- FOMC minutes were cautious; the only surprise was that the Fed discussed slowing QT; weekly jobless claims will be of interest; Banxico releases its minutes
- The markets got a stark reminder of simmering geopolitical risks yesterday; ECB officials are clearly split
- The yen is outperforming on higher JGB yields; Australia reported solid January jobs data; China commercial banks left their LPRs unchanged
The dollar is soft as risk on sentiment returns. DXY is trading lower for the first time since Monday near 106.888 as markets shrug off yesterday’s concerns about Ukraine (see below). The yen is outperforming on higher JGB yields (see below), with USD/JPY trading below 150 for the first time since early December. Sterling is trading higher near $1.2605 while the euro is trading higher near $1.0435. FOMC minutes show the Fed acknowledges the potential impact of Trump policies (see below), which will keep officials even more cautious. More and more tariff noise is likely in the coming days and weeks. However, we continue to look through that noise and focus on the underlying fundamental backdrop, which remains unchanged. The strong U.S. fundamental story of strong growth, elevated inflation, and a more hawkish Fed continues to favor higher U.S. yields and a stronger dollar.
AMERICAS
FOMC minutes were cautious. At the January 28-29 meeting, the Fed delivered the widely expected hold. The minutes showed that “Participants indicated that, provided the economy remained near maximum employment, they would want to see further progress on inflation before making additional adjustments to the target range for the federal funds rate.” In addition, “many participants noted that the committee could hold the policy rate at a restrictive level if the economy remained strong and inflation remained elevated.” Lastly, the Fed acknowledged that it is focused on Trump’s policies as “Participants cited the possible effects of potential changes in trade and immigration policy, the potential for geopolitical developments to disrupt supply chains, or stronger-than-expected household spending.”
The only surprise was that the Fed discussed slowing QT. Specifically, “Regarding the potential for significant swings in reserves over coming months related to debt ceiling dynamics, various participants noted that it may be appropriate to consider pausing or slowing balance sheet runoff until the resolution of this event.” Recall that the Fed is currently allowing up to $25 bln in USTs and $35 bin in MBS to mature each month without reinvestment. Bostic agreed that the Fed should “be more cautious today” with its balance sheet runoff, as he pointed out that “the debt ceiling is one factor that comes into that, but there are others as well, including how banks decide to deploy capital across their investment instruments.” Overall, slowing or pausing the unwind in Treasury holdings would weigh on yields.
Fed officials remain cautious. Vice Chair Jefferson stressed that “we can take our time to assess the incoming data to make any further adjustments to our policy rate” because of the US economy is strong and labor market solid. Jefferson added “Generally, households appear to be in a good position: Asset holdings are high across the income distribution, driven by high house and equity prices, and debt levels are subdued.” Strong U.S. household balance sheets are a key factor underpinning consumer spending activity. The next Fed cut is priced in for September after being pushed out to October right after the CPI data, while the swaps market is nearly pricing in a second cut in H2 after pricing in no further cuts after the CPI data. Goolsbee, Musalem, Barr, and Kugler speak today.
Weekly jobless claims will be of interest. That’s because initial claims will be for the BLS survey week containing the 12th of the month and are expected at 215k vs. 213k previously. Continuing claims are reported with a one-week lag and are expected at 1.868 mln vs. 1.850 mln previously. There is no Bloomberg consensus yet for February NFP but its whisper number stands at 139k vs. 143k reported for January.
On a side note, we are having less and less confidence about the state of the labor market going forward. Why? 1) Government layoffs and early retirement efforts under Musk. Will these workers find other jobs or drop out of the labor force? 2) Migrant deportations. Many of them work and anecdotal evidence suggests that the threat of deportation is keeping some undocumented workers at home. While starting off small, these policies may eventually snowball and have significant unintended consequences on the labor force, consumption, and agricultural production. It's early days but this is something to keep an eye on in terms of worrisome exogenous shocks to the economy (along with tariffs).
Regional Fed surveys for February will continue rolling out. Philly Fed manufacturing will be reported and is expected at 14.3 vs. 44.3 in January. So far, the February surveys have been mixed. Earlier this week, Empire manufacturing came in at 5.7 vs. -12.6 in January and New York Fed services came in at -10.5 vs. -5.6 in January.
