Global Economy & Markets, Weekly Roundup 26/07/22

The Federal Reserve is expected to increase the target range for the funds rate to 2.25% - 2.5% in response to surging inflation 
Key Takeaways
Monetary policy has tightened in response to surging inflation. The Federal Reserve is expected to increase interest rates further on July 27th, despite subdued growth. The advance estimate for Q2:2022 US GDP is due on July 28th. Consensus estimates stand at +0.5% qoq saar. The Atlanta Fed’s GDPNowcast model points to -1.6% qoq saar (+0.9% qoq saar excluding inventories’ negative contribution).

Investors, as implied by Fed Fund futures contract prices, assign a 25% chance of an 100 bps hike in the federal funds rate and 75% for a 75 bps one, from a current target range of 1.50%-1.75%.

The ECB increased the policy interest rates for the first time since July 2011, by 50 bps (0.5%), at +0.50% on Main Refinancing Operations and at 0% for the Deposit Facility Rate. The era of negative interest rates is thus over. According to the ECB, further normalization of interest rates will be appropriate, with the size of increments being left open to be decided on a meeting-by-meeting basis, as the economic outlook darkens (PMIs below 50, German Ifo deteriorated sharply, euro area banks’ lending standards tightened).  

The hike was larger than the one signaled in June’s meeting (0.25%), as the ECB judged that upside risks to inflation have materialized in the meantime with the headline CPI running at 8.6% yoy (July’s CPI is due on July 29th). Moreover, alongside the flexibility in PEPP reinvestments, the new Transmission Protection Instrument (TPI), can deal with potential unwarranted side-effects (market fragmentation) from a faster monetary policy tightening.

The TPI aims to safeguard the smooth transmission of monetary policy across jurisdictions. The TPI can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area. The ECB will be able to purchase mainly government bonds in jurisdictions experiencing a deterioration in financing conditions not warranted by country specific macroeconomic fundamentals. 

The following criteria will be applied for TPI activation, albeit with notable discretion:  i) reliable fiscal policy/not being subject to an excessive deficit procedure (headline budget deficit south of -3% of GDP); ii) no severe macroeconomic imbalances; iii) fiscal sustainability based on IMF, ESM, ECB DSA analyses and; iv) complying with the commitments related to the Recovery and Resilience Facility, that broadly interact with the European Commission’s country-specific fiscal recommendations under the European Semester.  

The scale of TPI purchases is not restricted ex ante, and it would depend on the severity of the risks facing monetary policy transmission, while the ECB accepts “pari passu” treatment with respect to bonds purchased by the TPI.  

Fears of gas shortages in Europe, induce economic growth pessimism. Gazprom announced a cut in gas flows via the Nord Stream 1 pipeline, to 20% of total capacity as of July 27th due to technical reasons, versus 40% currently. As a result, European natural gas benchmarks spiked, with the August 2022 Dutch TTF contract hovering at c. €195/MWh on Tuesday (July 26th), 22% above Friday’s level. 
Global Economy & Markets, Weekly Roundup 26/07/22

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