• The two-day FOMC meeting begins today; updated macro forecasts will be key; Powell’s press conference brings the most risk of a dovish surprise; Q1 GDP forecasts are getting marked down; U.S. Treasury reports January TIC data; Canada highlight will be February CPI.
  
• Eurozone Q4 labor costs fell sharply; Germany reported a firm March ZEW survey
  
• Two-day BOJ meeting ended with its first rate hike since 2007; other aspects of its unconventional monetary policy were eliminated; Governor Ueda delivered dovish guidance; RBA delivered a dovish surprise; RBA easing expectations shifted significantly as a result

The dollar is powering ahead despite the Bank of Japan rate hike as the two-day FOMC meeting is about to get under way. DXY is trading higher for the fourth straight day near 104, the highest since March 1. Clean break above 103.976 sets up a test of the February 14 high near 105. The yen is the biggest loser despite the first BOJ rate hike since 2007 (see below), with USD/JPY trading at a new cycle high near 150.70. AUD is also a big loser after a dovish hold from the RBA (see below) and is on track to test the February 13 low near 0.6445. The euro is trading lower near $1.0845 on soft labor cost data (see below) while sterling is trading lower near $1.2680. We embrace this dollar recovery and believe further gains are likely if the Fed sticks to its hawkish script tomorrow (see below). The U.S. data continue to come in mostly firmer and despite Powell’s recent dovish testimony before Congress, most Fed officials remain very cautious about easing too soon. We believe that the current market easing expectations for the Fed still need to adjust. When they do, the dollar should gain further. Last week’s inflation data sparked the start of this process and the FOMC decision tomorrow will be key for the continuation of this move.

AMERICAS

The dollar continues to power ahead. The greenback is seeing broad-based gains, but we note that the two worst performers on the day are JPY and AUD. JPY is lower despite the BOJ hiking rates for the first time since 2007 (see below), while AUD is lower as one would expect after the RBA delivered a dovish hold (see below). U.S. yields have been rising on higher-than-expected inflation readings that are likely to feed into a hawkish hold from the Fed tomorrow. Whether the rise in yields and the dollar can continue comes crucially down to whether the Fed validates the hawkish narrative or not.

The two-day FOMC meeting begins today. The Fed is widely expected to keep interest rates unchanged and begin in-depth discussions about slowing the pace of its balance sheet runoff that’s currently running at $95 bln/month. While the Fed delivered a hawkish hold in January followed by consistently hawkish official comments, Powell’s recent dovish testimony before Congress raises some risks that the Fed’s policy statement is tweaked to signal greater confidence that inflation is moving sustainably towards 2%.

Updated macro forecasts will be key. Growth and inflation forecasts are likely to be raised, reflecting the current macro backdrop of sticky inflation and a resilient economy and labor market. However, it’s the Dot Plots that will command the most attention and we see risks of a hawkish shift. We've noted before that it would take only two FOMC members to shift their 2024 Dot from 4.625% to 4.875% to move the Fed median in a similar manner. Looking ahead, it would take just three FOMC members to shift their 2025 Dot from 3.625% to 3.875% to get a similarly hawkish shift in the Fed median. Given the current economic outlook, it’s hard to justify 175 bp of total easing in 2024 and 2025 that’s currently implied by the Dots.

Chair Powell’s press conference brings the most risk of a dovish surprise. Will he reprise the hawkish tone of his January press conference? Or will he repeat his more dovish testimony before Congress earlier this month? If Powell can stick to the hawkish script, the message will remain consistent and market reaction will likely be limited. If he veers from the script and delivers a dovish tilt, then market reaction will likely be quite violent. The market sees no odds of a cut tomorrow, rising to only 10% in May and 65% in June. The first cut becomes fully priced in for July, which is a far cry from a March start that was priced in at the start of this year.

Q1 GDP forecasts are getting marked down. The Atlanta Fed’s GDPNow model is tracking Q1 growth at 2.3% SAAR and will be updated today after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q1 growth at 1.8% SAAR, down from 2.1% previously. Looking ahead, it is now tracking Q2 growth at 2.1% SAAR, down from 2.5% previously. This model is updated every Friday.

Housing data will hold some interest. February building permits and housing starts will be reported. Permits are expected at 0.5% m/m while starts are expected at 8.2% m/m, with much of the expected bounce back coming from weather-depressed activity in January. Yesterday, March NAHB housing market index came it at 51 vs 48 expected and actual in February. This is the highest since July 2023.

The U.S. Treasury reports January TIC data. The TIC data is not a market mover, but it’s a good indicator of foreign appetite for U.S. long-term securities (Treasuries, government agencies, corporates, and equities). Cumulative net foreign purchases of U.S. long-term securities are near historical high levels. Of note, both Japan and China have been boosting their purchases of USTs recently.

