Macro Insights: The Fed question lingers - to hike or not to hike Macro Insights: The Fed question lingers - to hike or not to hike Macro Insights: The Fed question lingers - to hike or not to hike

Macro Insights: The Fed question lingers - to hike or not to hike

Macro
Charu Chanana

Head of FX Strategy

Summary:  US CPI release was broadly in-line with expectations although the core came in hotter-than expected MoM, bringing a 25bps rate hike from the Fed back on the table for next week if further market disorders are avoided. However, growth concerns have risen with banks likely to tighten lending standards which could have a larger and quicker impact on the real economy compared to a rate hike. Near-term volatility could persist but heightening margin pressures especially in smaller enterprises could mean further flight to quality.


Inflation stays hot, lifting March rate hike possibility

US CPI continued to be hot, coming in bang in-line with expectations except for the core MoM print. Headline CPI rose 0.4% MoM in February but core (ex food and energy) was up 0.5% from 0.4% in January. The annual rate of headline inflation slowed to 6.0% from 6.4% while the core inflation moderated to 5.5% YoY from 5.6% previously.

The disinflation narrative in goods inflation got only a modest support, with core goods prices remaining flat vs. +0.1% MoM previously. Services inflation continued to be sticky with core services measure accelerating by 0.6% MoM vs. 0.5% earlier, and shelter costs rising another 0.8% MoM. Powell's preferred "Supercore" metric (which excludes shelter and rent) rose to 0.5% from 0.36%, the highest since September.

As inflation continues to prove harder to turn lower, it may be too soon for the Fed to take the foot off the pedal despite the brewing financial risks and concerns of a growth slowdown. Markets have now put 25bps rate hike back on the table at over 80% probability after dipping below 50% earlier this week. However, that will remain contingent on no further market disorders in the run upto the March 22 announcement.

Source: CME FedWatch

Using the right tools for the right cause

There is no doubt that the risks of a financial crisis have further complicated the monetary policy response function in the US. But looking at the response of the authorities to the financial risks, there is reason to believe that they have maintained the room to continue their fight against inflation. A pause or a cut at the March meeting, despite market remaining orderly from here, would spell panic for investors who would sense this as the Fed potentially still being cautious of systemic risks. Inflation print isn’t spelling relief yet, and the Fed will need to maintain its inflation-fighting credibility.

It will therefore be important for the Fed to decouple monetary policy from financial risks, while standing ready to respond to any market disorders to avoid creating further panic. The Bank of England, in a similar move in September, had to respond to market disorders by adding short-term liquidity but the monetary policy stayed focus on the price pressures and we have seen 175bps of rate hikes since then.

Credit risks on watch

The credit market remains key to monitor to asses any further stress in the system. Our Head of Equity Strategy, Peter Garnry, has noted the key indicators to watch in this piece. The FRA/OIS spread, or the spread between the U.S 3-month forward rate agreement and the 3-month overnight index swap rate, is a key funding stress indicator. The measure expanded to its widest since March 2020, although has cooled somewhat now. But there are still a lot of uncertainties ahead and this indicator remains key to monitor. If it rises again or remains elevated, it would suggest that the system remains fragile and vulnerable to further shocks.

US FRA-OIS Spread. Source: Bloomberg, Saxo

The mass credit rating downgrades in the US banking sector yesterday are a further cause of concern. Moody’s has cut the outlook for the US banking system to negative from stable and placed six US lenders on review for downgrade. The S&P also placed First Republic on Negative Creditwatch.

The other key indicator to track will be the financial conditions in the US, which have tightened the most for this cycle mostly due to the widening in credit spreads. This can be significantly more impactful for growth outlook or the outlook for the equity markets rather than a large interest rate hike which takes time to trickle down to the economy.

Implications

Even if the Fed stays focused on inflation in the near-term, the longer-run path is now quite uncertain. Growth concerns have risen with banks likely to tighten lending standards which could have a larger and quicker impact on the real economy compared to a rate hike. But with inflation still remaining uncomfortably high, and potentially boosted further by China reopening and the Fed’s added liquidity measures, this means we might be now heading towards Stagflation.

Another key thing to consider is that corporate margins could squeeze further, and the impact may be invariably larger for the smaller enterprises (best represented by RUSSELL 2000) as bank failures dent sentiment. The NFIB survey released yesterday also indicated that inflation remains the biggest problem for small enterprises in February in the US.

So in a way, rising risks of growth slowdown could bring yields lower, but the risk premium is likely to rise. Near-term yields could remain highly volatile as growth, inflation and market risk dynamics are interpreted. But flight to quality will likely prevail as we are getting into a tougher economic environment.

Quarterly Outlook 2024 Q2

2024: The wasted year

01 / 05

  • Macro: It’s all about elections and keeping status quo

    Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.

    Read article
  • FX: The rate cut race shifts into high gear

    As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.

    Read article
  • Equities: The AI and obesity rally is defying gravity

    Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.

    Read article
  • Fixed income: Keep calm, seize the moment

    With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.

    Read article
  • Commodities: Is the correction over?

    Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.

    Read article
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.