Weekly Overview: Central Banks Hold the Reins

This past week, we’ve seen significant movements in U.S. interest rates, marking a noticeable shift in thhe financial landscape. Before the release of the U.S. employment report on March 8, the two-year yield was hovering around 4.40%. However, by the end of the week, it surged to nearly 4.73%. This 0.33 percentage point jump is the largest weekly increase we’ve seen since last May. For the first time in four months, the expectations reflected in FED funds futures do not include at least three rate cuts for the future. This adjustment in interest rates has given the USD a boost, allowing it to outperform all G10 currencies last week.

Similar to the two-year yield, the 10-year yield also experienced a significant rise, increasing every day last week. With 0.23 percentage point increase, it marked the most substantial rise since October.

As a result, the DXY rose by 0.70%. This gaşn is notable as it ends a three-week trend of decline and represents the largest rise in eight weeks. The increasing rates have notably strengthened the greenback, particularly against JPY, which saw a 1.4% increase despite speculation that the Bank of Japan might end its negative interest policy soon.

Looking ahead, the focus shifts to upcoming central bank meetings. While most central banks are expected to maintain their current policies, aşş eyes will be on the FED’s Summary of Economic Projections. Although significant changes are not anticipated, there is a possibility that FED might adjust its outlook on future rate cuts, potentially signalling fewer cuts that previously expected. We’re also watching the Bank of Japan closely, which might hold off on rate adjustments until April.

The Bank of England, the Reserve Bank of Australia, and Norway’s central bank are likely to keep their policies unchanged. However, the Swiss National Bank might surprise markets with a rate cut due to low inflation and slowing growth, aiming to act before the ECB does.

Switzerland Inflation Rate

This weeks’s financial narrative underscores the delicate balance central banks must maintain in navigating economic conditions and monetary policy. As the developments unfold, they will undoubtedly influence global markets, impacting investors and economies worldwide.

United States

As we unpack the recent shifts and expectations around U.S. monetary policy, it’s clear that the landscape is evolving. The end of last year saw the market fully expecting a 25 basis point reduction in the Federal Reserve’s key interest rate at this week’s FOMC meeting. However, sentiment has shifted dramatically following the January jobs report and the Consumer Price Index (CPI) data released in February. Now, the market deems the chances of an imminent rate cut as negligible, aligning with Federal Reserve Chair Jerome Powell’s remarks to Congress that, while confidence is growing, immediate rate cuts are unlikely.

This adjustment in expectations is significant. Just a few months ago, the possibility of a June rate cut was high, but now it stands at around 59%, the lowest since last October. This suggests that Powell is unlikely to deviate from his recent congressional testimony in his upcoming press communication. Furthermore, President Biden’s comments hinting at upcoming rate cuts likely didn’t reveal any new information but echoed Powell’s sentiments.

Target Rate Probabilities Last Week

A common misunderstanding is the Federal Reserve’s willingness to cut rates before inflation falls back to the 2% target. This strategy has been part of the Fed’s projections for some time, suggesting a proactive approach to monetary policy, acknowledging the lagging effect of policy changes.

The upcoming update to the Summary of Economic Projections is anticipated to show minor adjustments from December’s forecasts, reflecting ongoing data and economic views. Last December, the Fed’s median projection hinted at modest growth and inflation expectations, which closely align with recent economist surveys.

Market dynamics and Fed policy seem to be in a delicate dance, with the market frequently adjusting its expectations to align more closely with the Fed’s projections rather than the Fed being led by market sentiment. The December FOMC meeting already signaled a potential shift towards fewer rate cuts than the market had priced in, a stance that appears to be solidifying with recent economic data.

There’s also growing interest in the Fed’s approach to its balance sheet under “quantitative tightening,” focusing not on asset sales but on allowing bonds to mature without reinvestment. The key questions revolve around the balance sheet’s size without compromising reserve levels and the impact of balance sheet reduction alongside potential rate cuts.

Operational discussions, such as the potential adjustment of the Fed’s bond portfolio’s duration and the composition favoring Treasuries over mortgage-backed securities, reflect a broader strategy for enhancing flexibility.

Looking at the Dollar Index, indicators suggest a positive outlook, with momentum indicators turning higher and key technical levels providing potential for further gains.

