April Flashlight for the FOMC Blackout Period: Waiting for Godot?

Summary

  • We share the market’s overwhelming expectation that the Federal Open Market Committee (FOMC) will leave the fed funds target rate unchanged at 5.25%-5.50% at the conclusion of its April 30-May 1 meeting.
  • Stubborn inflation and resilient economic activity through the first few months of the year have left the FOMC little reason to ease policy in the near term. A chorus of Fed officials, which tellingly include a number of “doves,” has indicated that there is no hurry to cut rates at this time.
  • An update to the Committee’s economic projections will not be released at the end of next week’s meeting, but the post-meeting statement and press conference will likely offer some clues on how the FOMC expects the policy path to evolve over the coming meetings.
  • Since the FOMC’s March 20 meeting, we (along with markets) have pushed back our expectations for when the FOMC will start to ease policy. We currently expect the FOMC to first cut the fed funds target rate by 25 bps at its September 18 meeting, followed by another 25 bps point cut at its December 18 meeting.
  • We anticipate the FOMC to announce a change to its ongoing balance sheet runoff program at its upcoming meeting even as it leaves the fed funds rate unchanged. We expect the Committee to announce that, beginning in June, runoff of Treasury securities will be capped at $30 billion/month compared to the current runoff cap of $60 billion/month. The $35 billion monthly runoff cap for MBS, however, is likely to remain in place. The pace of MBS runoff, at $15-$20 billion per month, is already running well below the current cap.
  • If we are off in our timing and the FOMC does not announce a slower pace of runoff on May 1, we would expect an announcement at the subsequent meeting on June 12. We anticipate this slower pace of QT running until year-end 2024. At its trough, we look for the central bank’s balance sheet to be roughly $6.9 trillion.
  • We do not believe slowing the pace of QT will have a material impact on the level of interest rates. The outlook for the federal funds rate will be far more critical to determining the level and shape of the yield curve in the months ahead, in our view.

Recent Data to Keep FOMC on Hold

The Federal Open Market Committee (FOMC) will hold its next policy meeting on April 30–May 1, and market participants overwhelmingly expect the Committee will maintain its target range for the federal funds rate at 5.25%-5.50%, an expectation we share. At the beginning of 2024, markets were essentially priced for a 25 bps rate cut at the March 20 meeting and a similar-sized reduction on May 1 (Figure 1). In the event, the Committee voted unanimously at its March meeting to keep rates on hold, and we look for another unanimous decision on May 1 to maintain the current target range. What has changed to induce the FOMC to keep policy unchanged so far this year rather than to ease as many investors had expected just a short while ago?

In short, inflation has been stickier and the economy more resilient than many observers had anticipated at the beginning of the year. The year-over-year change in the core PCE deflator, which Fed officials believe is the best measure of the underlying rate of consumer price inflation, slipped below 3% at the turn of the year while the deflator’s 3-month annualized rate of change moved to only 1.6% (Figure 2). Although the year-over-year rate has continued to edge lower, the 3-month annualized rate has risen, indicating that progress toward the FOMC’s target of 2% has stalled. Furthermore, data on real economic activity have generally been stronger than expected. For example, the economy created an average of 276K jobs per month in Q1-2024, up from 212K per month in the fourth quarter of last year. Stronger-than-expected data have led most forecasters to revise up their expectations for GDP growth this year. The consensus forecast for U.S. real GDP growth in 2024, as measured by the Blue Chip Panel of Economic Forecasters, was 1.6% in January. The Blue Chip forecast for this year now stands at 2.4%.

Fed Officials Indicate Little Urgency to Ease Policy

Sticky inflation and resilient economic activity give Fed policymakers little reason to ease policy in the foreseeable future. Fed Chair Jerome Powell noted on April 16 that “given the strength of the labor market and progress on inflation so far, it is appropriate to allow restrictive policy further time to work.” Recent comments by other Federal Reserve officials indicate that they too are in no hurry to cut rates. For example, Raphael Bostic, who is the president of the Federal Reserve Bank of Atlanta and a voting member of the FOMC this year, recently stated “my outlook for 2024 is one cut toward the end of the year.” San Francisco Fed President Mary Daly, also a voting member of the Committee who many observers consider to be “dovish,” recently said “there’s absolutely, in my mind, no urgency to adjust the policy rate.” When a well-known dove is expressing skepticism about the need to ease policy, one should probably not expect a rate cut anytime soon.

As is customary for the April/May meeting, the FOMC will not release a Summary of Economic Projections (SEP) at the conclusion of this upcoming meeting. Therefore, market participants will need to rely on the post-meeting statement and Chair Powell’s comments during his press conference for clues about the FOMC’s outlook for monetary policy. The statement the FOMC released at the conclusion of its March 20 meeting noted that “economic activity has been expanding at a solid pace,” and that “job gains have remained strong, and the unemployment rate has remained low.” The statement went on to say that “inflation has eased over the past year but remains elevated.” Recent data indicating that economic activity generally remains resilient and that inflation has been sticky suggest to us that meaningful changes to that part of the post-meeting statement are not likely on May 1. We do not think the Committee will want to indicate that an easing of policy is imminent via a dovish statement.

As discussed in our recent U.S. Economic Outlook, we do not believe the FOMC will have the confidence it needs at its next two policy meetings (i.e., June 12 and July 31) about a return of inflation to the Committee’s 2% target to cut rates at those meetings. If, as we forecast however, payroll growth slows in coming months and the 3-month annualized rate of change in the core PCE deflator settles back down, then we look for the FOMC to cut rates by 25 bps at its September 18 meeting and by another 25 bps in the fourth quarter. But if inflation remains elevated and/or the economy remains resilient in coming months, then the timeline for the commencement of Fed easing likely would be pushed back even further, perhaps into 2025.

