Market Strategist
Summary: While the focus stays on Fed, Powell and treasury yields, we get the first few central banks this week taking a less hawkish turn. Reserve Bank of Australia’s dovish hike may be followed by Bank of Canada’s pause, but the key message has remained around policy flexibility rather than claiming a victory on inflation. Comments suggest that central banks are not convinced about disinflation and continue to keep the door open for more rates hikes in Q2/H2.
The fist two months of the year have been a roller-coaster, but markets have recently become more certain of stickier inflation and resilient economy going into the month of March. Global money market curves have re-priced higher to reflect the tighter monetary policies as a result. For the Fed, markets have now fully priced in a 5.5% terminal rate, somewhat higher than what was suggested by the median dot plot in December. Meanwhile, 160bps of additional rate hikes are priced in for the ECB with terminal rate forecast approaching 4%.
While Powell’s testimony and the US jobs data remain key to watch this week to get a confirmation on the current market expectations for the Fed, some of the other G10 central banks have started to be more flexible in their tightening cycles despite the risks of inflation remaining elevated. This mostly includes the Reserve Bank of Australia and Back of Canada, both of which have pronounced property market risks compared to the other G10 economies. If inflation returns because of accelerating global growth or China reopening, both BOC and RBA may be forced to hike again.
USD could remain firm in light of the relative hawkishness that can continue to be priced in from the Fed vs. ECB or BOE where a lot is priced in, as shown in the chart below.
The RBA raised rates for the 10th consecutive time, taking the cash rate target to an 11-year high of 3.6%. Despite one more rate hike being signalled for the April meeting, RBA Governor Lowe sounded less hawkish in the wake of the recent slew of weaker than expected data on GDP, employment, wages and inflation. Market pricing for terminal rate eased from 4.2% to 4.0%.
AUDUSD has been hurt recently by the weaker global risk sentiment and the rise in geopolitical tensions, bringing the 0.67 level in focus for the first time since November. China’s growth targets have also been towards the lower end of the expected range, keeping the boost to AUD limited. Still, as better-than-expected Chinese headlines start to flow in from this month after the full reopening and the impact of Lunar New Year holiday, there are reasons to believe that AUD could continue to find support. The 61.8% retracement of the gains from the October low at 0.6547 will be the key support level to watch.
Market expects the BOC to pause its tightening cycle, keeping rates unchanged at 4.5%, after its message of “one and done” last month. Still, the message is likely to emphasise that the pause is conditional and the bank remains open to hiking rates again later in the year if inflationary pressures re-emerge. Employment and wage growth has softened, while the January CPI also eased from 6.3% YoY to 5.9% YoY. GDP growth for Q4 was also much weaker than expected as it came out flat vs. expectations of 1.6% annualized growth with Q3 being revised lower as well.
CAD is down 1.7% against the USD since the January 25 meeting even as oil prices remained mostly range-bound. More so, CAD has been stronger on the crosses with AUDCAD down 3.7%. There could be potentially more tactical weakness to come for CAD as risks of a lag to the US policy rate broaden, and a recovery will have to wait until the USD story starts to weaken or oil prices pick up materially.
While data and commentary from officials has been less supportive of the case for further tweaks in Bank of Japan policy, outgoing governor Kuroda is known for his surprises. At his last meeting on Friday, he may want to part with some sparks resulting in a numb yen in the run upto the meeting.
Japan’s labour unions have reportedly been asking for a record pay rise this year, which fueled some expectations that inflation may stay elevated. However January earnings data reported today showed real earnings down over 4%, the worst since 2014. Growth is nominal wages also slowed after a bonus-driven jump in December. Tokyo CPI for February was also softer than expected, and incoming Governor Ueda’s testimony remarks suggested he would be looking at policy continuity along with flexibility to respond to market pressures.
The outcome of meeting on March 10 could range from anywhere between a further tweak to the yield curve control policy all the way to Kuroda claiming victory with his policy and giving pressing remarks to maintain yield control as inflation remains externally-driven. The base case is still a no change and JPY has its eyes more firmly set on Powell’s testimony and the path of US yields from here.
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