Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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FX Update: Fed faces impossible communication task today.
John J. Hardy
Chief Macro Strategist
Summary: Not only does the Powell Fed face the impossible task of deciding whether to communicate measured caution with a rate hike or more significant caution with no rate hike today, the guidance task for what it will do next is even more challenging. To boot, the market reaction function to today’s FOMC decision and guidance may prove far from straightforward. Elsewhere, hot UK CPI this morning has market pricing near certainty of BoE hike tomorrow.
Today's Saxo Market Call podcast
Today's Global Market Quick Take: Europe from the Saxo Strategy Team
With markets visible volatility calming considerably over the last couple of sessions, the market is now happier to price the Fed to hike by 25 basis points at today’s FOMC meeting with quite high odds (+21 bps priced this morning in Europe), a move that would take the rate to 4.75-5.00%, with marginal odds of another hike in the following meeting or two, followed by the beginning of an easing campaign by Q4. The as-of-this-writing caveat is more than ever, as Fed “expectations” are to a large degree a function of the US treasury market getting kicked all over the place as investors and traders sought shelter from the banking turmoil fallout over the last couple of weeks, especially at the short end of the treasury curve.
So what does the Fed do? Even former NY Fed chief Bill Dudley can’t come up with a good course of actions in comments he made in a Bloomberg opinion piece, as he rightly points out the risk of the market getting spooked that the Fed knows something is terribly amiss if it fails to hike on the one hand, but on the other, risking aggravating the policy mistake of having taken rates too high too fast if the “banking malaise” worsens. Just as importantly, what will be the market reaction function – both in the immediate wake of the decision and in the days to come? The ECB meeting last week showed how quickly the market can change its mind on central bank action here. In any case, as I note in the EURUSD chart discussion below, I will be watching for sentiment swings across many indicators more than I will consider the implications for yield spreads based on Fed guidance.
And the underlying challenge for banks as I have discussed in recent reports could be less about depositors fleeing on concerns about a given bank’s stability and more about demanding higher returns on their savings and parking more funds outside banks, for example in treasuries or otherwise. Today’s Saxo Market Call podcast notes the general drop in bank deposits in US Commercial Banks that is completely without precedent. The traditional central bank toolbox doesn’t address that.
Chart: EURUSD
The EURUSD has rebounded as a function of financial market stability returning and how it behaves in the wake of tonight’s FOMC meeting will likely correlate closely to how risk sentiment treats the Fed’s decision and guidance rather than any implication of what the Fed is saying on rate guidance. If we look at the current 2-year yield spread relative to where we were on March 8, the day before the banking turmoil was unleashed on the markets, we are some 35 basis points in favour of the Euro, where its hiking expectations have been marked down less than the Fed’s expectations. While the relative shift in favour of the euro was far greater at times during the market turmoil, the turmoil itself makes it difficult for the market to do anything but head for safety, which during the recent bound meant the USD and even more so, the Japanese yen. Watching 1.0800-50 as the final resistance ahead of 1.1000 in the EURUSD chart, and for a bearish reversal scenario (close well south of 1.0700) if the USD serves as safe haven as more market turmoil ensues after FOMC today.
Elsewhere, this morning’s UK February CPI release certainly raised eyebrows with across-the-board surprises on the hot side for inflation – with the headline jumping to 1.1% MoM and 10.4% YoY vs. 0.6%/9.9% expected and 10.1% in January, while the core was a blistering 6.2% vs. 5.7% expected and 5.8% in January. This has the market pricing nearly 100% odds of a BoE hike tomorrow, just a meeting after the BoE was clearly looking for excuses to pause. Remember Governor Bailey’s comment on March 1 that it was possible that the BoE has come to the end of its hiking cycle and its very aggressive disinflation forecast from the February meeting: sub 4% by the end of this year and 1% for headline CPI in two years! Sterling is all over the shop, sharply down yesterday versus especially the euro, but fighting back there today and posting local highs against the US dollar.
Table: FX Board of G10 and CNH trend evolution and strength.
The US dollar is tilting lower again – but probably need the close of trading Friday to have a “confirmation” signal in place in either direction for the greenback, given the uncertainties around the reaction function to tonight’s FOMC meeting. A novelty to see sterling at the top of the G10 trending list after today’s hot UK CPI (and yesterday’s weakness).
Table: FX Board Trend Scoreboard for individual pairs.
Almost all USD pairs have now turned lower for the greenback – bracing for the FOMC meeting input. For sterling, almost all pairs in the plus column for sterling ahead of BoE tomorrow – an embarrassing one for the bank on today’s hot UK inflation print.
Upcoming Economic Calendar Highlights
- 1730 – Canada Bank of Canada to release “summary of deliberations”
- 1800 – US FOMC announcement
- 1830 – US Fed Chair Powell Press Conference
- 2130 – Brazil Selic Rate Announcement
- 0015 – New Zealand RBNZ Chief Economist to speak on inflation
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