The strength of the expected demand recovery in China received a setback after its leaders announced a conservative growth target of 5% for 2023 – one of its lowest targets in decades. This, combined with only a modest increase in fiscal support, lowered expectations for additional stimulus to accelerate the economic recovery. In Saxo’s opinion, part of the reason for this is the Chinese government’s desire to avoid making the same mistakes other governments and central banks have made, which have driven inflation to a four-decade high. Development consumers are now suffering the consequences as central banks increasingly apply their interest rate weapon to bring inflation under control.
Meanwhile, Federal Reserve Chair Powell stepped up his attack on sticky inflation. During his semi-annual two-day visit to Capitol Hill, he told lawmakers that he was prepared to increase the pace of rate hikes to a higher-than-expected level should incoming data continue to show strength. The swap market responded by lifting the terminal rate expectation above 5.66% from 4.75% at the beginning of February, before Thursday’s stock market rout across banking stocks helped bring the peak rate back down below 5.5%.
During the Q&A session on Tuesday that followed his prepared statement, a tasty exchange between Powell and Sen. Elizabeth Warren (D) highlighted the risk the FOMC takes as it continues to hike rates until something potentially brakes. The senator asked Powell what he will say to the two million people losing their jobs if he keeps raising rates. He answered: “Will working people be better off if we just walk away from our jobs and inflation remains 5%-6%?”.
His comment further supported the view that the FOMC will remain very data driven and, besides the small risk of a systemic event taking control, it will keep hiking rates despite the obvious risk to the economic outlook. Saxo will continue to watch the dollar closely, given its inverted correlation with commodities (especially gold) and increasingly how the market price the risk of a recession and with that the scale of the eventual drop-in rates. Saxo monitors this through the terminal Fed fund expectation and the size and speed of subsequent cuts once the terminal rate is reached, currently priced to occur around September this year.