• U.S. bank stocks were pummeled yesterday; February jobs report will be the highlight and is a large piece of the overall Fed puzzle; Fed tightening expectations remain elevated but have come off the highs after the SVB news; Canada also reports jobs data
  
• The monthly U.K. data dump was mixed; BOE tightening expectations remain steady; Norway reported soft February CPI data
  
• The two-day BOJ meeting ended with no change; the risk of a hawkish surprise from the BOJ was the only thing propping up the yen in recent sessions; the China reopening trade continues to unravel

The dollar is soft ahead of the jobs data. DXY is down for the second straight day and trading near 105.135 after trading at the highest since December 1 near 105.883 Wednesday. We believe it remains on track to test the November 30 high near 107.195. The euro is trading higher near $1.06 but we believe it remains on track to test the 2023 low near $1.0485. Sterling is trading higher near $1.20 but we believe it remains on track to test the late November low near $1.1780. USD/JPY is trading higher near 137 after the BOJ left policy unchanged. We believe the pair remains on track to test the December 15 high near 138.15 and then the November 30 high near 139.90. To state the obvious, Fed Chair Powell has successfully reset market expectations for the Fed. If the U.S. data continue to run strong, those expectations will be validated and the dollar should resume its climb.

AMERICAS

U.S. bank stocks were pummeled yesterday. At the root of the selloff were problems at a small niche institution called Silicon Valley Bank. Markets were taken by surprise when parent company SVB Group unexpectedly rushed to raise cash by selling $2.25 bln in new shares to cover losses from its sale of securities it held in order to meet a spike in demand for customer withdrawals. In many ways, this was an old-fashioned bank run. However, SVB is not an old-fashioned bank; its depositors are not mom and pop customers but rather tech firms backed by venture capital (VC). As we all know, the has been hardest hit by the current tightening of global liquidity and so we view these developments as more reflective of tech sector woes than financial sector ones. While other small niche banks are likely to come under stress, we downplay broad-based financial stability risks to the system. We do not think SVB impacts Fed policy whatsoever; while financial stability is the Fed’s unofficial third mandate, we do not believe SVB meets that criterion.

Still, the risk-off vibe cannot be denied and that’s not a bad thing. Global stocks fell overnight and U.S. futures point to a lower open. As faithful readers know, we have been puzzled by this year’s rally in risk even as the Fed tightened and recession risks rose. It looks like equity markets have finally gotten the message and have stopped fighting the Fed. Simply put, global interest rates are going higher and global recession risks are as well. Elsewhere, China is not going to be the savior of global growth this year (see Asia section below) and so the two biggest drivers of this year’s risk rally (Fed pivot and China reopening) are turning out to be nothing more than wishful thinking.

February jobs report will be the highlight. Consensus sees 225k jobs added vs. 517k in January, with the unemployment rate seen steady at 3.4% and average hourly earnings picking up to 4.7% y/y vs. 4.4% in January. Obviously, one big question is whether January NFP gets revised significantly in either direction. Most indicators suggest the U.S. labor market remain relatively robust and that has to be frustrating for the Fed. It has only one blunt instrument to affect the economy and it has used that tool aggressively this past year and yet the economy and labor market remain strong. This simply means that the Fed will have to go even higher for even longer. Is there an NFP number that cements a 50 bp hike this month? We don’t think so, as Powell has spoken about looking at the “totality” of the upcoming data in making its next policy decision. That said, another upside miss would surely raise market expectations for a 50 bp move.

Today’s jobs data is a large piece of the overall Fed puzzle. Powell said this week that “We have not made any decision about the March meeting.” And rightly so. He was clear that the decision is data dependent when he said that “We do have two or three more very important data releases to analyze before the time of the FOMC meeting. Those are going to be very important in the assessment we have of this relatively recent data.” Today’s jobs report will be followed by CPI March 14 and PPI and retail sales data March 15. While Powell has delivered a hawkish message, it must be backed up by strong data in order to validate the market’s more hawkish take on the Fed.

Fed tightening expectations remain elevated but have come off the highs after the SVB news. WIRP now suggests around 50% odds of a 50 bp hike at the March 21-22 FOMC meeting, down from over 70% pre-SVB. Looking ahead, 25 bp hikes in May and June are priced in that would take Fed Funds to 5.50-5.75%. Odds of a last 25 bp hike in Q3 have evaporated vs. over 30% odds pre-SVB. A strong jobs report today should bring the market focus back to the U.S. economy rather than the U.S. banking system. For now, we believe the uptrends in U.S. yields and the dollar remain intact. February budget statement will also be reported today.

Canada also reports jobs data. Consensus sees 7.5k vs. the whopping 150.0k in January, with the unemployment rate seen rising a tick to 5.1%. Bank of Canada expectations continue to adjust but WIRP suggests a final 25 bp hike to 4.75% is still expected in H2. This is subject to change, especially if we get a third straight strong jobs report today.

