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The Treasury market extended a slide Friday after US producer prices rose faster than forecast in January, dimming the chances the Federal Reserve will begin reducing interest rates before July and trimming expectations for cuts over the whole of 2024.
Yields of all maturities rose in the wake of a fresh dose of concern over inflation proving more sticky than some expected, with shorter tenors leading the march. This comes after a reading earlier this week showed consumer prices rose more than forecast.
The two-year yield, the most sensitive to changes in the outlook for US monetary policy, rose as much as 14 basis points to 4.72%. That came as short-term interest-rate swaps contracts trimmed odds of the Fed’s first rate cut coming in June down to only about 80%. For all of 2024, traders now see only about 85 basis points of easing, pushing the market as close as ever to three quarter-point hikes, which the median of Fed officials’ forecasts — known as the dot plot — signaled in the last quarterly update in December.
A lighter week for data that might begin with a bang. Monday morning, we get the January services sector PMIs for S&P Global and ISM. Given the recent run of data, it seems like we should be looking for an upside surprise. The ISM number should get a boost from the reversal of the shockingly low employment number in December. We don’t know how to explain another weak number in the context of the employment report. Upside surprise for the ISM measure could be the catalyst that forces market participants to undo the move in rates since last November.
Treasury yields extended Friday’s surge, pushing the two-year note’s toward its highest level this year, as strong economic data reinforced the message of Federal Reserve officials including Chair Jerome Powell that interest-rate cuts are unlikely to begin before May.
Yields across the maturity spectrum climbed as much as 10 basis points on the day, reaching session highs after the ISM gauge of service-sector activity for January exceeded economist estimates. Friday was the US bond market’s worst day in nearly a year after stronger-than-anticipated January employment data dashed hopes for a speedy pivot toward easier monetary policy.
The chance of a quarter-point cut in March dwindled to almost 10% after Powell said in an interview with CBS’s 60 Minutes which aired Sunday that Americans may have to wait beyond the Fed’s next meeting to cut interest rates. Minneapolis Fed President Neel Kashkari made similar comments Monday, and nine other central bank officials are slated to speak this week.
With Australian inflation slowing but still well above the Bank’s 2-3% medium term target band and estimates of neutral somewhere below 4%, the cash rate is restrictive as long as the RBA holds policy at the current 4.35% rate.
There is some local excitement around the prospect that prices (mostly as a result of energy price declines) could slow to as much as 2.9% by the end of this year. That would be a full year ahead of the RBA’s own projections.
We view the Bank as unlikely to suddenly relent on its hawkish policy stance, as December’s meeting debate over holding or hiking the cash rate illustrates. It is not so hawkish that it will hike again in February as some market participants think but it remains wary enough to try to push off pricing of rate of cuts for some months yet.
The Reserve Bank of Australia moved to a more neutral
stance on interest rates Tuesday but pointedly reminded markets not to rule
out the prospect of a further interest rate increase if inflation remains
The RBA kept the official cash rate on hold at 4.35% at the conclusion of its
first policy meeting for this year. While it said rates may rise more, the
central bank separately announced downward revisions to its inflation and
"The path of interest rates that will best ensure that inflation returns to
target in a reasonable timeframe will depend upon the data and the evolving
assessment of risks, and a further increase in interest rates cannot be ruled
out," the RBA board said in a statement.
In a press conference following the announcement, RBA Governor Michele Bullock
added that "the signs are good" about inflation but added "we've got to be
The comments suggest the RBA is likely to lag the Federal Reserve and other
major central banks like the European Central Bank in moving to cut interest
This deal now goes to the European Parliament where negotiations over it will start in January. Some tweaks are possible, but the main thrust of the reforms is unlikely to be changed.
The European Union hashed out a preliminary agreement on fiscal reform that will aim to reduce debt and protect investment in key areas such as defense and the green
The political deal will introduce a gradual fiscal adjustment path for nations whose government debt exceeds 60% of gross domestic product or whose deficit is above 3% of GDP. The agreement struck in Brussels late Friday between representatives of the European Commission, the European Parliament and member states in the EU Council still needs formal approval by national.
governments and the EU assembly to become law.
The Bank in November said it expected inflation would return to the 2% target by the end of 2025. Inflation would then fall below target, it said, as “an increasing degree of economic slack reduces domestic inflationary pressures.”
At that meeting, the Monetary Policy Committee (MPC) voted 6–3 to hold Bank Rate steady, with three members preferring to raise rates again by 25bps.
Later that month Bailey said in an interview that rates would not be cut for “the foreseeable future” at the same time as he expressed concern about sagging growth.
Now, the upcoming February meeting’s vote is likely to reflect that shift in concern with most members favoring a hold.
In November, the Bank’s now outdated projected inflation path back to target was based on an implied path for Bank Rate to remain at 5.25% until the third quarter this year before it declined “gradually to 4.25%” through end 2026.