In summary, the evolving monetary policy landscape and market expectations highlight the Fed’s careful navigation through economic indicators and forecasts. While immediate rate cuts appear off the table, the broader strategy indicates a cautious yet responsive approach to economic growth, inflation, and financial stability.

Eurozone

Germany’s announcement of a record €27.5 billion trade surplus for January hints at a robust economic performance, potentially signaling a stronger overall trade balance for the Eurozone when the aggregate data is released on March 18. This development, reflecting the highest quarterly average trade surplus since the first quarter of 2021, suggests a positive momentum in trade activities across the Eurozone.

The upcoming flash March PMI, set for March 21, is anticipated with interest for its insights into the economic health of the region. However, its market impact might be overshadowed by the scheduled central bank meetings, particularly the Swiss National Bank (SNB) meeting on the same day. The SNB faces a significant decision, with the market currently estimating only a 30% chance of a rate cut. Given the slowdown in economic activity and a decrease in inflation—falling to 1.2% in February from 1.5% in January and down from 3.2% a year earlier—the SNB might indeed opt for a rate cut. Such a move could provide a strategic advantage, potentially offering the Swiss franc a buffer against future rate cuts by the Federal Reserve and the European Central Bank (ECB).

The Swiss franc’s performance, having retreated from eight-year highs against the euro seen at the end of last year to levels last observed in November, could be further influenced by the SNB’s actions. A preemptive rate cut by the SNB, ahead of the Fed and ECB, might apply additional pressure on the franc, impacting its valuation.

Meanwhile, the euro’s recent movements against the dollar provide a glimpse into currency market dynamics. After reaching a two-month high near $1.0980 on March 8, the euro dipped to just below $1.0875, testing the uptrend support line established from this year’s lows. This fluctuation brings the currency pair to a critical juncture, near the 61.8% retracement of its recent rally, and hints at potential resistance levels that could influence its short-term trajectory.

These developments across trade balances, central bank decisions, and currency markets underscore the interconnected nature of the global economy. They highlight the importance of trade dynamics, monetary policy decisions, and their implications for currency valuations, offering valuable insights for investors and market observers alike.

United Kingdom

The UK’s inflation report for February, set to be released on March 20, is drawing significant attention, especially with the Bank of England’s (BoE) meeting following closely on March 21. Expectations suggest a significant reduction in the year-over-year inflation rate, potentially halving from the 4.0% recorded in January in the upcoming months. Despite the anticipation surrounding the CPI data and the preliminary March PMI data due just hours before the BoE meeting, the central bank is expected to maintain its current stance, with no changes anticipated.

Market speculation about the sequence of rate cuts among major central banks is heating up. The European Central Bank (ECB) is expected to initiate rate cuts before the BoE. However, recent discussions have shifted focus to whether the BoE might act before the Federal Reserve (Fed). Currently, the swaps market suggests a 50% likelihood of a BoE rate cut in June, with a cut fully anticipated by the August meeting. BoE Governor Andrew Bailey recently downplayed the economic contraction in the latter half of 2023, emphasizing the onset of recovery and potentially influencing the bank’s forward guidance.

Interestingly, the BoE is reevaluating its approach to its balance sheet, particularly the assets acquired under quantitative easing (QE). Deputy Governor Dave Ramsden indicated the possibility of unwinding these assets, signaling a shift in monetary policy strategy. This comes amid controversy over the BoE staff receiving an average 4% pay increase, in contrast to Bailey’s previous advice against large wage demands, highlighting the complexities of managing inflationary expectations and monetary policy credibility.

Sterling’s performance in the currency markets reflects the ongoing economic and monetary policy uncertainties. After experiencing its best week of the year with a 1.6% rally through March 8, sterling faced its worst week, dropping nearly 0.95%. The currency retreated from an eight-month high, touching down around $1.2725, testing key technical levels including the 20-day moving average and a significant retracement level of its recent rally. With daily momentum indicators signaling a downturn, a further dip below $1.27 could lead to additional pressure on the pound, possibly testing lower support levels.

These developments are critical for investors and market watchers, illustrating the delicate balance central banks must maintain between supporting economic recovery and managing inflation. The BoE’s upcoming decisions, particularly against the backdrop of global monetary policy shifts, will be pivotal in shaping market expectations and the trajectory of sterling in the near term.

