The Bank of Japan (BOJ) is almost certain to hold its policy rate steady at 0.5% this week though, as we have been writing, the case to raise rates on May 1 has been steadily building in the background.

Rising inflation, the latest bid by unions for wage increases and importantly, a higher yen, all have been supporting BOJ governor Kazuo Ueda’s bid to secure a “virtuous cycle” of wages and prices, so he can push the policy rate higher.

However Ueda’s caution to avoid rattling markets or signal that the Bank is stepping up the pace of its hikes is likely to limit his post March 18-19 meeting press conference comments to hints at the Bank’s readiness to hike again at a future meeting.

The SEP

We anticipate the SEP will reflect the standard theoretical impact of a supply side shock. The standard impacts are lower growth and higher unemployment and inflation. The Fed has more certainty about the nature of the shock than it did at the December FOMC meeting, and FOMC participants should incorporate that updated knowledge in their forecasts.

We think higher unemployment and inflation will offset each other and allow the median dots to remain the same as in December.

We see at least a 50-50 chance the Fed pauses QT at this meeting. The messaging around QT has been sloppy. On one hand, the Fed has rolled out a bunch of metrics to say that reserves are still abundant. On the other hand, the Fed sees that debt ceiling dynamics may temporarily make reserve less abundant. If the latter is a concern, it doesn’t make much sense to wait until the Fed is closer to a problem before pausing QT which argues for pausing at the beginning of April.

Powell can describe rising unemployment and inflation forecasts as having offsetting impacts on the policy rate projections; it’s simply the dual mandate in action. Higher unemployment is the pain necessary to ensure that inflation returns to trend.

Assuming the SEP follows our expectations, Powell may be asked to explain why the SEP continues to forecast rate cuts even with rising inflation forecasts. This isn’t easily explicable without a higher unemployment forecast. Without a higher unemployment forecast, the Fed needs to lower the expected number of rate cuts, otherwise the Fed’s reaction function will be perceived as more dovish and fuel inflation expectations.

There is no consensus for an imminent rate cut. With the data the Fed has on hand, the labor market is in balance and inflation threatens to be sticky above target. There is little room to consider a rate cut at the May meeting at this juncture; in Fed parlance, there is no hurry to cut rates (the hurry will come if initial claims start to rise). Powell can largely repeat his pre-blackout messaging.

Bottom Line: This week is shaping up to be a key moment for Federal Reserve Chair Jerome Powell. The Fed takes fiscal policy as given, and Powell needs to decide what that means in this environment. If Powell decides that Trump’s tariff salvos will soon wane, he will lean toward looking through tariffs as temporary and signal a willingness to adjust rates more quickly. We think, however, it is more likely than not that Bessent has disabused him of that notion, and he will follow the unified guidance of FOMC participants which is to push any rate decisions toward the back half of the year.

If You Don’t Have Time This Morning

For the Fed, risks are growing to both sides of the distribution. On one side, Trump-driven uncertainty is beginning to weigh on confidence, raising the risk that firms need to put investment and hiring decisions on hold until they see clarity on tariff policy and the federal budget. That raises the specter of the kind of coordinated pessimism that precedes periods of weaker growth. On the other side, inflation expectations have picked up, something that already keeps FOMC participants up at night as they ponder the impact of tariffs. The Fed doesn’t feel a need to address either side of the distribution for now. The Fed views the labor market as balanced and resilient and while inflation is off its peak, it’s still elevated. The Fed sees no urgency to act and is comfortable moving to the sidelines for the foreseeable future. It likely won’t cut rates in the coming months on inflation alone; rate cuts require that the Fed sees a threat to the employment mandate. That outcome strikes us as more likely than the possibility that the labor market overheats such that the Fed begins reversing last year’s rate cuts.

what will ultimately determine the rate path from March onwards will be the evolution of inflation. And in view of the divisions within the Executive Board, the February and March inflation reports will gain even greater importance.