Canada highlight will be February CPI. Headline is expected at 3.1% y/y vs. 2.9% in January, core trim is expected to remain steady at 3.4% y/y, and core median is expected to remain steady at 3.3% y/y. If so, headline would move further above the 2% target and means that the BOC can be patient before loosening policy. Canada’s OIS curve implies the first 25 bp policy rate cut will come July 24.

EUROPE/MIDDLE EAST/AFRICA

Eurozone Q4 labor costs fell sharply. Costs came in at 3.4% y/y vs. a revised 5.2% (was 5.3%) in Q3. This was the lowest since Q3 2022 and confirms the decline already reported in other wage data. The ECB wants even more data on the evolution of wages before cutting interest rates, but the trend is clearly going the way the bank would like. The ECB’s timelier indicator of negotiated wage rates for Q1 is scheduled for release on May 23, two weeks before the June 6 ECB meeting. Interest rate futures are pricing in roughly 85% odds of a 25 bp rate cut then. Guindos said “The evolution of wages is key and most of the wage bargaining agreements will have been concluded in the first months of this year. We will have more information in June.” Similarly, De Cos said that the bank will have “far more data” to decide on policy June.

Germany reported a firm March ZEW survey. Expectations came in at 31.7 vs. 20.5 expected and 19.9 in February, while current situation came in at -80.5 vs. -82.0 expected and -81.7 in February. Elsewhere, the eurozone measure of expectations came in at 33.5 vs. 25.0 in February. German March IFO business climate survey will be reported Friday. Headline is expected at 85.9 vs. 85.5 in February, with expectations expected at 84.7 vs. 84.1 in February and current assessment expected at 86.8 vs. 86.9 in February. Germany remains the weak link in the eurozone but the improvement in the sentiment indicators offer some optimism.

ASIA

Two-day Bank of Japan meeting ended with its first rate hike since 2007. The bank raised the policy rate from -0.10% to a target range of 0.0-0.1% and ended Yield Curve Control. Specifically, the BOJ will no longer target 10-year JGB yields of “around” 0% with 1% as an upper bound reference. Instead, the bank will continue its JGB purchases “with broadly the same amount as before.” It added that “In case of a rapid rise in long-term interest rate it will make nimble responses.” The monetary policy implications are minimal because the BOJ has been slowing JGB purchases for the past year and 10-year JGB yields have been trading well under 1% on average.

Other aspects of its unconventional monetary policy were eliminated. The BOJ will discontinue purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). This is not surprising considering the BOJ has not bought ETF/J-REITs since October 2023 and Japan’s stock market rallied recently to a 34-year high. Here too, the monetary policy implications are minimal because ETFs and J-REITs account for only 5% of the BOJ’s balance sheet. Finally, the BOJ will gradually reduce purchases of Commercial Paper (CP) and corporate bonds and will discontinue the purchases in about one year. Again, the monetary policy implications are minimal because CP and corporate bonds account for just 1% of the BOJ’s balance sheet.

Governor Ueda delivered dovish guidance. He said that “We judged that achieving the goal of sustainable 2% inflation has come within view. The large-scale monetary easing policy served its purpose.” However, Ueda added that “There is still some distance to 2%, if we look at it from the perspective of the expected inflation rate. Considering the gap, I think we will conduct normal policy as I mentioned earlier, keeping the importance of maintaining an accommodative environment in mind.”

The market reaction so far has been exactly the opposite what many expected. USD/JPY surged back above 150.00 and 10-year JGB yields dipped 2 bp to 0.72%. The market reaction suggests a rate hike was better telegraphed than what money market pricing implied (50-50 odds of a hike). We are sticking to our bearish JPY view because Japan’s improving inflation backdrop and soft economic activity suggest the BOJ is unlikely to normalize the policy rate by more than the 20 bp or so that is currently priced in over the next 12 months. Indeed, the bar for an aggressive BOJ tightening cycle is high. First, the BOJ “anticipates that accommodative financial conditions will be maintained for the time being,” just as Ueda warned. Second, the decision to end the negative policy rate was not unanimous. Two BOJ policymakers preferred to continue with the negative interest rate policy.

Reserve Bank of Australia delivered a dovish surprise. It kept rates steady at 4.35%, as expected, but unexpectedly dropped its tightening bias. The RBA tweaked its policy guidance from warning that “a further increase in interest rates cannot be ruled out” to “the Board is not ruling anything in or out.” Accordingly, the tone of the RBA statement was more cautious, noting that wages growth “appears to have peaked” and “household consumption growth remains particularly weak amid high inflation and the rise in interest rates.”

RBA easing expectations shifted significantly as a result. The market now sees a 35% probability of the first 25 bp cut coming in May and becomes fully priced inf by August. Before today’s decision, there was only a small 10% probability of a rate hike in May and didn’t become fully priced in until September. This in turn caused AUD to plunge to 0.6555 and Australian bonds to rally across the curve (mostly at the 3 and 5-year terms). AUD is likely to break below its February low near 0.6445 if, as we expect, the Fed delivers a hawkish message tomorrow.