Quantitative Tightening Set to Begin Its Next Phase

Although the FOMC likely will not change its target range for the federal funds rate at the upcoming meeting, we expect the Committee will announce some changes to its balance sheet runoff program, commonly referred to as quantitative tightening (QT). On June 1, 2022, the FOMC began allowing a maximum of $30 billion of Treasury securities and $17.5 billion of mortgage-backed securities (MBS) per month to roll off its balance sheet. In September 2022 these caps were increased to $60 billion and $35 billion, respectively, and they have subsequently remained unchanged. This passive runoff has driven a decline in the Fed’s balance sheet from a peak of nearly $9 trillion in Q2-2022 to $7.4 trillion today. As a share of GDP, the Fed’s balance sheet has shrunk materially, but it still remains larger than what prevailed on the eve of the pandemic (Figure 3).

Recent comments from Chair Powell and other Fed officials suggest the Committee expects to slow the pace of runoff “fairly soon,” a phrase we take to mean that a decision is coming at the May 1 meeting. The logic for slowing runoff is fairly straightforward: the ultimate “equilibrium” size of the Fed’s balance sheet is uncertain, and a prudent risk management policy calls for a slow-but-don’t-stop approach as the Fed feels out the optimal size for its balance sheet. The minutes from the last FOMC meeting noted that “slower runoff would give the Committee more time to assess market conditions as the balance sheet continues to shrink.”

We expect the FOMC will reduce the runoff caps for Treasury securities to $30 billion/month while it leaves MBS caps unchanged, with the new caps effective starting June 1. Note that MBS runoff has been running at roughly a $15-$20 billion per month pace, so the $35 billion cap has not been close to binding (Figure 4). If we are wrong and the FOMC does not announce a slower pace of runoff on May 1, we would expect an announcement at the subsequent meeting on June 12. We anticipate this slower pace of QT running until year-end 2024. At its trough, we look for the central bank’s balance sheet to be roughly $6.9 trillion (Figure 5).

Starting in 2025, we look for runoff to end and for the Fed to hold the size of its balance sheet flat for a couple of quarters. Such a move would allow the central bank to “grow into” its balance sheet, i.e., a flat balance sheet would still be shrinking as a share of the growing U.S. economy. At some point later in 2025, perhaps around mid-year or so, we expect balance sheet growth to resume to accommodate organic growth in Federal Reserve liabilities (e.g., paper currency and bank reserves). The Federal Reserve has continued to reiterate that it intends to hold primarily Treasury securities over the longer-run, and as a result we expect the FOMC will continue to passively reduce its MBS holdings in 2025 and beyond while replacing these MBS with Treasury securities, a move that would replicate what has occurred in the past.

Where does this leave bank reserves? Bear in mind that bank reserves are the key swing factor in the Fed’s balance sheet. Commercial banks hold deposits at the Federal Reserve for a variety of regulatory and liquidity needs. The Federal Reserve aims to ensure that the amount of reserves in the system are “ample” but not overly abundant. Estimating the lowest comfortable level of reserves is a challenging endeavor and involves a mix of historical analysis, outreach to financial institutions and monitoring of money market conditions. Under our base case scenario, bank reserves decline in the coming quarters and eventually level off around 10.5% of GDP (Figure 6). If realized, bank reserves would be well below the pandemic peak but still comfortably above the amount that prevailed in September 2019 when a repo market blowup spooked financial markets.1 This analysis assumes paper currency in circulation continues to grow at trend, RRP balances are at low levels and the Treasury’s General Account holds steady at $750 billion for the foreseeable future.

We do not believe slowing the pace of QT will have a material impact on the level of interest rates. If the Fed’s balance sheet bottoms out a bit under $7 trillion as we expect, then runoff is already three quarters complete. Furthermore, the FOMC’s communication with the public on this topic is well established, and financial markets should be well-prepared for the pending change. The outlook for the federal funds rate will be far more critical to determining the level and shape of the yield curve in the months ahead, in our view.

Endnotes

1 – For further reading, see Anbil, Sriya, Alyssa Anderson, and Zeynep Senyuz (2020). “What Happened in Money Markets in September 2019?,” FEDS Notes. Washington: Board of Governors of the Federal Reserve System, February 27, 2020.

Bitcoin Recovers, Altcoins Humbly Follow

Market picture

The crypto market is moving upwards, encouraged by Bitcoin’s positive momentum. Total cryptocurrency capitalisation reached $2.44 trillion, up 1.6% in 24 hours and 0.8% in seven days.

Bitcoin added 1.9% in 24 hours to $66.4K, gradually adding since last Thursday. The price hasn’t moved much in recent days, balancing the positivity from the halving and the negativity from the Nasdaq index’s decline.

Bitcoin is sticking to a classic upside pattern with a 61.8% Fibonacci retracement from the last rally. However, it’s worth remaining cautious until the price breaks above the 50-day moving average, which is now at $67.4K.

Altcoins are repeating the positive dynamics of the first cryptocurrency, adding since the end of last week. Still, they fell harder a fortnight ago and are recovering very sluggishly so far. As a result, the share of Bitcoin in total cap reached a three-year high near 55%.

