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.

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research 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 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. To the extent that any content is construed as investment research, you must note and accept that the 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 under relevant laws.

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

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo 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 Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning 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. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

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

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 are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.