Fed Fuels Risk Asset Rally

March 21, 2024

Fed Fuels Risk Asset Rally

  • USD is down and risk assets are up underpinned by the perceived dovish Fed hold. We doubt the Fed will deliver 75bps of rate cuts this year.
  • Policy-rate decisions by the SNB, Norges Bank, and BOE take centre stage today.
  • Australia’s economic data released overnight were good. New Zealand’s economy unexpectedly contracts in Q4.

USD plunged across the board, short-term Treasuries and US equities rallied, and Fed funds futures raised the probability of a June rate cut to over 80% because of the perceived dovish Fed hold. For 2024, the Fed’s new funds rate projection continue to imply 75bps of rate cuts despite higher GDP growth estimate (2.1% versus 1.4%) and higher core PCE inflation forecast (2.6% versus 2.4%). The combination of expected lower policy rates, stronger growth, and higher underlying inflation bodes well for risk assets and is weighing on USD.

In our view, the outcome of the Fed March policy meeting is not a dovish slam dunk. First, there was no indication from the Fed that it had gained greater confidence that inflation is moving sustainably towards 2%. Second, the median Fed funds rate projection for 2025 and 2026 were both lifted by 25bps to 3.875% and 3.125%, while the longer-term funds rate forecast is roughly 6bps higher at 2.6%. Third, the 2024 funds rate estimate was just one dove away from a hawkish shift.

Importantly, we doubt the Fed will deliver 75bps of rate cuts this year in part because of the encouraging US economic growth outlook. As such, USD downside is limited. Today, the March Philadelphia Fed Business Outlook survey (12:30pm London) and US PMI data (1:45pm London) will offer a timely update on the economic outlook.

Three other G10 central banks hold policy rate decisions today: SNB (8:30am London), Norges Bank (9:00am London) and BOE (12:00pm London).

CHF faces downside risk because we expect the SNB to cut the policy rate by 25bps to 1.50% and reiterate its willingness “to be active in the foreign exchange market as necessary”. Swiss headline and core CPI inflation have been running under the SNB’s 2% per annum target since June 2023 and tracking below the SNB’s December 2023 projection. Interest rate futures are pricing a 37% probability of a cut today.

The Norges Bank is widely expected to keep the policy rate at 4.50%. The focus instead will be on the bank’s policy guidance offered in the updated Monetary Policy Report. The December 2023 Report indicated the policy rate would stay around 4.50% until Q3 2024 before gradually moving down to a terminal rate of 2.50% in Q1 2026. The Norges Bank will likely bring forward the timing of when the terminal rate is reached because inflation in Norway is slowing faster than the bank’s forecast. This is a headwind for NOK.

The Bank of England (BOE) is widely expected to leave the policy rate at 5.25%. The risk is the MPC voting split shifts less hawkish, which can briefly weigh on GBP. Judging from recent comments, Jonathan Haskel is the most likely to switch his vote from a 25bps hike to a hold. Catherine L Mann will likely stay the course favouring a 25bps rate increase while Swati Dhingra should maintain her preference for a 25bps cut. Finally, we don’t anticipate material changes to the policy statement. The BOE will likely reiterate “monetary policy needs to be restrictive for an extended period of time” and that it “will keep under review for how long Bank Rate should be maintained at its current level”.

The UK PMI print (9:30am London) can offer GBP some support. The composite PMI is forecast to tick-up 0.1pts to 53.2 in March, indicating the UK economy will recover quickly from its technical recession.

EUR will take its cue today from the French PMI (8:15am London), German PMI (8:30am London) and Eurozone PMI (9:00am London). Overall, the composite PMIs are projected to show that the downturn in Eurosone economic activity continues to ease.

USD/JPY is holding above 150.00. BOJ Governor Kazuo Ueda curtailed expectations of an aggressive tightening cycle. According to Ueda, waiting too long to normalise the policy rate would have strengthened the need for “very rapid and large rate hikes”. Ueda also reiterated that accommodative financial conditions will be maintained for the time being and the BOJ is not planning to sell its stock of JGB now. Japan’s February CPI is the next domestic highlight (11:30pm London).

AUD is outperforming most major currencies. Australia’s economic data released overnight were good. Employment surged 116.5k in February (consensus: +40k) following a modest 15.3k rise the previous month. Meanwhile, the number of unemployed people fell by 52k, helping drag the unemployment rate sharply lower by 0.4pts to 3.7% (consensus: 4.0%) and below the RBA’s estimated full-employment range of 4.00 to 5.75%. Moreover, the Judo Bank Flash Australia Composite PMI improved to an 11-month high of 52.4 in March from 52.1 in February driven by an increase in service sector activity. Bottom line: tight Australian labour market conditions and faster growth momentum in services business activity, validate current money market pricing of only 50bps of cumulative RBA policy rate cuts this year.

AUD/NZD is breaking higher on diverging domestic economic performance. New Zealand’s economy unexpectedly shrank in Q4 2023. The policy-relevant real GDP (production-based) fell 0.1% q/q in Q4 after dropping 0.3% q/q in Q3. The RBNZ projected real GDP to be flat in Q4 while consensus expected a 0.1% rise. New Zealand expenditure GDP was flat in Q4 following a 0.3% q/q decline in Q3. In contrast, Australia real GDP rose 0.2% and 0.3% q/q in Q4 and Q3, respectively.

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