So far, we’ve no confidence that
Inflation is down on the mat
Thus, rates won’t be sinking
Til prices are shrinking
Said Jay in his Wednesday House chat

But also, it seemed clear to all
No rate hikes were likely on call
With that set aside
He then did confide
That Basel III cap rules may fall

It can be no surprise that Chairman Powell’s testimony yesterday explained that the Fed is still not yet confident that inflation is going to achieve their 2% target on a sustainable basis.  While he was clear that most of them thought that would eventually be the case, the proof is not nearly conclusive at this stage.  Of course, this is exactly what he told us last month and essentially what every Fed speaker since has repeated.  He did appear to rule out any further rate hikes at this time, but quite frankly, if inflation readings start to head higher, you cannot take those off the table.  At the very least, the current Fed funds futures pricing for cuts (3% in March, 20% for May and 87% for June show the market has really decided the first cut is a summer event.  Remember, though, between now and the June 12 meeting, we will see three more CPI and PCE reports as well as three more NFP reports.  It would not be impossible for these ideas to change between now and then.

One other thing to note is we have heard several FOMC members now discuss needing only two rate cuts this year.  Do not be surprised if the March dot plot has that as the median forecast and that would be a significant change to market perceptions.

The essence of the questions by the Congressmen and women revolved around two things; the fact that high rates were hurting people trying to buy houses and how proposed capital increases due to the Basel III regulations were going to kill the banking community.  While Powell empathized with the housing issue, he reminded them all that inflation hurts everyone.  But the big surprise was Jay indicated that he may overrule Regulation vice-chair Barr and look to reduce some of those capital requirements.  Not surprisingly, the GSIB bank stocks rallied on the news!

And in fact, so did the overall stock market.  The combination of what seemed to be a promise to avoid further rate hikes and relaxing capital requirements was just what the doctor ordered to alleviate Tuesday’s pain.

Is the table set
For a March policy change?
A new wind’s blowing

The yen (+1.1%) is on the move this morning after a combination of news that Rengo, the Japanese Trade Union Confederation, is asking for wage increases of 5.8% this year, the highest request in 30 years.  While they will likely not get the full amount, certainly wages are set to rise more substantially than in a long time there.  This is music to PM Kishida-san’s ears as he wants to see more spending, and apparently, this is AOK with Ueda-san who now believes that their 2% price target has a greater chance of being sustainable.  Alongside the yen’s rally, the OIS market has bumped up the probability of a March rate hike to above 50% and several analysts in Tokyo are making that their new call.

Thinking about the situation here, the BOJ meets a week from Monday, 2 days prior to the FOMC.  It strikes me that we have the opportunity for some real volatility as if Ueda-san does raise their base rate to 0.00%, I expect the market will be looking at this being the beginning of a series of hikes and start to move the entire Japanese interest rate curve higher.  That will be bullish for the yen.  But…if the Fed’s dot plot comes in at only 2 cuts, or possibly even 1 cut this year, that is also quite hawkish for the US rate situation, will likely see the yield curve back up and should support the dollar.  The reason we hedge is to prevent movement of this nature from having too great an impact on results.  Keep that in mind.

Interestingly, I believe those two stories are far more important to markets than the ECB meeting this morning.  There is virtually no chance of any policy change, so the real question is how the statement addresses the situation for the first rate cut and its potential timing.  The commentary that we have heard to date, at least to my ears, has been a split between April and June, with a slight nod toward the latter.  One key clue will be the updated economic and inflation forecasts with some analysts looking for lower outcomes there.  If that is the case, I expect that April will get a lot more press.

But ahead of the meeting, I would argue that the narrative is shifting as follows:  the Fed has indicated that the peak has been reached and it’s simply a matter of time before they start to cut rates while the ECB has been trying to hold out their hawkish bona fides.  As such, it should be no surprise that the dollar is under some pressure and the euro has rebounded to 1.09 for the first time since mid-January.  However, there is still a lot of new information on the horizon, specifically tomorrow’s NFP and next week’s CPI which can quickly alter the Fed narrative and with it, the dollar narrative.  Be careful.

Ok, let’s look at the overnight session where, not surprisingly, the Nikkei (-1.2%) fell on the back of the hawkish sentiment and stronger yen.  It has fallen back below the 40K level, so it remains to be seen if this is temporary or if, after 40 years, the new top was just barely above the old one.  Chinese shares were also weak despite a very strong Trade Balance, although the rest of Asia followed the US higher.  In Europe this morning, Spain’s IBEX (+0.6%) is once again leading the way higher although the major markets, FTSE 100, DAX and CAC are all little changed on the day.  Finally, at this hour (7:15), US futures are edging higher by about 0.25%.

In the bond market, yesterday saw Treasury yields fall 4bps and they are down a further 1bp this morning.  Market participants are going all-in on the idea that Fed funds are going to get cut soon.  I am not comfortable with that viewpoint at all.  As to European sovereigns, they too, have seen yields slide a bit, down 2bps-3bps this morning.  All this is in contrast to JGB yields, which backed up 2bps overnight on the new hawkish take.

In the commodity markets, oil (-0.75%) is softer this morning, unwinding yesterday’s modest rally.  For now, there has been much less focus on energy than on the interest rate story although I suspect that will change again going forward.  Gold (+0.4%) continues to be the absolute star of the commodity space, rallying for the 7th consecutive session and extending its all-time high levels.  My take is there is much more room on the upside here as it is not a widely held trade and if it continues, the momentum guys are going to want to get in.  But we are also seeing strength in the base metals with both copper (+1.3%) and aluminum (+0.9%) having strong sessions.  As long as the narrative is looking for US rate cuts, these metals have further to climb.

Finally, the dollar is under pressure everywhere, not just in Japan.  Both Aussie (+0.65%) and Kiwi (+0.5%) are strong on the back of commodity strength, and we are even seeing NOK (+0.2%) rise despite oil’s decline.  If you needed proof this is a broad dollar selling environment, that’s it.  Interestingly, in the EMG bloc, while almost every currency is firmer, the movement has been quite small, with nothing more than +0.2%.  So, this seems to be a comment on the ostensibly dovish Powell testimony that has bolstered the US stock market.

On the data front today, after the ECB leaves rates on hold at 4.5% we see Initial (exp 215K) and Continuing (1889K) Claims leading the way as they do every Thursday.  We also see the Trade Balance (-$63.5B), Nonfarm Productivity (3.1%) and Unit Labor Costs (0.6%) at 8:30.  Powell starts up again in front of the Senate at 10:00 and then this afternoon, Consumer Credit ($9.25B) is released.  In addition to Powell, we hear from Loretta Mester of the Cleveland Fed.  It will be quite interesting if she hints at only two cuts this year, following Goolsbee and Barkin.  I have a feeling that is the current direction and that is not in the pricing right now.

For now, the dollar remains under pressure, so unless Powell is perceived to be more hawkish this morning, I suspect the dollar can slide a bit more before it’s all over.

Good luck
Adf