News background

On 20 April at 0:10 GMT, the fourth halving in history took place on the Bitcoin network on block #840,000. The ViaBTC mining pool mined the block, and it saw the miners’ reward drop from 6.25 BTC to 3.125 BTC. Commissions in the first block of the BTC network rose sharply to $2.4 million after the halving. The record commission is attributed to user activity in the Runes Protocol.

The first cryptocurrency may enter a “re-accumulation phase” after halving. Then, a “parabolic uptrend” will begin, according to an analyst at Rekt Capital. In his opinion, the movement of BTC now follows the same pattern as in previous post-halving cycles.

In a clarified lawsuit against Tron founder Justin Sun, the SEC said his frequent visits to the United States entitled him to legal action. According to the SEC, San spent more than 380 days in the US between 2017 and 2019.

Ethereum blockchain made a net profit of $365.46 million in the first quarter, up nearly 200% from the previous period’s $123 million, according to The DeFi Report. Total transaction fees reached $1.17bn.

Tether, the issuer of USDT stablecoin, added support for The Open Network (TON) blockchain. Via Telegram, Crypto Bot users can now deposit USDT on the TON blockchain. Withdrawals will appear in the near future. There will be no fees for USDT transactions within Telegram, and users can instantly send the asset to their contacts in the messenger without a wallet address.

Telegram will start rewarding content creators and allow the purchase of goods for cryptocurrency, said Pavel Durov, the messenger’s founder. According to him, Telegram has integrated blockchain at a deep level.

Aussie Slips to 2024 Lows on Geopolitics

It was another rough week for the Aussie, pressured by strong US data, more hawkish Fedspeak and escalating Mideast geopolitical risks.

US data continued to impress with March retail sales (ex-autos and gas) rising 1.0%, materially stronger than expectations for a 0.3% gain. That, and more reserved Fedspeak around rate cut prospects, stressing patience, saw US10yr yields touch 4.69% last week, highs since November 2023. While the resilient US growth story and rising US rates kept the Aussie pressured last week, it was mainly rising Mideast risks that roiled it, at least temporarily.

As reports of an Israeli strike on Iran spread during Asia-Pacific trading on Friday US10yr yields fell more than 10bp at one stage, while Brent crude jumped almost US4/bbl and US equity futures were nursing early losses of around 2%.

Against that backdrop the Aussie slipped from around 0.6425 to new lows for the year at 0.6363. But as it became clear that key Iranian nuclear infrastructure facilities were untouched and Iranian officials were downplaying the event global markets quickly regained their composure.

The Aussie recouped losses and has started the new week back USD0.6400. Oil has also given back all of Friday’s squeeze.

But even as rising global market volatility often leaves the Aussie in the crosshairs it has not been the worst performing G10 currency lately. Month to date the Aussie is down 1.4%, but GBP and JPY have fared worse, with declines exceeding 2% against the USD. The ongoing squeeze in global commodity prices are helping shield the Aussie somewhat on crosses. The LME’s base metals index rose 5.3% last week taking its gains so far in April to 14%.

But volatility can still roil Aussie this week. The Nasdaq fell 5.5% last week and US earnings season kicks into high gear with results from the big tech names a key focus.

The local and global economic data calendars will give participants plenty to chew on too.

Locally, the main focal point will be on Q1 CPI. Analysts see Q1 CPI rising 0.8%, compared to 0.6% in Q4, though base effects will see the annual pace easing to 3.4%, from 4.1%. Westpac’s forecast for the trimmed mean is 0.8% for the quarter, taking the annual pace from 4.2%yr to 3.8%yr, the slowest since March 2022.

Markets do not expect the RBA to cut ahead of the Fed, with a full -25bp RBA cut not priced until December, versus Fed pricing for a September/November start to rate cuts. But a softer than consensus Q1 CPI could galvanise the potential for RBA rate cuts before the Fed.

On the international side, advance Q1 GDP on Thursday and the March monthly PCE deflator on Friday likely underscore the narrative around ongoing resilient US growth trends and the stalling in disinflation.

In the Eurozone, flash April PMIs on Tuesday likely show further recovery green shoots, while Friday’s Bank of Japan meeting and fresh economic projections will be closely scrutinised for any hints around further possible monetary policy adjustments later this year and any commentary around excessive yen weakness.

Event risk

Tuesday

Japan, Eurozone, UK, US S&P prelim Apr manufacturing and services PMIs

Wednesday

Australia Q1 CPI

Thursday

US advance Q1 GDP

Friday

Japan BoJ policy meeting

US Mar PCE deflator

Bitcoin Price Bullish after Halving-2024

On April 19, 2024, a halving occurred in the Bitcoin network, resulting in the reward for the mined block amounting to 3.125 BTC.

Historically, after the halving (which is associated with a reduction in supply), the price of Bitcoin heads to all-time highs. But, as Forbes reports, Goldman Sachs analysts warn against extrapolating the results of Bitcoin price movements after past halvings to the current moment. After all, back then, the halvings occurred during a period of loose monetary policy by the Federal Reserve, while this time the Fed is struggling with harsher-than-expected inflation.

JPMorgan analysts led by Nikolaos Panigirtzoglou are also cautious. “We do not expect Bitcoin price increases post halving as it has been already priced in,” they wrote.

However, this morning Bitcoin is trading above USD 66,000, the highest price in a week. Adding to the market’s positivity are rumors that the Securities and Futures Commission (SFC) in Hong Kong is going to approve spot applications for Bitcoin ETFs.

