pricing may play itself out first in the equity market,” Juckes went on to say.

“Even I can see that the S&P Index is testing the top of the downtrend channel it’s been in since the start of the year,” he added. “The biggest threat to a bearish dollar view in the weeks ahead is that equities can’t break free of this channel because rates move to price something closer to what the FOMC wants.”