Will ECB action shape the way for the FOMC & BoE?

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

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USD: Conditions remain fragile ahead of next week’s decisions

The 2-year UST bond yield rebounded yesterday, up 28bps as banking sector fears eased somewhat and the SNB action to support Credit Suisse opened up the opportunity for the ECB to deliver its 50bp hike as it had intended. We covered the ECB decision yesterday in an FX Focus piece (click here) but in essence there were two important take-aways that came with this decision. Firstly, the ECB communicated a strong commitment to support the markets by reminding market participants that the “ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed” and secondly the ECB dropped its unconditional guidance of future rate hikes and instead decisions will now be data-dependent.

These aspects of the ECB’s statement may have been the quid-pro-quo for building the majority within the Governing Council in favour of hiking by 50bps. We would also add perhaps that the inflation forecast by the ECB in December of 3.4% (which gave reason to very hawkish rhetoric) was somewhat flawed and the cut to that forecast yesterday to 2.9% gives some credibility to that view but also provides greater leeway for a more flexible guidance on future policy decisions going forward. The decision also helped provide support for EUR/USD, at a time when due to safe-haven dollar demand the euro was at risk of falling sharply further. That risk has not gone away of course and the fragility of investor sentiment means the re-emergence of concerns over particular banks is a high risk over the near-term.

But the ECB’s approach yesterday may well provide the template for the Fed next week. Indeed, you could argue that the Fed is in an even stronger position to justify a rate hike than the ECB was yesterday. The ECB has merely committed to providing additional liquidity if needed whereas the Fed has already acted. Indeed, balance sheet data released last night showed the extent of support undertaken already. The “Primary Credit” (the Discount Window) saw USD 152.9bn of liquidity support for banks while “Other Credit Extensions” captured loans to cover deposits of failed banks totalled USD 142.8bn and is guaranteed by the FDIC. So essentially we have had close to a USD 300bn expansion of the Fed’s balance sheet in a week and that could see the Fed wanting to pursue continued rate hikes, if conditions into the meeting next week allow. A 25bp hike next week is priced at about an 80% probability. We see that as reasonable at this juncture and if no further episodes of bank stress emerge that probability will drift higher into the meeting next week. In circumstances of that scenario we would expect the dollar to remain on a weaker footing given that a hike would in our view probably be the last – some difference from the 100bps that was priced last week.

For the BoE, the market-based probability of a hike is less – only a touch over 50%. That makes sense to us and we see a high chance that the BoE will pause. We were already arguing that the BoE should pause although we suspected the BoE could add one further “insurance” hike. But it was always a much closer call than for the ECB or the Fed and a hard fall in inflation this year could sway the BoE.

Changing US yield backdrop to keep pushing USD/JPY lower

Source: Macrobond 

JPY: Upside risks remain in place

The developments of late in the markets continue to suggest upside risks for the yen. From the point in which markets began to turn sour due to US banking sector concerns last week, the yen is the top performing G10 currency – up 3.2% versus the US dollar. The pound is the next best performing while NOK and CAD are the worst performing. For the yen what has emerged in the last week at the very least is that the scope for monetary tightening by the major G10 central banks is now much more limited.

The change in monetary policy guidance by the ECB yesterday is indicative of that and if the Fed does hike by 25bps next week, we will likely get some form of similar guidance from the Fed as well.  

This has reduced considerably the complications for incoming Governor Ueda in the task of looking to terminate YCC. Of course one could argue that the developments in the last week are arguments for not terminating YCC at all but we wouldn’t agree with that. A pegged bond yield regime is still passed its sell-by date and the fundamentals at least still point to justifying its removal.

Bit by bit we are getting more “shunto” wage negotiation information and it appears to be pointing toward at least enough information to confirm wage growth much closer to being consistent with price stability. A Bloomberg survey showed an expected average wage gain of 2.95%, which would be the highest since 1994. Honda Motor Co. Ltd confirmed a 5% increase with other larger companies are offering multi-decade records. Smaller companies will likely not be as generous but overall, wages in total look set to be close to the desired 3% growth rate suggested by the BoJ as consistent with price stability.  

So we would expect the YCC speculation to build again and the BoJ to take action, possibly as soon as at the end of Q2. Combined with bouts of haven demand and rates peaking globally USD/JPY looks set to continue its declining trend. We continue to run a short USD/JPY trade view in our FX Weekly.

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	09:30	Inflation Expectations	--	--	4.8%	!!
EC	10:00	Core CPI (YoY)	Feb	5.6%	5.3%	!!!
EC	10:00	Core CPI (MoM)	Feb	0.8%	-0.8%	!!!
EC	10:00	CPI (MoM)	Feb	0.8%	-0.2%	!!!
EC	10:00	CPI (YoY)	Feb	8.5%	8.5%	!!!
EC	10:00	Wages in euro zone (YoY)	Q4	--	2.10%	!!
EC	10:00	HICP ex Energy & Food (YoY)	Feb	7.4%	7.1%	!!!
EC	10:00	HICP ex Energy and Food (MoM)	Feb	0.9%	-0.4%	!!!
EC	10:00	Labor Cost Index (YoY)	Q4	--	2.90%	!
US	13:15	Capacity Utilization Rate	Feb	78.4%	78.3%	!
US	13:15	Industrial Production (MoM)	Feb	0.2%	0.0%	!!!
US	13:15	Industrial Production (YoY)	Feb	3.00%	0.79%	!!
US	13:15	Manufacturing Production (MoM)	Feb	-0.2%	1.0%	!!!
US	14:00	Michigan 5-Year Inflation Expectations	Mar	--	2.90%	!!!
US	14:00	Michigan Consumer Expectations	Mar	64.5	64.7	!!
US	14:00	Michigan Consumer Sentiment	Mar	67.0	67.0	!!
US	14:00	Michigan Current Conditions	Mar	70.0	70.7	!
US	14:00	Michigan Inflation Expectations	Mar	--	4.1%	!!!
US	14:00	US Leading Index (MoM)	Feb	-0.3%	-0.3%	!