Market conditions now key ahead of FOMC

Derek halpenny

Head of Research, Global Markets EMEA & International Securities

 

Global Markets Division for EMEA

T: +44 (0)20 7577 1887

E: derek.halpenny@uk.mufg.jp

_{MUFG Bank, Ltd.
A member of MUFG, a global financial group}

USD: CPI data enough to swing FOMC to hike but only if….

The market turmoil fuelled by the collapse of SVB and other regional banks has subsided somewhat and on this basis and the inflation data released yesterday, the markets have, correctly in our view, swung back to the probability of a 25bp rate at the FOMC meeting next Wednesday. A hike is not yet fully priced and the risk of an unchanged policy announcement, at about 20%, reflects the risk of some further blow-up in the regional banking sector between now and the FOMC meeting. If there is no further turmoil we would assume the Fed hikes next week.

Let’s not forget the market pricing before the SVB collapse. The rates market was priced for 100bps of additional tightening and close to 75% priced for a 50bp hike next week. Even if SVB had never happened, it is debatable whether the jobs and CPI data combined provided enough justification for upping the pace of hiking from 25bps to 50bps. The added risk-factor related to SVB and regional bank fragility creates uncertainty but Fed Chair Powell may be reluctant to announce an unchanged policy when he so recently stood before Congress and effectively encouraged the market to price for four more rate hikes. Again, assuming no further blow-outs in the financial markets emerge in the coming days we suspect the FOMC would prefer to emphasise the inflation fight as requiring further tightening. The remarkably generous Bank Term Funding Program may also sway the Fed of the need to keep the monetary policy strategy focused, for now at least, on fighting inflation.

The CPI data itself we believe had some good news but also contained reasons for concern. The primary concern and the reason why the FOMC would likely justify a rate hike next week if they do hike is the core service CPI, ex-housing measure, which in MoM terms accelerated from 0.36% to 0.50%, the largest increase since last September. The weakness in core goods continued though with the MoM rate unchanged after a 0.1% increase in January and a -0.1% fall in December. The YoY rate has now fallen from 12.4% to 1.0% in one year, the lowest reading since August 2020. Core goods deflation may well lie ahead in the not too distant future.

So some retracement in short-term yields in the US was in our view justified anyway given the 109bp drop in the 2yr UST bond yield was more about positioning-adjustment and safe haven flows rather than a pure rate expectations trade. Now with no further bad news from US regional banks and the in-line CPI data a rebound in US yields makes sense. USD/JPY remains the purest FX trade on US rate direction and we could see USD/JPY grind further higher over the short-term. But we very much doubt the markets will return now to pricing back in fully the 100bps of tightening that existed last Wednesday and that suggests to us limits to the upside for USD/JPY from here.

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Source: Macrobond 

GBP: Budget In focus with labour market a focus

The pound remains the second best performing G10 currency on a year-to-date basis, with only the Swiss franc outperforming. That is somewhat of a surprise given the pound usually tends to underperform during periods of risk aversion. We have often highlighted the GBP link between risk and broader financial market conditions. Even over the last five days when volatility and risk aversion have been more intense, the pound has been the third best performing currency.

Certain developments may well be helping to break that link. Firstly, there has been a dramatic narrowing of the UK’s current account deficit – the deficit has more than halved since the record GBP 46.5bn deficit in Q1. The Q4 data is set to narrow further as energy price declines narrow the trade deficit.

Secondly, PM Sunak is providing optimism that the negative trade implications from Brexit could be eased somewhat going forward. The Northern Ireland Protocol deal and the migrant deal agreed with France last week signal improved relations with the EU that could lead to improvements in the trade deal that reduce trade frictions.

Finally, there has been a notable improvement in fiscal credibility. Perhaps not a great achievement considering where the UK’s credibility fell to during the Truss premiership period but nonetheless Chancellor Hunt has brought much needed credibility. Today, Chancellor Hunt will present his first scheduled budget following his emergency budget last November. One highlight already widely reported is the decision to keep the Energy Price Guarantee at GBP 2,500 rather than increasing it as planned to GBP 3,000. This will result in CPI being much lower than the BoE projected in Q2 2023. It will confirm the likelihood of a very fast decline in YoY CPI this year.