China

In a strategic move signaling a nuanced approach to economic management, Beijing recently opted to utilize the one-year Medium Term Lending Facility, aiming to withdraw liquidity from the banking system for the first time in approximately 18 months. This action, involving a relatively modest sum of CNY 94 billion (about $13 billion), sends a clear message to Chinese banks regarding the government’s expectations for their participation in stimulating the economy. Despite the liquidity drain, it’s crucial to understand that this does not indicate a halt in stimulative measures aimed at achieving China’s 5% growth target. Instead, the gesture underscores a directive for banks to more actively support government initiatives, particularly in light of their propensity to invest in government bonds, which has pushed yields to two-decade lows.

This development comes against the backdrop of slowing loan growth, which dipped below 10% year-over-year for the first time in two decades, with households notably reducing their medium- and long-term debt, primarily mortgages. The timing is noteworthy, aligning with the upcoming release of critical economic indicators such as February’s retail sales, industrial production, fixed asset investment, and surveyed unemployment rates. It’s important to highlight that retail sales in China—a significant component of consumer spending—have been outpacing both investment and industrial output growth.

Simultaneously, currency dynamics, particularly involving the dollar and the Japanese yen, suggest a broader narrative of exchange rate management and its implications for trade and economic policy. The dollar’s recent surge against the yen underscores ongoing adjustments in currency markets, with implications for the Chinese yuan as well. Speculation around the yuan’s exchange rate management, especially in relation to the defense of certain levels against the dollar, points to a complex interplay of domestic policy objectives and international market forces.

Moreover, the interconnectedness of the yuan and yen, due in part to their inclusion in the same currency basket and their shared characteristics like low yields, highlights a broader context of how currencies can serve as funding sources and their sensitivity to external factors like U.S. interest rates. The correlation between changes in the offshore yuan and U.S. yields underscores the global interconnectedness of financial markets and the nuanced strategies employed by policymakers in navigating these dynamics.

This landscape illustrates the delicate balance between domestic economic objectives and the intricate web of international financial relations, with China’s recent policy moves shedding light on its strategic priorities and the broader implications for global markets.

Japan

The Bank of Japan (BOJ) is at a pivotal moment, with its upcoming meeting on March 19 closely watched by markets amid increasing speculation about a potential policy shift. This speculation is fueled by several factors, including comments from BOJ officials hinting at possible changes, stronger-than-expected wage growth, significant wage demands, and persistent inflationary pressures. While many anticipate an adjustment could be imminent, we’ve been leaning towards April for such a move, considering both the timing of Japan’s fiscal year and the end of government subsidies for household energy, which is expected to nudge inflation upwards by 0.4%-0.5%.

Adding to the intrigue, a report in the Japanese press suggested the possibility of the BOJ ending its yield-curve control policy, which currently caps the 10-year yield at 1.00%. Instead, the focus might shift back to a fixed quantity of bond purchases, moving away from directly targeting yields. However, recent data revisions indicating that Japan’s economy grew in Q4 2023, contrary to initial estimates of a contraction, may not be a decisive factor in the BOJ’s decision-making process. The early part of the year has seen the Japanese economy grappling with challenges, including the aftermath of a January 1 earthquake, which contributed to sharper than expected declines in industrial production, housing starts, and household consumption.

Currency market dynamics are also in play, with the dollar reaching six-day highs near JPY149.15 ahead of the weekend, hitting the 61.8% retracement of its losses since late February. This upward momentum in the dollar, supported by rising U.S. yields, has shifted the market’s focus back to the exchange rate’s sensitivity to interest rate differentials between the U.S. and Japan.

The correlation between the dollar-yen exchange rate and U.S. 10-year yields remains strong, underscoring the impact of U.S. monetary policy on currency valuations. However, the correlation with Japan’s two-year yield is notably weaker, suggesting that domestic yield movements have a more limited effect on the exchange rate.

Looking ahead, if the BOJ does decide to hike its target rate to zero, it could trigger further recovery in the dollar, as markets adjust to the new policy stance. Conversely, a decision to maintain the status quo might initially boost the dollar on disappointment, but would likely fuel expectations for a policy shift in April.

As these developments unfold, they underscore the intricate relationship between monetary policy decisions, economic indicators, and currency markets. The BOJ’s upcoming meeting is not just a local event but a significant moment with potential global market implications, closely intertwined with the Federal Reserve’s own policy trajectory and the broader dynamics of international finance.

