- Fed officials remain hawkish; we think many are coming around to the notion that the Fed has to move into restrictive policy; yet Fed tightening expectations have eased a bit; March PPI will be reported; bonds rallied after the CPI data; bull steepening should continue near-term; Canada is expected to hike rates 50 bp to 1.0%; Chile central bank minutes will be released
- U.K. March CPI data came in hot; BOE tightening expectations remain steady
- The weak yen continues to be a concern; until the BOJ changes its monetary policy stance, the yen is likely to continue weakening; Japan February core machine orders came in extremely weak; RBNZ hiked rates 50 bp to 1.5%; the hawkish RBNZ has done nothing for the Kiwi; China reported mixed March trade data
The dollar remains firm as U.S. rates continue to adjust. DXY is up for the tenth straight day and traded at a new cycle high near 100.523. After a clean break of the psychological 100 level, the March 2020 high near 103 is the next big target. The euro remains heavy near $1.0830 and is about to test of the March 7 low near $1.0805. Break below would set up a test of the March 2020 low near $1.0635. The relentless rise in USD/JPY continues as it is up for the ninth straight day and traded at a new cycle high near 126.30. There are no significant chart points until the 2002 high near 135.15. Until the BOJ changes its ultra-dovish stance, the yen is likely to continue weakening despite rising official concerns (see below). Sterling remains heavy and traded at a new low for this move near $1.2975 before recovering just above $1.30. We still look for a test of the November 2020 low near $1.2855 and then possibly the September 2020 low near $1.2675. Between the likely return of risk-off impulses and the even more hawkish Fed outlook for tightening, we believe the dollar uptrend remains intact.
Fed officials remain hawkish. Brainard said that the Fed would move policy to neutral “expeditiously” and added that fighting inflation is its top goal. She warned that the Russian invasion of Ukraine skews inflation risks to the upside and that if it persists, risks are even higher since it has potential to lengthen supply chain issues. She noted that financial conditions are already tightening and that will help cool demand, especially with the fiscal drag seen this year. Elsewhere, Barkin said that the Fed should “rapidly” hike rates to neutral, adding that “If necessary, we can move further.” Lastly, Bullard said he supports a 50 bp hike in May and that the rate should move up “sharply” after that. He added “There’s a bit of a fantasy, I think, in current policy in central banks. Neutral is not putting downward pressure on inflation. It’s just ceasing to put upward pressure on inflation.”
We think many are coming around to the notion that the Fed has to move into restrictive policy. There are two big questions left unanswered: what is neutral and how far above it does the Fed have to go? There are no easy answers but our gut feeling is that neutral is actually north of 2.5% in the current situation and that the Fed will have to go into restrictive territory. We look for a terminal Fed Funds rate of 3.5% for this cycle but acknowledge that risks are skewed to the upside.
Fed tightening expectations have eased a bit. WIRP suggests nearly 90% odds of back-to-back 50 bp hikes at the May 3-4 and June 14-15 FOMC meetings. Looking ahead, swaps market is pricing in nearly 250 bp of tightening over the next 12 months that would see the policy rate peak near 3.0% vs. 3.25% seen at the start of this week. As noted above, we still see room for the expected terminal rate to move even higher if inflation proves to be even more stubborn than expected.
March PPI will be reported. Headline is expected at 10.6% y/y vs. 10.0% in February, while core is expected to remain steady at 8.4% y/y. Yesterday, March CPI data came in mixed. Headline came in a tick higher than expected at 8.5% y/y vs. 7.9% in February while core came in a tick lower than expected at 6.5% y/y vs. 6.4% in February. Both were new cycle highs and is likely to cement a 50 bp hike at the May 3-4 FOMC meeting.
Bonds rallied after the CPI data. This was perhaps because markets were braced for even worse data. The 10-year yield traded at a new cycle high near 2.83% before the CPI data but is trading near 2.73% now. With inflation expectations remaining somewhat subdued, however, the real 10-year yield has still managed to rise to -0.14%, the highest since March 2020 and poised to move into positive territory for the first time since before the pandemic.
Bull steepening should continue near-term. Why? We continue to believe that the combination of QT and high inflation will continue to drive U.S. yields higher at the long end for the time being. At some point during the tightening cycle, the curve will likely resume flattening but for now, we favor the steepening trade. The 2-year yield is trading just below 2.40% and all segments of the U.S. curve are now in positive territory.
