- Fed Chair Powell stayed strictly on message; Fed Beige Book report painted a mixed picture; reports suggest Northwestern University Professor Janice Eberly has emerged as the frontrunner to succeed Lael Brainard as Fed Vice Chair; ADP and JOLTS added to the buoyant labor market outlook; BOC kept rates steady at 4.5%, as expected; Peru is expected to keep rates steady at 7.75%
- Divisions within the ECB have burst into the open; a more hawkish ECB is not necessarily a good thing for the euro
- Kazuo Ueda is one step closer to becoming the next Governor of the BOJ; Japan final Q4 GDP data were revised weaker; China reported weak February CPI and PPI data; Bank Negara kept rates steady at 2.75%, as expected
The dollar is consolidating post-Powell. DXY traded at the highest since December 1 near 105.883 yesterday but is trading lower near 105.272 today. We believe it remains on track to test the November 30 high near 107.195. The 200-day moving average near 106.573 may offer some resistance. The euro traded at the lowest since January 6 near $1.0525 yesterday but is trading higher near $1.0575 today. We believe it remains on track to test the 2023 low near $1.0485. Sterling traded at the lowest since November 21 near $1.18o5 yesterday but is trading higher near $1.19 today. We believe it remains on track to test the late November low near $1.1780. USD/JPY traded at the highest since December 16 near 137.90 yesterday but is trading lower near 136.25 today. We believe this dip is due to positioning ahead of the BOJ decision tomorrow (see below) and would use this as an opportunity to go short yen as the pair is 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 (see below) which, along with the strong U.S. data, has led to increased traction for the dollar.
Fed Chair Powell stayed strictly on message. In the second half of the Fed’s semiannual monetary policy report to Congress, Powell appeared before the House Financial Services Committee yesterday and stuck to his hawkish tone from Tuesday before the Senate Banking Committee. His statement was nearly identical: “As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.”
The only hint of equivocating came when asked he was about the Fed’s next move. In the Q&A, Powell said “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 in the first day of testimony 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.” Of course, tomorrow’s jobs report is the first of those releases and 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. Barr speaks today.
Fed tightening expectations remain elevated. WIRP now suggests nearly 70% odds of a 50 bp hike at the March 21-22 FOMC meeting. Looking ahead, 25 bp hikes in May and June are priced in that would take Fed Funds to 5.50-5.75%, with over 30% odds of a last 25 bp hike in Q3 that would move the range up to 5.75-6.0%. After all this repricing, an easing cycle is still expected to begin in Q4, albeit at much lower odds. Eventually, it should be totally and unequivocally priced out into 2024 during the next stage of Fed repricing. For now, we believe the uptrends in U.S. yields and the dollar remain intact.
The Fed Beige Book report painted a mixed picture. On overall economic activity: Overall economic activity increased slightly in early 2023. Consumer spending generally held steady, though a few Districts reported moderate to strong growth in retail sales during what is typically a slow period. On labor markets: Labor market conditions remained solid. Employment continued to increase at a modest to moderate pace in most Districts despite hiring freezes by some firms and scattered reports of layoffs. Labor availability improved slightly, though finding workers with desired skills or experience remained challenging. On prices: Inflationary pressures remained widespread, though price increases moderated in many Districts. Some Districts noted that firms were finding it more difficult to pass on cost increases to their consumers. Bottom line: the Fed left the door wide open for another hike this month and whether it’s 25 or 50 bp will depend on the upcoming data.
Reports suggest Northwestern University Professor Janice Eberly has emerged as the frontrunner to succeed Lael Brainard as Fed Vice Chair. Eberly served as chief economist at the Treasury Department under President Obama. Currently, she teaches in at the Kellogg business school and received her Ph.D. in economics from MIT. While she is well qualified, we expect some pushback from Democrats seeking a Latino candidate. Other names that have mentioned include Chicago Fed President Goolsbee and Harvard University Professor Karen Dynan. Some have already tried to cast Eberly as the more dovish of these picks but honestly, we really don’t have a lot to go on and so this is pure guesswork.
ADP points to another solid jobs report. Its headline reading came in at 242k vs. 200k expected and a revised 119k (was 106k) in January. The print adds to the sense that the economy is still humming along in February. Of course, recall that ADP missed big in January even after the revision and so the predictive power of ADP leaves a lot to be desired. That said, consensus for Friday NFP has edged higher to 225k vs. 517k in January. It’s worth noting that NFP has beaten ADP for seven straight months. Will this streak continue in February? The unemployment rate is 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.
JOLTS job openings added to the buoyant labor market outlook. Headline came in at 10.824 mln vs. 10.584 mln expected and a revised 11.234 mln (was 11.012 mln) in December. February Challenger job cuts and weekly jobless claims will be reported today and are expected to show continued strength in the labor market. Initial claims are expected at 195k vs. 190k last week and continuing claims are expected at 1.66 mln vs. 1.655 mln last week. Q4 change in household net worth will also be reported.