Canada

In the whirlwind of global central bank meetings, Canada’s upcoming economic data releases, though crucial, may not capture the market’s full attention. However, a deeper dive into Canada’s economic indicators, particularly the Consumer Price Index (CPI) and retail sales, reveals noteworthy trends and potential implications for monetary policy.

Canada’s CPI trajectory over the past five months through January highlights an interesting trend; the headline CPI has essentially flattened, with an annualized change hovering around -0.05%. While this might suggest a dramatic pause in inflationary pressures, it’s crucial to interpret these figures with caution. The slight downtick in headline inflation to 2.9% in January may see a minor reversal, yet the more critical core inflation metrics—which the Bank of Canada closely monitors—seem to have plateaued after previously trending downward.

Looking ahead, January’s retail sales data, expected on March 22, will be particularly telling. Following a robust 0.9% increase in December (0.6% excluding autos), preliminary figures from the Bank of Canada indicate a potential contraction of 0.4% in retail sales. This anticipated slowdown mirrors broader global economic sentiments and could influence the central bank’s policy decisions in the near term.

The swaps market’s current pricing suggests a growing anticipation of a rate cut by the Bank of Canada as soon as July. This reflects a broader recalibration of expectations as markets digest a complex mix of inflationary dynamics, economic performance, and central bank signaling.

Amidst these domestic considerations, the Canadian dollar’s performance against its U.S. counterpart provides a lens through which to gauge market sentiment. Despite the U.S. dollar strengthening against all G10 currencies over the past week, the Canadian dollar has shown relative resilience, registering only a modest 0.40% decline. This performance is part of a broader trend that has seen the U.S. dollar fluctuate within a defined range against the Canadian dollar since the start of the year.

The current trading dynamics suggest a period of continued range-bound activity for the USD/CAD pair, likely oscillating between CAD1.3400 and CAD1.3600. This scenario underscores the broader interplay between economic data releases, monetary policy expectations, and currency market reactions, highlighting the nuanced balance central banks are navigating in adjusting policy to align with evolving economic landscapes.

As the Bank of Canada and other central banks around the world grapple with these challenges, the coming weeks will be critical in shaping the monetary policy outlook and its implications for currency markets and economic growth trajectories.

Australia

As the Reserve Bank of Australia (RBA) prepares for its policy meeting on March 19, the consensus leans towards a decision to maintain the current interest rate, reflecting the economic slowdown and moderated inflation within the country. Despite these conditions, the RBA has hinted at a lack of immediate pressure to cut rates, suggesting a cautious approach to policy adjustments. The futures market’s anticipation of a 35% chance for a rate cut appears overly optimistic, considering the economic indicators and the central bank’s tone. A more realistic expectation might be a rate reduction later in the year, possibly by September, as current projections indicate.

Under the leadership of Governor Michele Bullock, who is often viewed as more dovish and assumed her role in September last year, the RBA has continued to navigate through an economic environment marked by deceleration. Even after implementing a quarter-point rate hike in November—a decision made amidst signs of economic cooling and a per capita contraction—the RBA has been deliberate in its signaling, possibly to avoid premature adjustments that could destabilize the recovery process.

The upcoming February employment report, due on March 21, will be crucial in providing further context to the RBA’s policy stance. Recent trends have shown a notable slowdown in job creation, with the smallest increase since October 2021 observed in the three months through January. Additionally, the loss of approximately 102,000 full-time positions in the second half of 2023 and an uptick in the unemployment rate from 3.5% in February 2023 to 4.1% in January 2024 highlight the challenges facing the Australian labor market.

Currency markets, particularly the Australian dollar, have responded to these economic signals with volatility. After reaching a peak near $0.6670 on March 8, the Australian dollar retreated to around $0.6550 before the weekend, aligning with key retracement levels from recent rallies. Looking ahead, the RBA’s upcoming meeting and statements could influence the Australian dollar’s trajectory. Should the central bank reiterate its cautious but firm stance on tightening, it might provide temporary support to the currency. However, resistance is anticipated in the $0.6600-25 range, especially with the Federal Reserve’s meeting on the horizon, which could introduce further volatility depending on the global monetary policy landscape.

In summary, the RBA’s policy meeting is a critical juncture for assessing Australia’s economic direction and the potential for future rate adjustments. With key employment data pending and global central bank decisions in focus, investors and market observers will be keenly watching for signals that could impact economic forecasts and currency valuations in the short to medium term.

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