Bank of Canada is expected to hike rates 50 bp to 1.0%. However, nearly half the analysts polled by Bloomberg see a 25 bp move instead. WIRP suggests a 50 bp hike is nearly 90% priced in and so the BOC is likely to meet those expectations. Looking ahead, swaps market sees the policy rate peaking near 3.0% over the next 12 months. Updated macro forecasts will be released today and 2024 will be added to the forecast horizon. Higher BOC rates have helped CAD outperform as it is the third best major at -0.1% YTD and behind only NOK (2.2% YTD) and tied with NOK (-0.1% YTD).
Chile central bank minutes will be released. At that March 29 meeting, the bank delivered a dovish surprise with a 150 bp hike to 7.0% vs. 200 bp expected. The bank noted more pessimism in consumer and business confidence and that activity is on a downward trend compared to last year. Looking ahead, the bank said that future hikes will be smaller under its base case scenario. Swaps market now sees the policy rate peaking near 8.5% over the next 6 months, down from around 9.75% prior to the March meeting.
Bank of England tightening expectations remain steady. WIRP suggests another 25 bp hike to 1.0% is fully priced in for the next meeting May 5. Swaps market is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 2.5%. Despite BOE tightening, sterling continues to sink and trade today at a new low for this move near $1.2975. Further losses are likely and we first target the November 2020 low near $1.2855. There are no BOE speakers scheduled this week.
The weak yen continues to be a concern. After USD/JPY traded at a new cycle high near 126.30 today, Chief Cabinet Secretary Matsuno said that currency stability is important and that abrupt moves are not desirable. He stressed that Japan policymakers will watch market moves with vigilance, especially the recent fall in the yen, and its effect on the Japanese economy. Based on their view that disorderly FX moves have a negative impact on the economy, Matsuno said Japan would address the situation appropriately and communicate closely with the U.S. and other major authorities. Matsuno’s comments follow nearly identical ones from BOJ Governor Kuroda, Finance Minister Suzuki, and Prime Minister Kishida.
Until the BOJ changes its monetary policy stance, the yen is likely to continue weakening. At this stage of the recovery, verbal intervention is all that we can expect. Actual FX intervention without a change in monetary policy divergence would be doomed to failure. That is why the April 27-28 BOJ meeting is shaping up to be very important. Updated macro forecasts will be released and FY24 will be added to the forecast horizon. These forecasts should provide a signal as to whether the BOJ is willing to budge from its ultra-dovish stance. Stay tuned.
Japan February core machine orders came in extremely weak. They were expected at -1.5% m/m but instead plunged -9.8% vs. -2.0% in January. In general, the Q2 data have been coming in weak due to omicron. Bloomberg consensus sees Q1 GDP contracting -0.1% SAAR but then rebounding to 4.8% in Q2. Such a strong rebound is increasingly in doubt and so the government is preparing another fiscal package to help boost growth.
Reserve Bank of New Zealand hiked rates 50 bp to 1.5%. WIRP had suggested nearly 75% odds of a 50 bp hike and so the move was hardly surprising. The bank said “The Committee agreed that their policy ‘path of least regret’ is to increase the OCR by more now, rather than later, to head off rising inflation expectations. It is appropriate to continue to tighten monetary conditions at pace.” The bank said it is comfortable with its expected rate path from the February meeting, which sees the policy rate at 2.5% by early 2023 before peaking near 3.5% in 2024. Updated macro forecasts and expected rate path won’t come until the next meeting May 25, where odds of a follow-up 50 bp move stand near 60%. Swaps market sees 200 bp of further tightening over the next 12 months and another 100 bp over the following 12 months that would see the policy rate peak near 4.5%, up from 4.0% at the start of this week.
The hawkish RBNZ has done nothing for the Kiwi. After an initial spike to test the 200-day moving average near .6905, NZD has since fallen sharply to trade near .6780. A close below yesterday’s low near .6805 would result in an outside down day that heralds further losses ahead. The mid-March low near .6730 is near and a break below would set up a test of the January low near .6530.
China reported mixed March trade data. Exports rose 14.7% y/y vs. 12.8% expected and 6.2% in February, while imports fell -0.1% y/y vs. 8.4% expected and 10.4% in February. The strong showing for exports is certainly welcome, but markets are likely to focus on the extremely weak imports as a sign that lockdowns are crushing domestic activity. Of note, the World Trade Organization just lowered its forecasts for global trade and warned that Russia’s invasion of Ukraine will slow the global recovery and reduce goods trade. The WTO added that China’s strict response to Covid outbreaks threatens to slow its growth and exports. March data is just the start and April is likely to get even worse. PBOC sets its 1-year MLF rate Friday and is expected to cut 10 bp to 2.75%. More aggressive stimulus will be needed.