• Fed Chair Powell was downright hawkish; he acknowledged the Fed can affect countries around the world; we believe the Fed wants higher yields in lieu of another rate hike; the Fed releases its Beige Book report; BOC Governor Macklem did not offer much policy guidance during yesterday’s fireside chat
  
• ECB officials are sounding more dovish; U.K. reported March CPI; BOE easing expectations have been pushed out.
  
• Japan reported March trade data; New Zealand reported Q1 CPI data

The dollar rally is taking a breather. DXY is trading lower for the first time since last Monday near 106.165 after making a new cycle yesterday near 106.517. It remains on track to test the November 1 high near 107.113. The euro is trading higher near $1.0645 but the clean break below $1.0755 sets up a test of the November 1 low near $1.0515. Elsewhere, sterling is trading higher near $1.2465 after higher-than-expected CPI data (see below). USD/JPY is trading lower near 154.60 after making a new cycle high near 154.80 yesterday. The dollar rally should continue as recent data confirm persistent inflation and robust growth in the U.S. In turn, Chair Powell and other Fed officials have taken a more hawkish turn. This should keep upward pressure on U.S. yields, and this is what the Fed wants in lieu of another hike (see below). We believe that while market easing expectations have adjusted violently after CPI and now Powell (see below), there is still room to go. When the market finally capitulates on the Fed, the dollar should gain further.

AMERICAS

Fed Chair Powell was downright hawkish. He acknowledged that with regards to reaching the 2% inflation target, “The recent data have clearly not given us greater confidence and instead indicate that is likely to take longer than expected to achieve that confidence.” He added that “Given the strength of the labor market and progress on inflation so far, it is appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us.” This is quite a change in tone from the March FOMC meeting, which now seems like ancient history. There were no dovish slips.

Powell acknowledged that the Fed’s decisions can affect countries around the world. This is clearly referring to currency weakness for many countries and the resulting impact on their monetary policy decisions. However, do not take this as a sign that this will impact Fed decision-making. The Fed runs monetary policy according to U.S. conditions and U.S. conditions alone. Indeed, a strong dollar is an obvious side effect of high U.S. interest rates and is part of the disinflation process. Barring some sort of massive global economic crisis, the Fed will continue to run tight policy to meet its inflation mandate. While G-7 and G-20 policymakers may discuss the strong dollar at meetings this week, in the end nothing will be done in terms of coordination.

Other Fed officials are taking the same cautious view. Barkin said it’s smart for the Fed to take its time on a decision to cut rates, noting that CPI data has not been supportive of the soft landing thesis. Vice Chair Jefferson said “Of course, the outlook is still quite uncertain, and if incoming data suggest that inflation is more persistent than I currently expect it to be, it will be appropriate to hold in place the current restrictive stance of policy for longer.” Mester and Bowman speak today.

Fed easing expectations continue to adjust. Odds of a June cut have fallen to 15% vs. 60% last week, while odds of a July cut have fallen below 50% vs. fully priced in last week. The market now sees 95% odds of the first cut coming in September and only 70% odds that we get a second cut in December. The rise in U.S. yields is taking a breather today after the 2-year made a new cycle high yesterday near 5.01% and the 10-year did the same near 4.69%. Both are the highest since November and should eventually test their October highs near 5.26% and 5.02%, respectively.

We believe this is what the Fed wants in lieu of another rate hike. That is, the Fed wants the market to do the tightening for them. Financial conditions remain too loose and so some combination of higher yields, wider spreads, stronger dollar, and lower equities is needed to tighten conditions. The Chicago Fed’s weekly measure of financial conditions through last week will be reported today and are expected to show the first tightening since February. However, it won’t be enough to slow the economy and further tightening of financial conditions is needed.

The Fed releases its Beige Book report. The Beige Book is being prepared for the April 30-May 1 FOMC meeting and is expected to show again that the U.S. economy remains in a healthy state. The previous Beige Book in March noted that the outlook for future economic growth remained generally positive, with contacts noting expectations for stronger demand and less restrictive financial conditions over the next 6-12 months. It will be interesting to see if the updated view on prices is consistent with recent elevated CPI prints. The March Beige Book highlighted that price pressures persisted, but several Districts reported some degree of moderation in inflation.

