Beware the Ides of the March…Treasury yields continued their ascent this week after US producer price inflation came in hotter than anticipated, hot off the heels of the warmer CPI numbers. The 10yr advanced to 4.3%, trading a wee bit shy this morning at 4.285%, pushing gold further sideways at $2,170 as the flag moves towards completion, and giving some lift to the US dollar. Stocks pulled back – the question is whether if yields continue to climb, does it exert pressure on equity markets?

Markets are surely questioning whether the Fed can now commit to cutting in June? The PPI report was the last major piece of economic data before the Fed’s meeting next week and follows a CPI report that also pointed to stubborn inflation pressures. PPI rose to 1.6% in Feb, from 0.9% previously, the 0.6% month-on-month increase was the fastest since August. Meanwhile the headline CPI rose by 3.2% YoY in February. Core CPI was still a very stubborn 3.8% YoY, from 3.9% YoY in January, while the ‘supercore’ inflation measure remained unchanged at 4.3% YoY. The 6-month annualized core rate was 3.8%, and 3-month annualized rate was 4.3%. These are not really numbers you associate with rate cuts, but the market has not overly reacted. There are lots of reasons why the Fed will still cut in June, even if it seems a bad idea.

PPI hotter than expected…kissing goodbye to a June cut? The arrow marks the Fed’s December ‘pivot’.

Source: U.S. Bureau of Labor Statistics

fred.stlouisfed.org

As I commented after the December meeting: “Was that the Arthur Burns moment? Powell seems to be ditching his Volcker mask and gone for the Burns one.”

In the last month we have seen the market’s odds for a June cut come down from more than 80% to about 60%. And most of that move to price out a June cut came in the last week off the heels of the CPI and PPI prints.

As I also noted in December: “Jay Powell declared victory over inflation and the market is celebrating the triumph. The question is whether it’s come too soon. You cannot deny inflation is coming down, but it looks as though the ‘last mile’ just got that bit harder.” 

So, much rides on the Fed next week. A fresh dot plot will tell us a lot about how cautious members have become in recent weeks. Even if the numbers this week haven’t drastically altered the expectations for June – there is a lot of time between now and then – it could have an important impact on FOMC members’ projections for core PCE inflation and their views on cuts for the year.

It’s more complicated than inflation data may suggest – pain is in the mail, so to speak, and the Fed may decide its best to cut in the summer to avert a recession; wearing higher inflation as the price of this. ISM employment components are in contraction, the NFIB survey suggests hiring by small firms is the weakest since May 2020 and the quits rate has slowed a lot. Plus there are a lot of well-publicised layoffs among large employers.

Quits rate back to pre-Covid norm

Source: U.S. Bureau of Labor Statistics

fred.stlouisfed.org

Inflation has come down to a point where policy rates are currently restrictive – cutting can be explained simply as moving to a more neutral position. Currently the FOMC thinks the neutral rate is about 2.5%, which means there are 300bps of cuts just to get to neutral. Hence why the market has been, overall, quite relaxed about these inflation numbers.

And remember, this is an election year – Powell may well be under intense pressure from the Treasury to cut. So even if inflation is showing signs of reaccelerating and broadening again, it does not mean that a June cut is suddenly going to be ditched.

As I said a lot last year, central banks are going to have to accept higher inflation and may eventually move the goalposts.

And as BofA says today: “US headline/core CPI trending to 3.6-4.0% by June when Fed expected to cut rates; implicitly Fed tolerating higher inflation (eases US debt burden); weaker policy credibility = weaker currency…why crypto & gold at all-time highs.”

We’ve heard mutterings about allowing central banks to raise their inflation targets and for I’ve been saying for a while now that CBs will either explicitly or implicitly need to accept they are not going back to 2%. Probably the tacit acceptance will just become de facto policy. Credibility will be lost, but so what?