Bank of Canada kept rates steady at 4.5%, as expected. This was the first pause since the bank started hiking last March. While the bank said it is prepared to hike again if needed, the statement removed the reference to excess demand in the economy. The bank noted that the latest data remain “in line with the bank’s expectation that CPI inflation will come down to around 3% in the middle of this year.” It added that “With weak economic growth for the next couple of quarters, pressures in product and labor markets are expected to ease.” Overall, the tone was on the dovish side so USD/CAD traded at the highest since October near 1.3815. The cycle high from October 13 near 1.3975 is the next target. The 2-year yield differential in favor of USD is the widest since April 2019 near 77 bp and points to further CAD weakness. Bank of Canada expectations continue to adjust. Next meeting is April 12 and WIRP suggests only 25% odds of a hike then. However, a 25 bp hike sometime in Q3 is still fully priced in. This is of course subject to change after the jobs report Friday.
Peru central bank is expected to keep rates steady at 7.75%. At the last policy meeting February 9, the bank delivered a dovish surprise and kept rates steady vs. an expected 25 bp hike to 8.0%. It saw inflation starting to fall in March and moving back to the 1-3% target range by Q4. However, it warned that the pause did not signal an end to the tightening cycle. Much will depend on the data, of course.
Divisions within the ECB have burst into the open. Bank of Italy Governor Visco said “Uncertainty is so high that the Governing Council of the ECB has agreed to decide ‘meeting by meeting’, without ‘forward guidance. I therefore don’t appreciate statements by my colleagues about future and prolonged interest rate hikes.” This comes after Austrian central bank Governor Holzmann suggested that the 50 bp hike next Thursday will be the first of four such moves that would bring the deposit rate up to 4.5%. Vujcic speaks today.
A more hawkish ECB is not necessarily a good thing for the euro. The growth and inflation mix in Europe is much more unbalanced than it is here in the U.S. There, inflation pressures remain high even though the economy has been flirting with recession. Some observers believe the growth outlook for this year has improved but we ask how that is possible when the impact of the past 300 bp of tightening have yet to be fully felt, with risks of another 150 bp of tightening still in the pipeline. Recall that the ECB started hiking rates last July, a full four months after the Fed did. The OECD sees eurozone growth at 0.5% this year, he same as the U.S. This seems way too optimistic and we expect the U.S. to outperform in 2023. And we haven’t even talked about rising fragmentation risks as eurozone interest rates rise and growth slows.
ECB tightening expectations remain elevated. WIRP suggests a 50 bp hike March 16 is priced in. Looking further ahead, a 50 bp hike May 4 is about 75% priced. 25 bp hikes June 15 and July 27 are priced in that would result in a peak policy rate near 4.0%, up from 3.75% at the start of last week and 3.5% at the start of last month. Odds of another 25 bp hike in Q4 peak near 60%. With CPI still running hot, it appears that the hawks remain in the driver’s seat.
Kazuo Ueda is one step closer to becoming the next Governor of the Bank of Japan. He and the nominees for the two Deputy Governor posts (Uchida and Himino) were approved by the lower house of parliament today. All three will are expected to pass in the upper house vote tomorrow. Ueda will take his post April 9 while the two Deputies will take their posts March 20. None will be part of the BOJ meeting that begins today.
The Bank of Japan meeting ending tomorrow will be the last one under current Governor Kuroda. While no change is expected, we cannot totally rule out one last surprise from Kuroda. WIRP suggests only 5% odds of liftoff tomorrow but even this small risk of a surprise may be the main reason why the march higher in USD/JPY was interrupted yesterday, with some positioning adjustment seen by those unwilling to be short yen going into the meeting. Looking ahead, WIRP suggests over 25% odds of liftoff April 28, rising to nearly 45% June 16 and then over 80% for July 28. That said, the actual tightening path is seen as very mild as the market is pricing in only 20 bp of tightening over the next 12 months followed by only 35 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.
Final Q4 GDP data were revised weaker. Growth came in flat q/q vs. 0.2% expected and preliminary, while the annualized rate came in at 0.1% vs. 0.8% expected and 0.6% preliminary. Private consumption was the main culprit as it was revised down to 0.3% q/q vs. 0.5% preliminary. Business spending was unchanged, while an upward revision in net exports was offset by a downward revision in inventories. While this was an improvement over the -1.0% q/q posted in Q3, it’s really nothing to celebrate and suggests the BOJ will be in no mood to surprise markets tomorrow by taking any steps towards removing accommodation. As such, we’d use this dip in USD/JPY as an opportunity to get short yen at more attractive levels.
China reported weak February CPI and PPI data. CPI came in at 1.0% y/y vs. 1.9% expected and 2.1% in January while PPI came in a tick lower than expected at -1.4% y/y vs. -0.8% in January. Very low price pressures will give the PBOC leeway to ease policy this year but we no longer expect aggressive monetary easing after policymakers set a rather modest growth target for this year “around 5%.” Some optimists may hope that China’s disinflation will provide some relief globally but we do not believe China has been much of a factor behind the high inflation of the past year in the first place. Mainland inflation peaked near 2.8% y/y in September and has fallen sharply even as inflation in most of its trading partners remains elevated.
Bank Negara kept rates steady at 2.75%, as expected. The bank said it “will continue to calibrate the monetary policy settings that balance the risks to domestic inflation and sustainable growth.” It expects both headline and core inflation to moderate over the course of this year but still remain elevated. The bank surprised the markets with a pause back in January. Since then, headline inflation eased to 3.7% y/y in January, the lowest since June 2022, and so it seems we have seen the end of the cycle after only 100 bp of tightening.