It Might Take Until Summer for Fed to Start Easing Cycle

Markets

Fed Chair Powell signaled last week that the Fed wants additional confirmation that the economy is on a path that should bring inflation back to 2% in a sustainable way, even as inflation developed favorably over the past six months. The labour market in this respect is an important variable. Since the December meeting, the Fed again shifted its focus from inflation to both pillars of its mandate: price stability and maximum employment. For now, the employment pillar doesn’t force the Fed to scale back policy restrictions. The US economy in January again added an impressive 353k jobs, with an 126K upward revision for the previous two months on top. Wage growth accelerated to 0.6% M/M and 4.5% Y/Y (from 4.3%; 4.1% expected). Despite the recent rise in productivity, this kind of wage growth probably isn’t in line with inflation sustainably returning to 2%. Data from the consumer survey were less buoyant, but the unemployment rate remained stable at a low 3.7%. US yields jumped between 17 bps (5y) and 10.2 bps (30y). German yields followed at a distance, adding between 11.3 bps (5y) and 6.8 bps (30y). Markets now see only about 20% chance of a March rate cut and aren’t even sure anymore about a first step in May (80%). Even as markets had to scale back expectations on an early/aggressive rate cut cycle, equites held up well supported by positive earnings from tech bellwethers (Nasdaq +1.74%). The dollar outperformed. DXY closed at a new YTD top (103.92). EUR/USD dropped below the 1.08 handle (close 1.0788). Friday’s trends in bond and FX markets are extended this morning. Fed Chair Powell in an interview with CBS yesterday, repeated that it’s unlikely that the Fed will cut rates already in March as he sees a danger that recent good inflation readings might not be a true indictor of where inflation is heading. Confirmation is highly needed. The CBS interviewer indicated that Powell even suggested that it might take until summer for the Fed to start its easing cycle. The US 2y yield again adds 5 bps. USD extends its ascent (DXY 104, EUR/USD 1.078). Asian equities are trading mixed, with especially Chinese stocks showing volatility. They currently recover after another early session sell-off as the securities regulator vowed to take steps to contain the risks from the equity decline.

Market focus is again on the US with the services ISM and the senior loan officer opinion survey (SLOOS). The ISM is expected to revert an ‘unexpected’ December dip (52.0 from 50.5). Also prices and employment subindices deserve attention. For the loan survey, it will be interesting to see to what extend Fed policy is filtering through to actual credit practices as the economy continues to perform well. More signs of US eco resilience might push the US 2y yield for a test/break of the 4.5% resistance area. The technical picture of the dollar is improving. A sustained break of DXY above 104 in this respect would be illustrative. EUR/USD is also captured in a protracted downtrend with 1.0724/12 next key reference on the cards.

News & Views

Slovak Finance Minister Kamenicky said that his government wants to show investors that they have a clear consolidation trajectory and that its plan to reduce the budget deficit is credible. Rating agency Fitch as recently as December, downgraded Slovakia from A to A- over a deterioration of public finances and an unclear consolidation path. The budget deficit was 6.5% of GDP last year and is only to narrow to 6% this year. The government therefore is working on a €1.5bn package to cut spending and increase revenue, including cutting energy subsidies given the improving inflation outlook and energy market developments. Hungary’s economy minister Nagy delivered the opposite message, confessing that this year’s budget deficit target would be 4.5% of GDP rather than 2.9%. He forecasts the deficit narrowing to 3.7% of GDP in 2025 and to 3% in 2026.

The Turkish central bank (CBRT) fired its chair Erkan, 8 months into her job. She cited personal reasons and a smear campaign against her in local media as decision to step aside. She will be replaced by deputy governor Karahan who has credentials as an economist at the New York Federal Reserve and is expected to stick with the anti-inflation campaign or even take it slightly further. The CBRT raised policy rates to 45%, but suggested after its final 250 bps move in January that the rate hit a peak. The Turkish lira still holds close to all-time low levels near EUR/TRY 33.