In part due to base effects, the ECB expects services inflation to finally drop to levels compatible with its 2% target over the coming months. More importantly, there is widespread evidence that wage pressures are coming down dramatically. And on the activity side, there is a chance that the already modest expectations for 2025 growth will need to be revised down in March, yet again.

If You Don’t Have Time This Morning

As we have expected since the beginning of the year, the Fed is positioning for an extended pause. FOMC participants are in no rush to again recalibrate interest rates. With growth solid, the labor market roughly in balance, and inflation still above target, the Fed is content to sit back and adjust policy, if necessary, only after it sees the impact of Trump policies.

The Reserve Bank of Australia (RBA) looks set to serve up its first rate cut in almost five years this month as the balance between considerations of keeping downward pressure on inflation without spiking unemployment, starts to tip toward downside growth risk.

The RBA will likely cut its cash rate 25 basis points to 4.10% at its February 17-18 forecast round meeting, accompanied by a slight reduction in its inflation forecasts if the most recent quarterly inflation data have confirmed its projections that further progress is likely.

The decision will not come without arduous Board debate and agreement to go it slow thereafter. Governor Michele Bullock’s press conference will center on that inflation-vigilant hawkish message.

In short, under “current law” scoring the Joint Committee on Taxation or Congressional Budget Office in its projections assumes tax cuts will expire as legislated and thus show savings after the expiry of certain elements of the 2017 TCJA. Extending the TCJA under that scoring would, in theory, “add” plus or minus $4 trillion of costs over a 10-year projection period.

Under “current policy” scoring, as the description suggests, the calculation is based on current policy, rather than legislation, and so simply extending the current TCJA policies would not add significant costs beyond technical adjustments here and there.

Importantly, there is precedent for using “current policy” scoring, including for example in the last administration when former president Joe Biden rejiggered some children’s assistance programs into new initiatives but at no new additional expense, and which raised no hackles from either side of the aisle.

So, the name of the game for Republicans may be not to offset the entire current law scored “cost” of the TCJA extension plus and real new costs of additional tax cuts, but to find perhaps $2 trillion or so in cost cuts over the standard 10-year projection period.

And so, despite Trump’s statement at Friday’s press conference with Japanese Prime Minister Shigeru Ishiba that he was now leaning more towards targeted “reciprocal” tariffs than a universal tariff, it seems clear to us that substantial revenue will need to be raised via tariffs no matter how these are labeled.

In other words, we do not expect “reciprocal” tariffs to be as modest as might be inferred from effective tariff rate differentials between the US and its major trading partners.

Rather, we expect the Trump administration will also factor heavily for non-tariff barriers, from China’s subsidies of domestic enterprises to the European Union’s heavy use of Value-Added Taxes (VAT) that effectively tax imported and other domestic consumption goods but are not applied to exports.

And finally, regarding the initial 25% tariff lobbed against Mexico and Canada for their lack of action in stemming the flow of fentanyl and migrants across the US border, which was delayed by 30 days after promises to cooperate, many in Washington think that may have been a dry run of the president’s powers under the IEEPA (International Economic Emergency Powers Act) for potential future tariffs as well.

In short, under “current law” scoring the Joint Committee on Taxation or Congressional Budget Office in its projections assumes tax cuts will expire as legislated and thus show savings after the expiry of certain elements of the 2017 TCJA. Extending the TCJA under that scoring would, in theory, “add” plus or minus $4 trillion of costs over a 10-year projection period.

Powell will be on Capitol Hill this week. Powell will appear at the Senate and the House on Tuesday and Wednesday, respectively, for the semi-annual Humphrey-Hawkins testimony (see below). Also, this week is Cleveland’s Beth Hammack, New York’s John Williams, Atlanta’s Raphael Bostic, and Dallas’ Lorie Logan. We anticipate these speakers will reiterate that the Fed is on hold for now as it works to understand the impact of Trump policies.

