Markets Aren’t Too Worried About Future Inflation Risks

Markets

Three in a row. Yesterday’s scenario on core bond markets was another repeat from Monday and Tuesday: consolidation during European dealings, before taking a step higher after early US eco releases. ADP employment increased by 145k in March following an upwardly revised 261k in February, but fell short of expectations (210k). After the ADP report, markets also had to stomach a disappointing services ISM (51.2 from 55.1 vs 54.4 expected). Details showed a broad-based setback. Business activity fell slightly from 56.3 to 55.4, but big declines in new orders (52.2 from 62.6) and new export orders (43.7 from 61.7) don’t bode well for coming months. The backlog of orders fell below the 50 boom/bust mark for the first time since end 2020 (48.5 from 52.8). Employment growth slowed from 54 to 51.3. Supplier deliveries (45.8 from 47.6) fell to the lowest level since 2009 in a sign that supply chain bottlenecks are something from the past. Moderating demand and smoother supply chains pull prices paid from 65.6 to 59.5, the slowest pace of price increases since July 2020. The loss of momentum added to market pressure that the Fed is probably done with tightening. A full percentage point of rate cuts is discounted by January 2024, reflecting markets’ bearish outlook on the US economy with financial stability risks adding to uncertainty. We stick to the view that the Fed will very unlikely follow such path given the inflation outlook. Giving in to such easing pressure now risks becoming the bigger policy mistake, allowing inflation to claw back in the second half of the year. Markets aren’t too worried about future inflation risks and bank on short term economic support from the Fed, something they got used to over the past decade. US Treasury yields ended 4.5 bps (2-yr) to 1.8 bps (5-yr) lower. Intraday swings had been larger, but for the first time this week yields managed to close some bps above intraday lows. This might point to some fatigue with technical support levels at play as well. The US 2-yr yield tested the March lows between 3.55% and 3.71% but avoided a new closing low (close at 3.78%). The US 5-yr yield tested the 3.3%/3.23% support zone before closing at 3.37%. The US 10-yr yield tested 3.29%/3.28% support and closed at 3.31%. If anything, it shows that volatility remains very high. It also means that above-mentioned support zones are still at risk of giving away with jobless claims (today), payrolls (tomorrow) and US CPI inflation (Wednesday) lining up. Erring on the dovish side of expectations going into the Easter weekend might be another motive. The jury is still out with Fed members at the moment not providing sufficient counterweight. We don’t expect them to call for many more rate hikes, but at least to put the notion of rate cuts to bed. Recall that the March dot plot (Mar 22; after SVB turmoil) showed unanimity on keeping rates stable and even above 5% (17 out of 18) for the remainder of the year. US stock markets for the first time this week lost ground despite lower yields with doom and gloom scenario’s at play. Bearish engulfing patterns suggest more downside. The dollar profited in the same vein with EUR/USD back below 1.09 from an open around 1.0950.

News and views

The National Bank of Poland kept its policy rate unchanged yesterday at 6.75%. The NBP sees weakening of activity around the world and in Poland even as unemployment remains low. Polish inflation remained elevated in March but decreased to 16.2% Y/Y (from 18.4%). Lower commodity prices, a slowdown in PPI, weakening economic activity and the effects of earlier strong monetary tightening suggest a further decline in inflation in coming months. The NBP repeats its previous assessment that the decrease in inflation would be faster if it were to be supported by an appreciation of the zloty consistent with the fundamentals of the Polish economy. It may intervene in the FX market to limit fluctuations of the zloty that are inconsistent with the direction of monetary policy. NBP governor Glapinski gives a press conference this afternoon. PLN underperformed HUF and CZK, closing near EUR/PLN 4.687

The Reserve Bank of India this morning surprisingly left its policy rate unchanged at 6.5% instead of hiking by 25 bps. The RBI is ready to take further action against inflation if needed. Its policy stance is still labelled as ‘withdrawal of accommodation’. The central bank raised its policy rate by 250 bps this cycle and wants to evaluate the impact. Inflation is judged to moderate from 6.44% in February to 5.2% in the FY starting in April (inflation target 2%-6%). The RBI slightly raised its growth forecast to 6.5% from 6.4%, but risks have increased after recent events. The Indian rupee initially weakened slightly, but currently trades little changed near USD/INR 81.9.