EUROPE/MIDDLE EAST/AFRICA

The monthly U.K. data dump was mixed. January GDP, IP, services, construction output, and trade were all reported and came in mixed. GDP came in at 0.3% m/m vs. 0.1% expected and -0.5% in December, IP came in at -0.3% m/m vs. flat expected and 0.3% in December, services came in at 0.5% m/m vs. 0.3% expected and -0.8% in December, and construction came in at -1.7% m/m vs. flat expected and actual in December. The trade deficit came in at -GBP5.86 bln vs. -GBP7.1 bln expected and -GBP7/15 bln in December. While the recent resilience in the economic data is noteworthy, we simply can’t get excited about the U.K. outlook. Much of the January strength was simply a modest bounce-back from the strike-depressed December. While the recession may not be as deep as anticipated back in the fall, it was more from luck (warmer than expected winter) than design.

BOE tightening expectations remain steady. WIRP suggests a 25 bp hike March 23 is over 90% priced in, as is a 25 bp hike May 11. One last 25 bp hike is fully priced in for August 3 that would see the policy rate peak near 4.75% vs. 4.5% at the start of last week. This is still well below the peak near 6.25% right after the disastrous mini-budget back in September. We’d also like to point at that because the BOE started tightening in December 21, the economy is just starting to feel the impact as 2023 gets under way and so there are still headwinds ahead.

Norway reported soft February CPI data. Headline came in at 6.3% y/y vs. 6.8% expected and 7.0% in January, while underlying came in at 5.9% y/y vs. 6.3% expected and 6.4% in January. Both inflation measures have resumed the disinflation trend that was interrupted by the January spike, though headline is still more than triple the 2% target. At the last policy meeting January 19, Norges Bank kept rates steady at 2.75% but noted that “The policy rate will need to be increased somewhat further.” Governor Bache later said rates “will most likely be raised in March.” The expected rate path from December saw the policy rate peaking near 3.0%, with gradual easing expected in H2 2024. Updated macro forecasts and expected rate path will come at the March 23 meeting, when a 25 bp hike to 3.0% is expected. Of note, the swaps market is now pricing in a peak policy rate near 3.25% vs. between 3.25-3.5% ahead of the CPI data.

ASIA

The two-day Bank of Japan meeting ended with no change. Rates were left steady and more importantly, there were no tweaks to Yield Curve Control. The decision was unanimous and a downward revision to the bank’s assessment of exports and production suggests caution remains the watchword. Governor Kuroda took a small victory lap, noting that Japan is no longer wracked by deflation and that the economy has seen major progress over the past decade. He also said that the bank’s sustainable 2% inflation target is getting a little closer. We comment Governor Kuroda for the work he has done in his two terms as Governor. Japan indeed is a very different place then it was when he took over the bank back in 2013. That said, it feels a bit like an unfinished job as exiting accommodation will be a tricky task that he has passed on to his successor.

The risk of a hawkish surprise today from the BOJ was the only thing propping up the yen in recent sessions. With no change in policy, USD/JPY is a big buy down here. If the pair can make a clean break above the 200-day moving average near 137.50, it would open up a move to the November 30 high near 139.90 and then the November 11 high near 142.50. Japan also reported February PPI at 8.2% y/y vs. 8.4% expected and 9.5% in January. This was the lowest since October 2021 and supports the view that price pressures are starting to ease and that there is little urgency to tighten policy.

This was the last meeting under current Governor Kuroda as Governor-elect Ueda will take over to run the next meeting. Of note, Kuroda said he knows Ueda very well and believes he will be effective at leading the BOJ. WIRP suggests around 20% odds of liftoff April 28, rising to over 35% June 16 and then nearly 90% for July 28. That said, the actual tightening path is seen as very mild as the market is pricing in only 15 bp of tightening over the next 12 months followed by only 30 bp more over the subsequent 24 months. That is why we expect any knee-jerk drop in USD/JPY after liftoff to be fairly limited.

The China reopening trade continues to unravel. MSCI China has given up all of its 2023 gains and traded at the lowest since December 22 below 63 today. The December 20 low near 61.75 is drawing near and a break below would target the November 28 low near 54.85. However, it’s not just China. DJIA has been leading this move and is already trading at the lowest since November 4 and on track to test that month's low near 31727. S&P 500 is close on its heels and has already given up over 62% of its 2023 gains and is on track to test its December 22 low near 3764. Same goes for MSCI EM as it’s on track to test its December 290 low near 943. Elsewhere, XBT has given up nearly 62% of its 2023 gains and a break below 19704 would set up a test of its December 20 low near 16277. Believe it or not, NASDAQ has been outperforming and has given up less half its 2023 gains. Bottomline: the 2023 risk rally is quickly buckling under the weight of higher interest rates, receding global liquidity, and rising recession risks. We are still nowhere near the end of this process.