The all-important inflation data is the highlight of the week. The NY Fed inflation expectations numbers on Monday will gain additional attention as the Fed works to understand the impacts of tariff threats. Later in the week market participants get all the components that feed into PCE-inflation. The Fed anticipates that base effects will begin washing out of the data and bring down year-over-year inflation.

A slower-than-expected pace of progress will reinforce the Fed’s expectations that policy rates will remain unchanged for the foreseeable future. That said, we think the Fed is setting the stage for staying on hold even if inflation falls as anticipated. Market participants will be unnerved by any significant upside surprise in this week’s numbers. Although FOMC participants clearly do not anticipate rate hikes ahead, a high inflation number will lead market participants to put more weight on that potential outcome.

The Fed is moving toward a hawkish repositioning at the March FOMC meeting. With the economy settling into a patten of steady growth, the Fed sees room to turn its attention to the possibility that supply side disruptions attributable to Trump’s policies may un-anchor inflation expectations. Last Friday’s data only reinforces the Fed’s desire to move more firmly to the sidelines. The combination of solid job growth, a lower unemployment rate, and rising inflation expectations all feed into the hawkish repositioning.

The stated logic of a pause in April would be to downshift the pace of rate cuts as soon as rates touched the top end of a theoretical long-term neutral range.

But with euro interest rates still clearlyrestrictive by any real-world metrics, at least for this cycle, markets have over these last days fully priced a cut in April, or as we said “a straight line” of 25bp cuts every meeting through June, and beyond that a destination a bit south of 2%.

On a related note, we also made a bit of hay out of indications in Davos by ECB President Christine Lagarde that an ECB staff review due out on February 7 of the euro area long-term neutral range could peg that at a 1.75% to 2.25% range, as opposed to the slightly higher 1.75% to 2.5% range usually cited by analysts and reporters.

UK Chancellor Rachel Reeves’ declaration that the ruling Labour Party’s “number one mission” is growth, has set the stage for the Bank of England (BOE) to resume rate cuts with a 25-basis point easing to 4.50% at its February 6 meeting.

Notwithstanding the government’s plans to reinvigorate the UK economy over time, the government’s still bleak fiscal position remains, and the risk of persistent financial tightening suggests the Bank will be forced to cut rates to 3.75% by year’s end and likely further next year.

The European Central Bank will cut 25bp, from 3% to 2.75% on its benchmark deposit facility rate, when the Governing Council convenes this week in Frankfurt.

While preserving the flexibility of its “meeting by meeting” approach to rate decisions, President Christine Lagarde will affirm what markets already know, that this is not the last rate cut, and that more cuts are likely to follow.

The cadence and final destination for rates will be left open, but we continue to expect the ECB to cut rates by 25bp at every meeting – Jan, Mar, Apr, Jun – until the deposit rate hits 2% in June (see also SGH 1/15/25, “ECB: Shifting Balance of Risks”).

Putting exogenous forces for a moment to the side, market expectations of ECB rate cuts have also pulled back of course by a backup since December in rate cut expectations by the US Federal Reserve. Furthermore, markets have put great weight on the assessment by Executive Board Member Isabel Schnabel that the nominal neutral rate for the euro area economy lies well north of 2%, and so by extension any cuts below 2.5% will be delivered much more cautiously, feeding into the narrative of an April meeting skip.

While she is extremely influential, Schnabel’s assessment of a significantly higher than 2% neutral rate is not shared more broadly across the Governing Council, and ECB.

Indeed, in an interview last week in Davos, Lagarde pegged neutral as probably somewhere between 1.75% and 2.25%. From Lagarde:

You know, the [ECB] teams do as much work as they can to pin it [neutral] down within a range that is as reduced as possible. At the moment, it’s anything between, you know, 1.75, and 2.25, people will be discussing that at length. When we get closer to that, it will, the debate will be a little bit hotter, but it’s that very, very subtle point where our monetary policy neither stimulates nor restricts, and it’s, it’s a touch and go.

