No Hurry, No Worry
- Fed in no rush to resume easing.
- US and Eurozone report Q4 GDP today. The data will spotlight US economic outperformance.
- ECB expected to cut the policy rate 25bps to 2.75%.
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USD and Treasury yields retraced all their post Fed decision kneejerk upswing. US and European equity futures are marginally higher.
Yesterday, the Fed delivered a hawkish hold. The FOMC left the target range for the Fed funds rate unchanged at 4.25-4.50% (widely expected) and signaled the bar to resume easing is high. First, the statement removed previous reference that “inflation has made progress toward the Committee's 2 percent objective.” When asked about that omission, Fed Chair Jay Powell said it was not meant to send a signal but rather to shorten the sentence on inflation. We find this hard to believe given that the Fed knows the market is hanging on its every phrase and wording. Second, the decision to keep rates on hold was unanimous. Third, Powell stressed that “we do not need to be in a hurry to adjust our policy stance.”
Fed funds futures continue to imply 50bps of rate cuts in 2025. With US inflation stalling above 2% and economic activity solid, the Fed will struggle to deliver on those easing expectations. Bottom line: monetary policy divergence between the Fed and other major central banks remains a key USD tailwind.
US Q4 advanced GDP estimate is due today (1:30pm London). Growth is expected at 2.6% SAAR vs. 3.1% in Q3, with personal consumption the main growth driver. The Atlanta Fed GDPNow model estimates Q4 growth at 2.3% SAAR while the New York Fed GDP nowcast model estimates Q4 growth at 2.6% SAAR. Regardless, the US economy is tracking well above long-run annual trend growth of 1.8%.
EUR/USD is holding above 1.0400. Eurozone Q4 advanced GDP estimate is up next (10:00am London). Growth is expected at 0.1% q/q vs. 0.4% in Q3. Forward-looking survey indicators point to downside risk to growth. The Eurozone’s soggy growth outlook leaves plenty of room for the ECB to bring down the policy rate towards the middle of its neutral range - estimate at around 1.50% to 3.00% - which is an ongoing drag for EUR.
The ECB is widely expected to cut the policy rate 25bps to 2.75% (1:15pm London). We also expect the ECB to reiterate that it “is not pre-committing to a particular rate path.” ECB President Christine Lagarde’s post-meeting conference may offer more near-term policy guidance (1:45pm London). Watch-out to see if Lagarde re-emphasizes the need for a “very cautious” easing cycle and/or acknowledges if there was once again a discussion around the proposal for a 50bps cut. There are no new macroeconomic projections due at this meeting. The next update is published in March.
JPY is the top performing major currencies overnight. There is no fundamental trigger behind broad JPY strength. Bank of Japan Deputy Governor Ryozo Himino reiterated the bank’s guidance that more hikes are in the pipeline if its economic and price outlooks are realized. Markets continues to imply the BOJ policy rate to peak around 1.00% over the next two years. This seems about right as the BOJ expects inflation to stabilize around its 2% target in 2026. Bottom line: the BOJ shallow policy normalization cycle is an ongoing headwind for JPY.
NZD/USD is heavy under 0.5700 and trading close to the level implied by 2-year NZ-US bond yield spreads. New Zealand January ANZ business outlook survey was disappointing but still extremely high. Business confidence dipped 8 points to a five-month low at 54.4 and the expected own activity fell 4 points high to a four-month low at 45.8. Reported past activity, which has the best correlation to GDP, improved slightly to 0.2 vs. 0 in December suggesting a modest recovery in economic activity is underway. In line with RBNZ guidance, markets continue to imply another 50bps rate cut to 3.75% in February and the policy rate to bottom around 3.00% over the next 12 months. RBNZ/Fed policy trend remains drag for NZD/USD.
USD/CAD is grinding higher above 1.4400. As was widely expected, the Bank of Canada (BOC) slashed the policy rate 25bps to 3.00% yesterday. The BOC also announced two changes to its monetary policy implementation framework. These tweaks are technical and have no material monetary policy implications.
First, the BOC will end quantitative tightening (the process of letting bond holdings roll off the balance sheet as they mature, without replacing them) and begin purchasing assets as part of normal balance sheet management in early March. Second, the BOC announced that the deposit rate will be set at a spread of 5bps below the policy rate (i.e.: 2.95%). The aim is to mitigate some of the upward pressure that has been seen on the overnight rate relative to the policy rate in recent months.
More importantly, the BOC signaled it may pause easing while warning that US trade policy is a major source of uncertainty for Canada’s economy: (i) BOC emphasized again that “the cumulative reduction in the policy rate since last June is substantial” but scrapped previous easing guidance. (ii) BOC still projects inflation to remain close to the 2% target over the projection horizon. (iii) BOC projects GDP growth to rise above potential output in 2025 and 2026.
Nonetheless, markets expect the BOC to deliver more rate cuts. We agree. Interest rate futures imply almost 75bps of BOC cuts over the next 12 months that should see the policy rate bottom near 2.25%. This would be at the lower end of the BOC’s neutral range estimate of 2.25% to 3.25%. While USD/CAD is extremely overvalued (we estimate fundamental equilibrium around 1.2000), the overshoot has more legs. FED/BOC policy trend, risk of all-out trade war between Canada and the US, and the Trump administration’s focus on lowering energy prices support a higher USD/CAD.