Technical analysis of the BTC/USD chart shows that:

→ Bitcoin price made a double false breakout of the psychological level of USD 60,000 last week – April 17 and 18;

→ after this maneuver, the Bitcoin price confidently recovered into the consolidation zone, shown by a narrowing green triangle;

→ Bitcoin price today may be affected by the USD 66,500 level, which is the central axis of the consolidation zone, as well as the former support level (as shown by the arrows);

What about the longer term? The demand activity seen around the USD 60,000 level can be interpreted as a stable interest in the main cryptocurrency on the part of investors, which may ultimately lead to an attempt by the Bitcoin price to attack the USD 70,000 level near the upper border of the consolidation zone.

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Sterling Finally Snapped. Speech by BoE Ramsden the Straw that Broke the Camel’s Back.

Markets

Sterling finally snapped. A speech by Bank of England Ramsden was the straw that broke the camel’s back. He referred amongst others to the April CPI figure which will likely show the UK converging with the EU. Earlier last week, Bank of England governor Bailey also referred to that number which might even (temporarily) dip to/below the BoE’s 2% inflation target. Bailey’s comments suggested that the BoE would rather team up with the ECB in turning policy less restrictive in the near term than with the Fed which is clearly hinting at higher for longer. Ramsden on Friday added that he has more confidence that inflation persistence is easing with the current restrictive policy stance cutting service inflation. Employment and activity data showed weakness as well last week while the BoE covered the upside (March) CPI surprise with its dovish statements. UK money markets over the past weeks followed the US rather than the EMU example, making them vulnerable to a correction on the BoE’s guidance. UK gilts on Friday outperformed with yields falling 2.1 bps (30-yr) to 10.2 bps (2-yr). Money markets currently discount an inaugural 25 bps rate cut in August, with a second one to be delivered at the end of the year. Loss of interest rate support hurt sterling. EUR/GBP managed a first close outside of the 0.85-0.86 trading range since mid-January. The pair jumped from 0.8558 to 0.8614, taking out 38% retracement on the EUR/GBP-decline from Nov 23 (0.8768) to Feb 24 (0.8493) at 0.8601 in the process. EUR/GBP 0.8665 (62% retracement) is minor next resistance ahead of that 0.8768. Cable (GBP/USD) already fell out of the 2024 sideways trading range on USD-strength (< GBP/USD 1.2519) with the pair closing at a new YTD low of 1.2367. Similar 62% retracement as in EUR/GBP stands at 1.2364, the final support ahead of 1.2037.

Today’s eco calendar won’t move markets with EMU April consumer confidence the sole important release. ECB President Lagarde gives a lecture at Yale university, but she’ll stick to previous comments. On Friday for example she stressed two-sided inflation risk and that the ECB won’t commit to a preset rate path in H2 2024. We saw some underperformance at the front end of the EMU curve on Friday as more governors put (hawkish) risks against a (dovish) rate path for H2. This also gave some temporary support for EUR/USD (1.660). Stock markets remain in correction/sell-on-upticksmode with Nasdaq losing another 2%. On a weekly basis, the tech index fell over 6%.

News & Views

S&P raised the outlook on the Greek BBB- rating from stable to positive, reflecting an expectation that the tight fiscal regime will continue to spur a reduction in the government debt ratio. S&P also expects growth to continue to outperform EMU peers. The New Democracy government after last year’s election outlined and begun implementing a robust reform agenda aimed at unblocking structural bottlenecks. 2023 growth was slightly softer than expected, but at 2% remained relatively healthy. Even so, S&P indicates that fiscal receipts have not softened, increasing by 6.2% last year, due to still high inflation and dividends from fiscal reforms. In the medium term, S&P projects real GDP growth to average 2.4% in 2024-2027, due to a pick-up in investment driven by NextGenEU projects, improved balance sheets of households and the banking system and the fact that the Greek economy is still 22% below its pre-debt crisis peak. Greece could reach the government’s primary budget balance target of 2.1% this year. Public debt which reached a peak level of 207% of GDP in 2020 is expected to fall to about 131% by 2027.

German Finance Minister Lindner on the sidelines of the IMF meeting in Washington said its country is opposed to a new round of joint debt issuance by the EU as members states should maintain responsibility for their own finances. The comments came as other EU members aim for now joint borrowing to finance the energy transition, the shift to the digital economy and a revamp of their militaries to address Russia’s threat. In this respect, Lindner indicated that this opposition is not only a question of getting around objections of the constitutional court on a stricter interpretation of legal limits on government borrowing. Lindner also argued that the results of the EU’s €800bn pandemic recovery fund were mixed and that a repletion of doesn’t seem advisable.

Graphs

GE 10y yield

ECB President Lagarde clearly hinted at a summer (June?) rate cut and seems to have broad backing. EMU disinflation will continue the next two months and bring headline CPI (temporary) at/below the 2% target. Together with weak growth momentum, this gives backing to deliver a first 25 bps rate cut. A more bumpy inflation path in H2 2024 and the Fed’s higher for longer strategy make follow-up move difficult.

US 10y yield

The March dot plot contained several hawkish elements including a symbolically higher neutral rate. In our view they set the stage for a later (September at the earliest) start of a possibly shallower cutting cycle. Upcoming CPI readings (through base effects) and resilient eco data should confirm this. US yields continue to enjoy a solid bottom across the maturity spectrum, setting fresh YTD highs.

EUR/USD

Economic divergence (US > EMU) and a likely desynchronized rate cut cycle with the ECB exceptionally taking the lead pulled EUR/USD towards the YTD low at 1.0695. Stronger-than-expected US March inflation figures forced a technical break, opening the path to last year’s low at 1.0494.