And I go back to speech by Christine Lagarde last April, which I think I repeated last week. This, I said at the time, was “a signal that we are about to go into a protracted economic (and maybe real) war and it will require the mobilisation of the state and people – developed world central banks (Fed, ECB, BoE, BoC, RBA) will act together to orchestrate fiscal spending and suppress yields”.

Higher for longer means inflation, not necessarily rates.

The Fed is just one of several central bank meetings next week

Bank of Japan

The conclusion of wage negotiations in Japan has seen the biggest pay rises in about three decades setting the scene for the meeting of the Bank of Japan which concludes Tuesday. Sources have indicated that there may be enough in the wage talks to justify a policy shift at its March meeting, though policymakers may choose to wait until April. “The outcome of this year’s annual wage negotiation is critical” to deciding on when the BoJ should exit negative rates, Governor Kazuo Ueda told parliament this week. Jiji reported that the BoJ is planning to end negative interest rates at next week’s meeting. BoJ sources and leaks have not always been accurate but whether it’s March or April, the BoJ is about to pull the trigger, it seems. The yen slackened into Friday again after slipping all week – but would you want to be short JPY into this meeting?

Reserve Bank of Australia

No change is expected from the RBA on Tuesday, though more talk of possible hiking would be something for the market. The central bank left its benchmark rate at a 12-year high of 4.35% in February thanks to cooling inflation, but minutes of the meeting showed policymakers did discuss rate hikes. The RBA noted that “a further increase in interest rates cannot be ruled out”, but markets see this as positioning talk designed to prevent investors from pricing in too much easing this year. AUDUSD has slipped a big figure the last two sessions on USD strength.

Bank of England

No change is expected on Thursday but the BoE expects inflation falling to 2% in the next couple of months, leaving the path clear for the MPC to move more swiftly towards cutting rates than some peers. Or maybe not – inflation is seen falling to 2% but then picking back up to 3% later in the year. Bank of England Governor Andrew Bailey said that the UK is “near or at full employment” and seems less worried about a wage-price spiral. Wage growth has come down, too, as a cooler jobs report saw traders bring forward expectations for the BoE to cut in June from August. However, the minimum wage in the UK is about to go up 10% and wage growth remains relatively high at around 6%. Markets will be waiting to see if the BoE is willing to lean into the idea of a June cut or retain a slightly more cautious outlook. My preference is that they stress the need for more evidence that inflation is coming down before moving. Sterling has had a good run this year, testing $1.29 before pulling back on renewed USD buying.

Swiss National Bank

The SNB could be the first to cut – CPI inflation fell to 1.3% in January vs a forecast 1.7%%, as it was in December. That surprise fall showed inflation undershooting the SNB’s forecasts for Q1, prompting many to speculate the central bank will cut this month. It may, however, to prefer to wait until the likely moves by the ECB and Fed in June. Bank J Safra Sarasin chief economist Karsten Junius believes the SNB should go ahead and cut, saying an early move would be the “best insurance” against negative inflation. “The SNB has managed to bring inflation back into the target range. By cutting interest rates at its next policy meeting on March 21, it can help reduce the real overvaluation of the Swiss franc and support the economy’s return to potential growth,” he wrote on the Neue Zuercher Zeitung’s ‘The Market’ site.

Reference:

Producer Price Index News Release summary – 2024 M02 Results (bls.gov)

Consumer Price Index Summary – 2024 M02 Results (bls.gov)

Jobs Report – NFIB

BOJ to debate ending negative rates in March if wage survey strong – sources | Reuters

RBA leaves official interest rate on hold fuelling hopes mortgage repayment pain has peaked | Reserve Bank of Australia | The Guardian

BOE Governor Says UK Economy Is Near Full Employment Level – Bloomberg

Neil Wilson

Chief Market Analyst at Finalto

All opinions, news, research, analysis, prices or other information is provided as general market commentary and not as investment advice and all potential results discussed are not guaranteed to be achieved. The information may have been derived from publicly available sources, company reports, personal research, or surveys. Past performance is not indicative of future performance. Trading carries risk of capital loss. Service available to professional clients only.