Q1 growth remains robust. Official data will be out next week with consensus currently at 2.0% SAAR vs. 3.4% in Q4. However, the Atlanta Fed’s GDPNow model is tracking Q1 growth at 2.9% SAAR and will be updated next Wednesday. Elsewhere, the New York Fed’s Nowcast model is tracking Q1 growth at 2.2% SAAR and Q2 growth at 2.6% SAAR and will be updated Friday.

February TIC data will be reported. The data should show that underlying demand for USD-denominated assets remains robust. Net foreign purchases of long-term U.S. securities totaled USD1.035 trln in the twelve months through January, more than offsetting the cumulative trade deficit of USD777 bln for the same period. Of note, both Japan and China have been increasing their UST holdings in recent months.

Bank of Canada Governor Macklem did not offer much policy guidance during yesterday’s fireside chat. However, he acknowledged that “there’s some downward momentum in underlying inflation.” Indeed, while headline CPI picked up a tick to 2.9% y/y in March, both core-trim and core-median eased to 3.1% (lowest since June 2021) and 2.8% (matching the July 2021 low), respectively. Momentum in core-trim and core-median have also cooled sharply, with three-month annualized rates of 1.4% and 1.1%, respectively. Bottom line: the BOC has room to start easing in June (70% priced in), which in turn could further weigh on CAD. Of note, Canada’s 2024 budget has neutral monetary policy implications. The budget deficit is projected to shrink from -1.4% of GDP in 2023/2024 to -1.3% in 2024/2025 and -1.2% in 2025/2026.

EUROPE/MIDDLE EAST/AFRICA

ECB officials are sounding more dovish. Yesterday, President Lagarde said “If we don’t have a major shock in developments, we are heading towards a moment where we have to moderate the restrictive monetary policy that we have,” adding that it is likely to happen in “reasonably short order.” Villeroy said “We should, barring major shocks or surprises, decide on a first rate cut at our next meeting on June 6. I would then argue in favor of a policy of pragmatic and agile gradualism. There’ll have to be further cuts this year and next; their pace will be guided by the data, in a genuine meeting-by-meeting approach.” For now, three cuts are priced in this year, with only 10% odds of fourth cut vs. 50% at the start of this week. We expect the hawks and the doves to continue battling for control of the narrative. Cipollone, de Cos, Schnabel, and Lagarde speak later today.

U.K. reported March CPI. Headline came in a ticker higher than expected at 3.2% y/y vs. 3.4% in February, core came in a tick higher than expected at 4.2% y/y vs. 4.5%, and CPIH came in two ticks higher than expected and remained steady at 3.8% y/y. Headline was still the lowest since September 2021 but still well above the 2% target. The 0.6% m/m increase was driven by higher prices for motor fuels. Importantly, services inflation came in two ticks higher than expected and remained quite high at 6.0% y/y vs. 6.1% in February and so the BOE will remain cautious.

Indeed, Bank of England easing expectations have been pushed out. The first cut is now seen in September vs. August at the start of this week. Odds of a second cut in December have fallen to 60% after being fully priced in at the start of this week. This adjustment higher is GBP-supportive. Greene, Bailey, and Haskel speak later today.

ASIA

Japan reported March trade data. Exports came in at 7.3% y/y vs. 7.0% expected and 7.8% in February, while imports came in at -4.9% y/y vs. -5.1% expected and 0.5% in February. Exports were the weakest since November and are even weaker in dollar terms. Shipments to China rose 12.6% y/y, while those to the U.S. and Europe rose 8.5% and 3.0%, respectively. Elsewhere, weakness in imports suggest domestic activity is slowing.

New Zealand reported Q1 CPI data. Headline picked up a tick as expected to 0.6% q/q, while the y/y rate fell as expected to 4.0% vs. 4.7% in Q4. This was the lowest y/y rate since Q2 2021 but still well above the 2% target. Non-tradeable CPI came in at 1.6% q/q vs. 1.3% expected and 1.1% in Q4, but this was offset by tradeable CPI deflation of -0.7% q/q vs. -0.2% expected and actual in Q4. We believe the data weaken the case for RBNZ policy rate cuts in the near-term. Indeed, the market pushed out the timing of a first rate cut by a month to November and is no longer pricing in two cuts this year.