EUR/GBP

Debate at the Bank of England is focused at the timing of rate cuts. Most BoE members align with the ECB rather than with Fed view, suggesting that the disinflation process provides a window of opportunity to make policy less restrictive (in the near term). Sterling’s downside turned more vulnerable with the topside of the sideways EUR/GBP 0.8493 – 0.8768 trading range serving as the first real technical reference.

Relief Before Earnings

The week starts with a relief rally in equities following a calm weekend on the geopolitical scene. The US 2-year yield pushes above 5% ahead of US GDP and PCE updates. Four of Magnificent 7 are due to report earnings this week.

Oil under pressure following calm weekend

US crude kicks off the week under selling pressure, near the $81.50pb level. But the $80pb psychological level, which also coincides with the major 38.2% Fibonacci retracement on December to April rebound, will likely act as a strong support to the actual retreat as the Middle East tensions could resurface anytime.

But, one thing that could send the price of a barrel below that level is a further fall in rate cut expectations from the Federal Reserve (Fed), and eventually the other central banks. Even though the European Central Bank’s (ECB) Villeroy said that the ECB shouldn’t wait much even though the Mid East tensions drive oil prices higher, there is little chance that the ECB will ignore a potential U-turn in euro area inflation dynamics on the back of surging energy prices and US dollar appreciation.

US two-year yield above 5%.

The strong economic data from the US and hawkish comments from the Fed members closed the door on the expectation of a summer rate cut from the Fed. The US 2-year yield has been testing the 5% level since 10th of April and looks ready to go above this week. The US will reveal the first estimate of Q1 GDP on Thursday and the core PCE price index on Friday. The US economy is expected to have grown 2.5% in Q1 and the core PCE is seen flat on a monthly basis and lower on a yearly basis. Atlanta Fed’s GDPNow forecast points at a first quarter growth of nearly 3% and the last three CPI prints in the US surprised to the upside. Risks to the US economic data remain tilted to the upside.

Is it a bad thing? Robust growth is good news for everyone if inflation continues to slow. Otherwise it’s bad news, because it means that the Fed should try harder to fight inflation by keeping its monetary policy at a sufficiently restrictive level to slow down the economy and eventually push it into recession. Therefore, the combination of growth and inflation will give investors the next indication regarding how far the Fed stands from its first rate hike. Activity on Fed funds futures gives more than 50% for a September rate cut. And because September is too close to November elections, that could delay the first cut to the end of the year. Voila.

All eyes on magnificent seven

The S&P500 and Nasdaq have significantly decoupled from the yields and the Fed expectations since last year as the AI rally fueled optimism in technology stocks and sent these indices to record levels. But the first set of earnings from the most popular chip stocks disappointed last week. Both ASML and TSM reported their Q1 results last week, and both companies failed to satisfy investors despite highlighting that the AI should continue to boost their revenue and profits this year.

This week, 4 of the Magnificent 7 companies will be revealing their Q1 results: Microsoft, Google, Meta and Tesla..

And if the tech stocks can’t boost appetite, the rest of the S&P500 will hard it hard to do so. The S&P500 index is expected to print a 4% earnings decline in Q1 – a decent contrast with the +38% expected for the Magnificent 7. And among the Magnificent 7, Tesla and Apple don’t look promising. So all hopes rely on 5 stocks. 5 stocks will determine where the S&P500 should be headed next.

US House Passes Military Aid Bill to Ukraine, Israel and Taiwan

In focus today

In a relatively quiet start to the week economic data-wise, markets will continue to closely monitor developments in the Middle East. Reports still suggest that Israel’s retaliatory attack on Iran on Friday was relatively limited in size and force which alongside Iran’s lack of response over the weekend could indicate a de-escalation of the conflict. This has also set the tone in the market opening this morning with price action generally reflecting relief.

In the euro area, focus is on consumer confidence for April today. Consumer confidence has remained stuck at low levels for the past months despite solid fundamentals for household finances. Private consumption has likely remained weak for this reason so an increase in consumer confidence could be a trigger for stronger consumption and thus growth.

Tuesday and Wednesday we look out for business sentiment surveys PMIs from the euro area and Ifo from Germany. Thursday, we receive first estimate of the Q1 GDP from the US. On Friday the Fed’s preferred inflation measure PCE is released. Also Friday we get the Tokyo CPI excl. fresh foods for April. We expect the Bank of Japan to keep rates at the current level when they announce their rate decision the night before Friday. We expect the Hungarian Central Bank to announce a 50 bp cut to interest rates on Tuesday.

Economic and market news

What happened over night

In China, the loan prime rates were left unchanged as expected by markets. Chinese rates are on hold for now due to the pressure on the currency and the hawkish signals from the Fed.

What happened over the weekend

In the US, the house of representatives passed a 95 billion USD legislative package providing security assistance to Ukraine, Israel and Taiwan on Saturday. The Senate, controlled by the Democrats, is expected to vote on the bill Tuesday. They are expected to pass it, since they passed a similar measure over two months ago, which the house speaker Mike Johnson denied letting come to a vote in the House, which he finally did on Saturday.

Fed’s Golsbee generally considered a dove said progress on inflation has stalled. It merits a pause to allow incoming data to provide more insight into how the economy evolves, he said.

The Oil market quickly calmed down again last Friday. The market was briefly alarmed by the news of Israel’s retaliatory bombings in Iran, sending oil prices above USD90/bbl, but it ended the day around USD88/bbl.

