Havens Surge

April 19, 2024

Havens Surge

  • A flight to safety is gripping financial markets and hawkish Fed views are piling up.
  • UK consumer spending remains weak.
  • Japan inflation slowed more than expected in March.

Safe haven assets are shining amid the darkness cast by escalating Israel-Iran tensions. American officials confirmed Israel launched a retaliatory strike on Iran earlier today. A modest risk-off environment quickly gripped financial markets. CHF and JPY are outperforming. USD is firm against most other major currencies. US Treasuries rallied across the curve with 10-year yields falling as much as 13bps to lows around 4.50%. Gold and Brent crude oil prices spiked-up briefly above US$2’400 an ounce and US$90 a barrel, respectively. Global equity markets are selling-off.

Meanwhile, the favourable US macro backdrop suggests the Fed can keep hitting the snooze button, further underpinning USD strength. The Philadelphia Fed manufacturing business outlook index rose above all estimates to a 2-year high at 15.5 in April and price indexes point to sticky inflation pressures. The labour market also remains solid as initial claims remained relatively low at 212k for the week ended April 13.

Fed officials are cranking up the hawkish rhetoric. New York Fed President John Williams floated the possibility of rate hikes yesterday. Williams emphasised it was not his base case scenario but “if the data are telling us that we would need higher interest rates to achieve our goals, then we would obviously want to do that.” Meanwhile, Minneapolis Fed President Neel Kashkari (non-voter) said the Fed could “potentially” wait until 2025 to lower rates and Atlanta Fed President Raphael Bostic warned “inflation is high – it’s too high” and “I’d have to be open to increasing rates” if inflation moves away from the Fed’s target.

Today, Chicago Fed President Austan Goolsbee participates in a moderated Q&A session (3:30pm London) and the Fed releases its Financial Stability Report (FSR) (9:00pm London). The last FSR dates from October 2023.

GBP is lower versus USD and EUR. UK consumer spending remains weak. Retail sales volumes were unexpectedly flat (consensus: +0.3% m/m) in March after rising by just 0.1% in February. Excluding volatile automotive fuels, retail sales fell 0.3% m/m in March following a 0.3% increase in February. Going forward, UK consumer spending is expected to recover underpinned in part by positive real wage growth. Until then, poor UK retail sales activity and high underlying inflation complicates the BOE’s task of achieving price stability and supporting growth.

ECB officials continue to lean against expectations of widening policy divergence between the Fed and ECB. ECB policymaker Holzmann warned yesterday “if the Fed doesn’t cut rates at all this year, I hesitate to imagine us cutting three or four times.” His comments echoed those made recently by ECB President Lagarde and Governing Council member Vasle.

The ECB’s concern is that wider policy divergence between the Fed and ECB leads to a sharply weaker EUR/USD. This could derail the ECB’s progress on inflation (via higher imported inflation) at a time when Eurozone economic growth is sluggish. Regardless, this is not the Fed’s problem. As long as US economic activity remains solid the Fed will not be in a rush to loosen policy. Bottom line: narrowing EU-US bond yield spreads remain a drag on EUR/USD.

Japan inflation slows more than expected. In March, headline CPI inflation slowed 0.1pts to 2.7% y/y (consensus: 2.8%), core (ex-fresh food) eased 0.2pts to 2.6% (consensus: 2.7%) and core (ex-fresh food & energy) dropped 0.3pts to 2.9% (consensus: 3.0%). Bottom line: underlying inflation is in a firm downtrend and the bar for an aggressive BOJ tightening cycle is high. As such, USD/JPY should resume its uptrend if a full-blown military conflict in the Middle East can be avoided.

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