The Fed will leave interest rates unchanged at the end of this week’s FOMC meeting. We don’t think Fed Chair Jerome Powell will give a nod toward cutting rates in March. There isn’t yet any appetite at the Fed for a rate cut given still resilient growth and Trump-related policy uncertainty.

This week’s FOMC meeting should end without any fireworks. Unless the data unexpectedly breaks weaker, the Fed will remain on hold for the near term as it assesses the economy and the impacts of Trump’s policy agenda. We expect that Powell will maintain the status quo for policy expectations in the post-meeting press conference and we don’t think he will give a nod in favor of a March cut.

With the threat of US tariffs looming, the Bank of Canada (BOC) is poised to keep easing from its first meeting this year on January 29 and follow with additional rate cuts through this year as the country braces for a trade battle with the US.

BOC Governor Tiff Macklem, who arguably overachieved on his campaign to wrestle inflation back down to within the Bank’s target band, is now facing tariff-inspired downside growth risks far greater than he probably foresaw.

US President Donald Trump’s blanket 25% tariffs threat against Canada on February 1, if applied across the board, would plunge the US’ northern neighbor into recession.

Notwithstanding the BOC downshifting to a 25-basis point rate cut at this meeting, in our last report (see 1/7/25; “BOC: Not Done Yet”) we warned that December’s 50 bps cut to 3.25% was by no means its last move.

After January’s cut, the Bank may opt to skip the March 12 meeting while it waits for more clarity about the extent of US duties on Canada and resume cuts at its April 16 forecast round which would take rates down to 2.75%.

Trump and Xi discussed Ukraine, and Xi conveyed that Russia’s President Vladimir Putin was willing to meet Trump without any preconditions and hoped they would meet as soon as possible. Trump said a possible meeting with Putin is being prepared.

The Fed is on hold for the foreseeable future. With economic activity and job growth still resilient, the Fed has an opportunity to be very patient while it assesses the policies of the new administration. We don’t anticipate a rate cut in the first half of the year and believe that Fed hawks will put up a bigger fight before acquiescing to another round of recalibration cuts.

Markets have taken almost a full rate cut out of the euro rate curve over the past month, and almost two rate cuts since the peak dovish pricing of early December.

This has been driven in large part by a relentless back up in US yields and 2025 Fed rate cut expectations (see “SGH Tim Duy’s Fed Watch” reports), from which there was some relief finally today, and by a consistent message from European Central Bank officials stressing the virtues of sticking to a “gradual” – meaning 25bps – pace of rate cuts in the face of uncertainty.

The employment report supports our expectations that the Fed will hold rates steady for the foreseeable future, likely at least for the first half of this year. Lacking a pressing reason to cut rates and an uncertain path of inflation given Trump’s tariff threats, the Fed expects it has time to move to the sidelines and assess the impacts of past policy actions. Most FOMC participants still expect additional rate cuts this year if inflation falls as expected, but we note those same participants may see those cuts as unnecessary if growth and labor markets remain resilient.

Hawkish Minutes Overshadow Dovish Waller

Federal Reserve Governor Waller reiterated support for additional rate cuts if inflation falls as expected, but the release of the December FOMC meeting minutes reveal that the consensus on the Fed wants to delay rate cuts. Even Waller suggests that the Fed expects to hold policy steady until Trump-related uncertainty lifts. That uncertainty likely won’t lift until the second half of the year, which may put the Fed in an uncomfortable position of not responding quickly with easier policy if inflation falls meaningfully by March as base effects wash out of the data.

Canadian Prime Minister Justin Trudeau’s resignation will keep a dovish lean to Bank of Canada (BOC) monetary policy this year as it looks to prevent the current economic slowdown from escalating into a full-blown recession.

The Bank will likely step down to 25 basis-point cuts from its first meeting of the year on January 29 after easing 50 bps to 3.25% in December – the second consecutive 50 bps increment.

But greater-than-expected economic drag as a result of protracted political uncertainty, as well as the looming specter of US tariffs may prompt rates to be cut to a more deeply accommodative level than the BOC was previously contemplating.