Over the weekend, the US Congress passed new sanctions against the Iranian oil industry. Iran’s oil production has increased by 600-700kbl per day over the year. If that oil disappears from the market, others will have to replace it, for example, Saudi Arabia, the US will have to sell from its strategic reserves, or the oil price will rise. Initially, we anticipate that the market will take a wait-and-see approach regarding the effect of the new sanctions. The US will likely tread carefully, given that a sharp rise in oil prices would probably be unpopular among voters ahead of the presidential election in November.

In Europe, ECB’s Nagel said that the monetary policy needs to remain restrictive even after the first rate cut, and that it is too early to begin to discuss a rate path beyond the June meeting. We see a first rate cut coming in June as close to a done deal.

Equities: Global equities sold off on Friday as investors fled from tech stocks. Global tech lost more than 3% on Friday, while 5 out of 10 sectors managed to book gains, including financials. It is rare to see such a sharp sector rotation where financials, defensive, and small caps are outperforming simultaneously. The S&P 500 dropped 0.9% on Friday, while banks and insurance were the two best-performing industries despite yields ending marginally lower. The S&P 500 equal-weight outperformed MAG 7 by more than 1%, and defensives outperformed cyclicals by 2%. This just illustrates it was not a geopolitical or macro related, but a micro story where investors are questioning tech and AI-related earnings outlook after being disappointed by ASML and Taiwan Semiconductor. In the US on Friday, the Dow was up 0.6%, the S&P 500 was down 0.9%, the Nasdaq was down 2.1%, and the Russell 2000 was up 0.2%.

FI: There are not that many tier-1 economic data or events this week and the focus will still be on the Middle East. 10Y US Treasury yields have stabilised around the 4.6% together with 2Y UST trading around 5%. The key question is whether the market will continue to reprice the Federal Reserve. Previously, there has been good value in buying 2Y Treasuries around 5% given that we do not expect the Federal Reserve to hike rates. We still believe that the 5% level in 2Y and 4.75% in 10Y offer decent value for investors. The Bund ASW-spread has been testing the 35bp-level given the geopolitical uncertainty but has stabilised around 34-35bp level for now. We still expect it to move back to 30bp when the geopolitical uncertainty dampens.

FX: Friday’s session was initially characterized by a strong USD and weaker Scandies, however this reversed towards the close and both SEK and NOK ended the day as outperformers within G10, defying the global equity sell-off. At the other end of the spectra, we found GBP following dovish remarks from previous BoE’s Ramsden. USD/JPY looks set to start the week trading above 154.

Sunset Market Commentary

Markets

The impact of this morning’s “limited” Israeli retaliatory attacks against Iran gradually waned throughout today’s trading session. Initial flows all changed course. Some examples: US yields are currently up to 3 bps lower compared to over 10 bps during (illiquid) Asian trading hours. Brent crude surged from $87/b to almost $91/b before returning to the starting position. EUR/CHF yo-yoed from 0.97 to 0.9565 and back. Today’s empty eco calendar in the EMU and the US obviously couldn’t entice. Luckily, some ECB governors hit the wires to entertain us. The way they close ranks on a 25 bps rate cut in June contrasts with the diverging views for H2 2024. ECB Kazaks says that it’s too soon to declare inflation victory. He acknowledges that the ECB does take the Fed into account, even though the central bank has its own mandate. ECB Vasle earlier this week suggested that ECB and Fed policy can diverge (short term) but that they can’t continue running async. ECB Holzmann put it into numbers yesterday. If the Fed ends up keeping policy rates stable this year, the ECB can’t go along cutting rates 3 or 4 times. ECB Vucjic joined the choir, saying that the ECB can move first but that Fed divergence would be felt. He also warned for the bumpy inflation path ahead. Base effects will cause the disinflation process to a virtual stand-still while higher energy (or commodity prices in general) have the potential to move the monthly inflation pace. On the other sides of the aisle are the likes of Maltese ECB governor Scicluna who grabbed dovish headlines by suggesting to cut at a 50 bps (!) pace should inflation move back below 2%. Good luck with that. ECB President Lagarde reiterated on the sidelines of the IMF-gathering in Washington that Frankfurt won’t pre-commit to a specific rate path. Risks to the inflation outlook are two-sided, she added. In its March projections, the ECB put forward 2.3% average inflation for this year, 2% in 2025 and 1.9% in 2026. Upside risks around this trajectory include geopolitics (and their impact on oil prices; ECB took into account average price for Brent crude <$80/b), wages (sticky 4.46% Y/Y in Q4 with Q1 2023-figure to be released mid-May) and more resilient profit margins at companies as consumption holds up given high employment levels. Downside risks include a smoother transmission mechanism and an unexpected deterioration in the economy. European rate markets gradually come to terms with the fact that follow-up rate cuts after June are not a given. You see a repricing away from 3 or 4 cuts this year to 2 or 3 tops. The front end of the curve underperforms with German yields adding up to 4 bps (2-yr) and setting a new YTD high at that tenor. The 10-yr yield rises by 1.3 bps to test resistance at 2.52%. The euro gets some reprieve from today’s rate dynamics, with the pair rebounding from 1.0610 to 1.0670.