Its February 1 update could show it now expects inflation to return to target this year, far sooner than it expected in November when senior members of the MPC including Bailey, stressed the need to keep Bank Rate at its 15-year high until the path back to target was in sight.
The Bank of England opened the door to interest-rate cuts for the first time since the pandemic struck — affirming predictions that inflation will fall to target this spring — while warning that price pressures could reemerge.
The UK central bank removed key guidance that borrowing costs may have to rise again, with Governor Andrew Bailey acknowledging that keeping rates unchanged would push inflation “significantly” below the target of 2%. The nine-member Monetary Policy Committee split three ways on how to act, with a majority of six opting to leave the key rate unchanged at 5.25%.
Still, MPC member Swati Dhingra pushed to cut rates, the first vote for a reduction in almost four years. Catherine Mann and Jonathan Haskel stuck with their previous position to raise rates to 5.5%.
Traders held bets that the BOE will deliver at least four quarter-point interest-rate cuts this year, with the first coming in June. The chance of an earlier move in May remains at around 50%.
The European Union is grappling with how to secure 50 billion euros in financing for Ukraine for the next four years, without which Kyiv will not have enough money to keep the country, and war, running.
EU leaders tried to agree on the cash in December but failed after Hungary, keen under Prime Minister Viktor Orban always to maintain good relations with Moscow, blocked the agreement that would have required unanimous approval of all 27 EU governments.
EU leaders will have another go at it on February 1 and it appears they are likely to succeed, probably at the cost of yielding to Hungary’s demands that the disbursements be reviewed annually.
European Union leaders struck a deal as Hungarian Prime Minister Viktor Orban yielded to their demands to lift his veto on a €50 billion ($54 billion) financial aid package for Ukraine. The forint reversed an earlier drop on the news.
“This locks in steadfast, long-term, predictable funding for Ukraine,” European Council President Charles Michel said in announcing the deal in a post on social media platform X Thursday.
As part of the accord, the member states agreed to debate the implementation of the Ukraine aid package every year and, “if needed,” the European Commission, the bloc’s executive body, could be asked to propose a review in two years, according to a draft document seen by Bloomberg News. The Hungarian leader’s demand for a veto was dropped.
Powell will be threading a needle at the FOMC meeting. The Fed looks prepared to move to a balanced risk assessment and will want to maintain flexibility going forward as it eyes its next move. Powell can’t cut off March given inflation and the possibility that labor markets surprise on the downside, but at the same time won’t endorse March.
Having pushed the inflation story as far as it can go, the focus is back on the real economy. On that side, a run of better-than-expected data reduces the urgency for rate cuts, leaving the timing of the first cut dependent on softer employment data between now and the March meeting. We currently assess the odds of a March cut at 30%.
*FED SWAPS CUT ODDS OF MARCH RATE CUT TO CONTRACT LOW NEAR 30%
The Federal Reserve held interest rates steady for a fourth straight meeting and signaled an openness to cutting them, though Fed Chair Jerome Powell threw cold water on investors’ hopes that reductions would begin in March.
The central bank’s policy-making Federal Open Market Committee showed it is in no rush to reduce rates, noting in a statement Wednesday that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”
Powell reinforced this message by saying, “Based on the meeting today, I would tell you that I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting.”
The current context, we will be data-dependent. We will be looking at this meeting by meeting. Based on the meeting today, I would tell you that I don't think it is likely that the Committee will reach a level of confidence by the time of the March meeting to identify March at as the time to do that, but that is to be seen. So, I wouldn't call it, you know -- when you ask me about in the near term, I am hearing that as March. I would say, I don't think that is -- it is probably not the most likely case, or what we would call the base case.
Furthermore, while we had thought the March forecast round could set the stage for a cut at the April 11 meeting, if inflation bounces around above 2% as expected, and with little data between the March and April meetings, this also appears unlikely, even though it is possible.
We expect the most likely base case for a first rate cut by the ECB to be at the June 6 forecast round meeting.
The argument for June over April is partly about waiting for the results in May of the all-important national wage data. The ECB will have some sense even by March of tracking wage data (see below), and April could be live depending on the totality of the data, but the preference will be to see the hard data and not rely too much on tracking data with little history. And while it is not written in stone that the first cut has to come at a quarterly forecast round meeting, that is far cleaner for both internal consensus and external communication. Perhaps most interestingly, waiting until June has a lot to do with tactics around managing the pace and destination of cuts as well.
January 13, 2024
What is it that the market is getting so wrong by expecting ECB rate cuts by March or April, and for these to then continue rather aggressively in 2024? Do you believe the market discounts euro area recession, due in part to a more restrictive German budget, that were not included in the more recent ECB staff projections?
The inflation release for December was broadly in line with our projections – I’m not seeing some major downside surprise. It was in line with our signal that there would be a jump. And the continued progress on the easing of core inflation is welcome. But we do see some headwinds to services inflation this year and, for the time being, wages are still growing well above any kind of long-run equilibrium rate. We don’t expect energy prices to continue falling at the same rate as last year.