But much of the focus will be on trying to expand the potential growth rate of the economy. While the corporate tax rate will still increase from 19% to 25%, the budget is expected to include capital allowances to encourage business investment. There will also be changes to the taxation of pensions that will allow higher pension pots to be built without being taxed more onerously. The current framework is being blamed for curtailing labour supply in the 50-64 age bracket.

The budget is unlikely to be a market-mover (unless there are some growth-positive surprises) but today could serve as a reminder that the high and sustained level of uncertainty and pessimism linked to the UK in recent years has passed and that certainly points to the potential for better GBP performance ahead

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
US	09:00	IEA Monthly Report	--	--	--	!!
EC	10:00	Industrial Production (YoY)	Jan	0.2%	-1.7%	!
EC	10:00	Industrial Production (MoM)	Jan	0.4%	-1.1%	!
US	11:00	MBA Mortgage Applications (WoW)	--	--	7.4%	!!
CA	12:15	Housing Starts	Feb	220.0K	215.4K	!!
UK	12:30	Spring Statement	--	--	--	!!
US	12:30	Core PPI (MoM)	Feb	0.4%	0.5%	!!!
US	12:30	Core PPI (YoY)	Feb	5.2%	5.4%	!!!
US	12:30	Core Retail Sales (MoM)	Feb	-0.1%	2.3%	!!!!
US	12:30	NY Empire State Manufacturing Index	Mar	-8.00	-5.80	!!
US	12:30	PPI (MoM)	Feb	0.3%	0.7%	!!!
US	12:30	PPI (YoY)	Feb	5.4%	6.0%	!!!
US	12:30	Retail Control (MoM)	Feb	-0.3%	1.7%	!!!!
US	12:30	Retail Sales (YoY)	Feb	--	6.38%	!!!
US	12:30	Retail Sales (MoM)	Feb	-0.3%	3.0%	!!!
US	12:30	Retail Sales Ex Gas/Autos (MoM)	Feb	--	2.6%	!!!!
US	14:00	Business Inventories (MoM)	Jan	0.1%	0.3%	!
US	14:00	NAHB Housing Market Index	Mar	40	42	!
NZ	21:45	GDP (QoQ)	Q4	-0.2%	2.0%	!!!
JP	23:50	Core Machinery Orders (MoM)	Jan	1.8%	1.6%	!
JP	23:50	Trade Balance	Feb	-1,069.4B	-3,498.6B	!

Source: Bloomberg

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
US	09:00	IEA Monthly Report	--	--	--	!!
EC	10:00	Industrial Production (YoY)	Jan	0.2%	-1.7%	!
EC	10:00	Industrial Production (MoM)	Jan	0.4%	-1.1%	!
US	11:00	MBA Mortgage Applications (WoW)	--	--	7.4%	!!
CA	12:15	Housing Starts	Feb	220.0K	215.4K	!!
UK	12:30	Spring Statement	--	--	--	!!
US	12:30	Core PPI (MoM)	Feb	0.4%	0.5%	!!!
US	12:30	Core PPI (YoY)	Feb	5.2%	5.4%	!!!
US	12:30	Core Retail Sales (MoM)	Feb	-0.1%	2.3%	!!!!
US	12:30	NY Empire State Manufacturing Index	Mar	-8.00	-5.80	!!
US	12:30	PPI (MoM)	Feb	0.3%	0.7%	!!!
US	12:30	PPI (YoY)	Feb	5.4%	6.0%	!!!
US	12:30	Retail Control (MoM)	Feb	-0.3%	1.7%	!!!!
US	12:30	Retail Sales (YoY)	Feb	--	6.38%	!!!
US	12:30	Retail Sales (MoM)	Feb	-0.3%	3.0%	!!!
US	12:30	Retail Sales Ex Gas/Autos (MoM)	Feb	--	2.6%	!!!!
US	14:00	Business Inventories (MoM)	Jan	0.1%	0.3%	!
US	14:00	NAHB Housing Market Index	Mar	40	42	!
NZ	21:45	GDP (QoQ)	Q4	-0.2%	2.0%	!!!
JP	23:50	Core Machinery Orders (MoM)	Jan	1.8%	1.6%	!
JP	23:50	Trade Balance	Feb	-1,069.4B	-3,498.6B	!

Source: Bloomberg