News & Views

Belgium’s budget deficit widened significantly in 2023, the National Bank of Belgium reported in a press release today. The increase from 3.6% in 2022 to 4.4% last year pushed up the debt ratio to 105.2% of GDP (+0.9%pt vs 2022) and came despite the phasing out of temporary factors linked to the pandemic and the energy and Ukraine crises. The NBB tied the deepening deficit to a marked rise in public spending (a.o. after lifting the minimum benefit levels) as well as the structural increase in costs associated with population ageing, rising interest rates and the automatic indexation of social benefits and public sector salaries. Primary expenditure (ex. interest payments) picked up again as a result to 52.6% of GDP after two years of declines. The interest burden rose from 1.6% to 2% of GDP. The rise in the budget deficit reflected a widening of the deficit at both the federal level, by €6.8 billion to €20.6 billion, and the level of the communities and regions, by €2.0 billion to €7.1 billion. Breaking down the latter, the Flemish Community printed a €2.8 billion deficit, the Walloon region €2.2 billion and the Brussels-Capital region €1.5 billion. Each saw their debt-to-revenue ratio rise to 52%, 204% and 205% respectively.

Slovakia tapped bond markets outside the euro area for the first time in a decade. It sold a total of CHF635 million in 4-year and 10-year notes yesterday. Speaking to Bloomberg afterwards, the country’s debt chief Bytcanek said there are plans for further issuance in Swiss francs and possibly the dollar (next year) for the sake of diversification. Growing financing needs combined with rising yields on its euro-denominated bonds and the ECB offloading its bloated bond portfolio have at least as much pushed the country to explore ex-EMU markets. Slovakia is on track to record the highest budget shortfall in the EU with government estimates amounting to 6% of GDP. In absolute terms, debt repayments and projected deficits for the current and forthcoming years are estimated at some €10bn annually.

Sunset Market Commentary

Markets

German Bund yields in fixed income markets gapped lower at the open this morning, catching up with US Treasuries late yesterday and in Asian dealings this morning. The drop was followed by a drift higher only to reverse course again after some comments from Villeroy. The French ECB governor said he’s open to rate cuts at each meeting after June, which would mean a total of five this year. Unrealistic, clearly, but after the recent Bund sell-off it didn’t go unnoticed. The Dutch policymaker Knot was more neutral, keeping the door open for June but calling discussions about what happens afterwards premature. We also want to give him credit for pimping Lagarde’s now widely used “we are not Fed-dependent” one-liner to “we aren’t the 13th Fed district”. Anyway, German yields do add a few basis points but that was probably inspired by reports of Israel and the US holding talks on a Rafah offensive. Oil prices extended earlier gains amid risks of geopolitical tensions flaring up again and that supported yields too. German rates add up to 3 bps at the front. US Treasuries marginally underperform, triggered by lower-than-expected weekly jobless claims (212k vs 215k) and an unexpected sharp improvement in the Philly Fed business outlook from 3.2 to 15.5 (2 expected) – the highest since April 2022. Prices paid, new orders and shipments all jumped with this 6-month ahead gauge suggesting solid growth going forward. On the flipside, the employment index edged down to -10.7 and the workweek index fell sharply from -0.2 to -18.7. US rates nevertheless extended earlier gains to trade between 2 and 4.2 bps higher across the curve. The US dollar found a bottom at the start of European dealings and clawed back some more losses after the data releases. DXY tries to recapture 106. EUR/USD is slightly down for the day, trading at around 1.065. USD/JPY bounced of the 154 big figure. Sterling found its composure after sliding against the euro yesterday. EUR/GBP eased to 0.8556 in, yet again, technically insignificant trading. European stock markets rise marginally to the tune of 0.2%. Equity markets on Wall Street open mixed with the likes of the S&P and Nasdaq coming close to first support levels around 4990 and 15596.

News & Views

The German Bundesbank turned a bit less negative the economy in its April monthly report. Contrary to what was expected last month, the Buba now thinks real GDP increased slightly in Q1. This expectations is based on recent slight increase in industrial production, which was supported by a rise in goods exports. Exceptionally mild weather in February also led to an extraordinarily strong increase in construction output. Even so, the Buba stays cautious on the recovery going forward. Higher financing costs and increased economic uncertainty are dampening investment activity. Demand for German industrial products from Germany and abroad remains weak. Private households continue to be hesitant in their spending, despite a fairly stable labor market, sharply rising wages & falling inflation rates. The Buba concludes that an increase in output in Q2 remains uncertain, but at the same time acknowledges recent improvement in business sentiment (Ifo), opening the possibility of the economy picking up more significantly than was expected until last month.

MPC member Jan Prochazka of the Czech National Bank (CNB) in an interview indicated that the bank should maintain the current pace of 50 bps rate cuts at the next policy meeting on May 2. Prochazka sees little room for the CNB to accelerate the process going forward. Prochazka draws comfort from headline inflation having returned to the 2% target, but remains concerned about the structure of price developments. The decline in headline inflation was mainly driven by food and energy costs, but there is basically no disinflation happening in services. In this respect an improvement in economic activity/domestic demand also is a reason for caution. Aside from persistent inflationary risks, hawkish signals from the US Fed are also seen as preventing the CNB from accelerating rate cuts. He labelled the delay in rate cuts abroad as the ‘biggest source of change’ in the CNB forecast. In this respect Prochazka indicated that he doesn’t see the need to push back against current market pricing which discounts the policy rate to be reduced to 4.0% in a 12-month horizon from 5.75% currently.

The Weekly Bottom Line: Dialing Back Expectations

U.S. Highlights

  • U.S. headline retail sales beat expectations in March, advancing for a second consecutive month. The strong showing bolstered the case for a delayed start to the Fed’s interest rate cutting cycle.
  • Comments from senior Federal Reserve officials has the timing of possible interest rate cuts in question amid signs of persistent strength in the U.S. economy and higher-than-anticipated inflation.
  • In contrast, the housing market continues to feel the weight of higher interest rates as housing starts and home sales dipped in March.