Our baseline staff projections include a significant recovery in the European economy this year due to stronger demand in Europe which is, on its own terms, inflationary. But we flagged in December that there are downside risks to our forecast. And that is one of the big data questions we have for these weeks: will we see a recovery or a continuation of the kind of stagnation we had for much of 2023? We remain very data dependent.
The ECB needs to assess wage settlements before getting an orientation on monetary policy in 2024. Many wage deals will happen this month and during the spring. Do you think you will have a clear enough idea by the governing council on April 11th?
I have a range of data I want to see. We do receive the data on the latest wage settlements every week. We have a wage tracker measure that we use as an early indication of the wage dynamics. We also look at market data on wages. But the most complete dataset is in the Eurostat national accounts data. The data for the first quarter will not be available until the end of April. By our June meeting, we will have those important data. But let me emphasise, we do have other data that we will be looking at every week, because, as you say, a lot happens every month and we look at all of the data available to us.
It will take time to have a good understanding of whether the wage settlements are decelerating. We expect that 2024 will still have high wage increases, and it is important for people to recover the losses from high inflation. But the scale of that will determine the timing and the scale of rate adjustment this year.
European Central Bank officials who until
recently had been wary of even discussing interest-rate cuts now
look increasingly open to commencing them in June.
The Fed releases the minutes of the December FOMC meeting on Wednesday. The directionality for the Fed is clear as falling inflation is pushing it toward a rate cut. The minutes are unlikely to directly point to a March cut, but I suspect they will reveal the Fed becoming increasingly confident that inflation is on a path to price stability.
Federal Reserve policymakers agreed last month that it would be appropriate to maintain a restrictive stance “for some time,” while acknowledging they were probably at the peak rate and would begin cutting in 2024.
“Participants viewed the policy rate as likely at or near its peak for this tightening cycle,” according to the minutes of the Dec. 12-13 Federal Open Market Committee meeting released Wednesday.
The minutes indicated increased optimism among participants about the path of inflation, noting “clear progress.” The committee expressed a willingness to cut the benchmark lending rate in 2024 should that trend continue, though they gave no indication easing could begin as soon as March, as futures traders expect.
In the leadup to April, look for the BOJ to use its published meeting materials to recast its language on overshooting the inflation goal and to tilt its risks assessment from focusing on downside risks to a more balanced risk outlook.
(2) The Bank of Japan (BOJ) is targeting an April 2024 exit from negative interest rates, with a risk that the decision is brought forward to March.
A January move is off the table. Instead, the Bank will use its January 22-23 forecast round meeting to signal via updated forecasts that its inflation goal is in better view and that it is closer to a live meeting.
Bank of Japan board members were divided on how to communicate a tweak to yield curve control, with some showing tolerance for explaining the move as laying the groundwork for an exit from ultra-loose policy, minutes of their October meeting showed.
One member said it was necessary to clearly indicate that the measure was not intended as preparing for a future end to YCC and negative interest rate policy, the minutes showed on Friday.
But another member said the BOJ should not strongly deny the chance that the tweak to YCC could lead to an end to the current stimulus programme, according to the minutes.
"With a future exit in mind, it was important for the BOJ to provide communication to markets that prepare them" for when Japanese interest rates turn positive, one member was quoted as saying.
The debate highlights a growing awareness within the BOJ of the chance of phasing out its complex framework consisting of YCC, huge asset buying and a negative short-term rate target.
(2) Bloomberg 1/4/2024
Bank of Japan board members discussed the
potential timing of the nation’s first interest rate hike since
2007 during their meeting last week, with several members
indicating they see no rush to make the move.
“It would not be too late even if the bank makes a decision
after it sees developments in labor-management wage negotiations
next spring,” one of nine board members said at the December
18-19 gathering. There is only a small risk of underlying
inflation overshooting its 2% target by a significant degree,
the same member said.
Another voiced the opinion that there is now “sufficient
leeway” to determine whether a virtuous wage-inflation cycle has
been achieved after the bank enhanced the flexibility of its
yield curve control mechanism in October.
Those opinions may help cool market speculation as to
whether policymakers will end the world’s last negative rate
regime at their January meeting.
The yen weakened and yields fell after the release of the
summary, an indication that investors’ initial impression was to
nudge back their expectations of an imminent rate hike
Reconsider the growth numbers as the immediate consequence of a disinflationary shock. With inflation collapsing, growth receives a mechanical boost, and this appears to have begun in the third quarter. Inflation effectively returned to a 2% annualized rate in June on a monthly basis and has held there, and we were so busy looking at three-, six-, and twelve-month averages it just slipped right past us. Inflation has simply collapsed:
Inflation has officially fallen to the critical 2% level, according to a measure released Friday morning by the Bureau of Economic Analysis, adding fuel to the historic equity market rally heading into year’s end.
The core personal consumption expenditures price index fell to 1.9% in November on a six-month annualized basis.
The core PCE index is the Federal Reserve’s favored inflation metric as it directly tracks how much Americans spend on less volatile goods and services.