Banco de Mexico releases its minutes. At that meeting February 6, the bank cut rates 50 bp to 9.5%. It was a dovish cut as the bank said “The Board estimates that looking forward it could continue calibrating the monetary policy stance and consider adjusting it in similar magnitudes.” Yesterday, the bank released its quarterly inflation report. The 2025 growth forecast was halved to 0.6%, while the 2026 forecast was kept steady at 1.8%. Of note, the bank said it did not make any assumptions regarding the impact of potential U.S. trade policies. The swaps market has reacted to the dovish signals and is now pricing in 125 bp of further easing over the next 12 months that would see the policy rate bottom near 8.25% vs. 8.5% before the February decision.
EUROPE/MIDDLE EAST/AFRICA
The markets got a stark reminder of lingering geopolitical risks yesterday. U.S.-Ukrainian relations are at a low point as President Trump attacked President Zelenskiy. Furthermore, Trump has sidelined Europe and excluded Ukraine as he began talks with Russian President Putin on ending the three-year conflict. It seems likely that any Ukraine peace deal that eventually emerges from these talks will favor Russia. Indeed, early indications suggest that Russia will be allowed to keep what it already holds in Ukraine, NATO will not invite Ukraine to join NATO, and the U.S. will maintain little or no presence in the region. The euro was hurt the most amongst the majors yesterday on the Ukraine headlines, but PLN, HUF, and CZK also took it on the chin as Eastern Europe is right there on the front lines. The impact on FX has worn off today but geopolitical risks continue to simmer.
European Central Bank officials are clearly split. After dovish comments from Panetta and others, Executive Board member Schnabel took up the hawkish mantle. Schnabel said that “We are getting closer to the point where we may have to pause or halt our rate cuts. We need to start that discussion.” Schnabel stressed that “I’m not saying our monetary policy is no longer restrictive. What I’m saying is I’m no longer sure whether it is still restrictive.” It’s puzzling to us why so many ECB officials are drawing the line at neutral, when the data suggest that the bank needs to move to accommodative. Yet ECB easing expectations remain unchanged. The swaps market is pricing another 75 bp of easing over the next 12 months that would see the policy rate bottom at 2.00%, which is near the bottom end of neutral rate estimates. Unlike the Fed, however, we believe the ECB has scope to overdeliver on these rate cut expectations, which can pull EUR/USD lower. Makhlouf and Nagel speak later today.
ASIA
The yen is outperforming on higher JGB yields. The 10-year JGB yield is trading at the highest level since November 2009. The break higher in yields is due to a combination of higher than expected CPI readings as well as increased Bank of Japan tightening expectations. The next hike is still priced in for September but the swaps market now sees nearly 60% odds of another hike that would see the policy rate peak near 1.25% vs. 1.0% previously. January CPI data tomorrow could reinforce current rate hike expectations and offer JPY additional support.
Australia reported solid January jobs data. A total of 44.0k jobs were created vs. 20.0k expected and a revised 60.0k (was 56.3k) in December, while the unemployment rate came in as expected at 4.1% vs. 4.0% in December. The mix was favorable, as 54.1k fulltime jobs created were only partially offset by -10.1k parttime jobs lost. The RBA signaled it will pay particular attention to labor market development to guide future policy decision, and so the strong jobs report validates its guidance for a cautious easing path ahead. Indeed, Deputy Governor Hauser echoed comments made earlier this week by Governor Bullock, stating that he does not share the market’s confidence in the rate cut path. The market is now pricing in only 50 bp of easing over the next 12 months that would see the policy rate bottom at 3.70% vs. 3.45% earlier this week.
China commercial banks left their 1- and 5-year Loan Prime Rates unchanged at 3.10% and 3.60%, respectively. The PBOC will set its benchmark 1-year MLF rate in the next few days and is expected to keep it steady at 2.0%. Looking ahead, more monetary easing is the pipeline which is a drag on CNH. For now, USD/CNH is lower on broad USD weakness. As was widely expected, the Chinese leaders in December said they would switch from a “prudent” to an "appropriately loose" monetary policy stance. To escape the debt-deflation loop, however, policymakers need to ramp up fiscal measures to boost consumption.