Canadian Highlights

  • The federal government took the stage this week as it presented a beefed-up budget, with a focus on addressing housing affordability.
  • Canadian CPI inflation also made headlines with an encouraging print, which saw core inflation rates move further towards the Bank of Canada’s (BoC) target.
  • Market expectations for the first BoC interest rate cut continued to solidify around June or July, increasing the probability that it will move ahead of the Fed.

U.S. – Dialing Back Expectations

This week featured releases on retail sales and the housing market in March. Also high on the market’s radar were comments made by the Federal Reserve Chair, which suggested the central bank may be changing its tune on the path and timing of interest rate cuts. Overall, markets responded strongly to the new information with stocks heading lower and treasury yields rising (10 year yields were up 9 basis points at time of writing) as investors recalibrated their expectations for rate cuts this year.

A stronger-than-expected gain in retail sales in March reinforced that the U.S. economy is still strong, and is expected to lead growth among developed countries this year, according to recent IMF projections. Headline retail sales rose for a second consecutive month in March, after a string of monthly declines, with sales in the key control group acting as a driver (Chart 1). Given the soft start to the year, March’s increase just managed to lift the quarter into positive territory (up 0.2% q/q annualized). The notable uptick also represents an upside risk to our own forecast for 2024 Q1 consumer spending, and doesn’t help the Fed in its goal of taming price growth.

On Tuesday, the Federal Reserve Chairman and the Vice Chair at two separate events both signaled that the central bank may be changing its tune. While policymakers started the year anticipating that they would commence the rate cutting cycle soon, hotter-than-expected inflation has shifted that calculus. In a prepared remark, Vice Chair Jefferson noted that interest rates could remain at their current restrictive level for longer if inflation persisted. Later, Fed Chair Powell echoed that sentiment. He noted that excluding a sudden economic slowdown, interest rates would need to stay restrictive for longer. The Fed Chair’s new tone is essentially one of dialing back expectations as markets had aggressively priced in numerous cuts this year. Investors on average are now expecting one and two cuts.

Higher rates are having a measurable effect on the housing market as data on existing home sales and housing starts and permits all declined in March. Both housing starts and building permits retrenched in March. In another release, existing home sales fell 4.3% m/m in March – the largest decline in over a year. While the measure managed to post a gain for the first quarter as a whole, relative to the subdued levels in 2023 Q4, the prospect of higher for longer interest rates are likely to see these gains pared back in the future. In fact, this week, the average rate on a 30-year fixed rate mortgage climbed above 7% for the first time this year and is likely to weigh on housing activity going forward (Chart 2).

Given recent readings on inflation and retail spending, and FOMC members comments acknowledging that rates will likely need to remain restrictive for longer, next week’s consumer spending and income data for March are highly anticipated. In particular, the Fed’s preferred inflation metric – the core PCE deflator – will be very closely watched to see how much of the recent hot CPI inflation carries over to PCE.

Canada – Another Big Budget for the Liberals

The federal government took the stage this week as it presented a beefed-up budget full of new spending promises. The government was applauded for making strides to address the country’s housing shortage but is also taking heat for hiking taxes via a new capital gains inclusion rate. Canadian CPI inflation made headlines too, with an encouraging print that reinforced bets the Bank of Canada (BoC) would initiate its first cut in June or July.

The Liberal government spent the better part of the last few weeks touring the country marketing its housing plan, which was fully unveiled in Budget 2024. This is one of the biggest pieces of housing policy Canada has ever seen, which aims to build nearly 4 million new homes by 2031. Encouragingly, there are also a host of policies to ramp-up rental supply, which has been stretched thin due to the government’s failure to control the rapid growth of Canada’s population. While the government is moving in the right direction, achieving its ambitious goals will be a challenge. Canada is currently on track to build just under 2 million homes over the next eight years, so doubling that will be a tall order for a construction sector that is already bumping up against capacity constraints.

The budget wasn’t just about building new homes. The government announced $53 billion in new spending, with just 16% of that dedicated to housing. Indeed, there were over two hundred new policy items in the budget. There was spending on defence, pharmacare, a disability benefit, money for AI investment, an EV supply chain investment credit, and money aimed towards indigenous reconciliation. This continues a trend where the Liberal government attempts to fill as many gaps as it can through increased spending. Recall that the BoC has previously called out the government’s spending ways for contributing to Canadian inflation.

Speaking of inflation, it is not often that a Canadian CPI inflation report takes a backseat, but that’s what happened this week. Importantly, the average of the BoC’s core inflation measures came in at 3.0% year-on-year (down a tenth). On a three-month basis these are averaging just above one percent – a signal that the annual numbers will continue to decelerate in the coming months. This goes to the argument that we have been making for quite some time. That the slowdown in the Canadian economy has set the foundation for lower inflation. We are seeing this play out.

Has the BoC seen enough to cut rates? While we think the inflation evidence is clear, the central bank is taking a patient approach. While economic growth has been weak, the bottom hasn’t fallen out of the economy. This has afforded the Bank extra time to wait-out inflation, ensuring that the recent move is more durable. Notably, markets believe the moment is quickly approaching, with bets narrowing in on the June/July announcement dates. Interestingly, this also means that the BoC is expected to make its move well ahead of the Fed. The loonie has consequently reached it’s lowest level since late 2023 against the greenback.