Euro Still Outperforms Dollar

Markets

The countdown to this evening’s Fed policy decision was spiced by comments from ‘The ECB and its Watchers’ conference organized by the Institute for Monetary and Financial Stability at the Goethe University in Frankfurt. At the opening speech, ECB chair Lagarde repeated the messages from last week’s press conference. After Thursday’s 50 bps hike, the ECB shifted to a data-dependent approach. Still, if its baseline scenario holds, the ECB has ‘ground to cover to make sure that inflation pressures are stamped out’. At the same time, the ECB is ‘ready to act and provide liquidity support to the financial system if needed and to preserve the smooth transmission of monetary policy’. In this respect, there is no trade-off between price stability and financial stability. Further ECB steps are guided by the inflation outlook, underlying inflation and an analysis of the process of monetary transmission (how do tighter monetary conditions translate into slower demand?). Other ECB members (Lane, Rehn) later confirmed Lagarde’s assessment. Was it due to the ECB comments or ‘simple’ follow-through action as uncertainty eased further, German yields rose another 14 bps (2-y) to 5.0 bps (30-y). Gilts underperform (2-y +23 bps) both Bunds and Treasuries. UK February CPI data published this morning (headline 1.1% M/M and 10.4% Y/Y, from 10.1%, core up from 5.8% to 6.2%) leave the BoE little choice but to raise the policy rate by 25 bps tomorrow. Markets also again embrace the idea of a BoE policy rate peak beyond 4.5%. Awaiting this evening’s Fed policy decision US yields currently gain between 7 bps (2-y) and 1 bp (30-y). Equites extend this week’s rebound (Euro Stoxx 50+0.5%, S&P little changed). On FX markets, the euro still outperforms the dollar, with EUR/USD intraday testing the 1.0803 resistance (currently 1.0785). The move isn’t solely euro strength. USD DXY slipped further south to test the 103 area. Higher core yields still put the yen in the defensive, but losses are smaller than at yesterday’s repositioning (USD/JPY 132.8). Sterling gains stay modest despite additional interest rate support post this morning’s CPI data with EUR/GBP holding near 0.88(1). Of course, current intraday trends are highly conditional to this evening’s Fed policy decision.

US money markets currently see an 80%+ probability for a 25 bps Fed rate hike bringing the target range for the Fed funds rate to 4.75-5%. We expect the Fed to take a similar approach similar to the ECB, using specific/separate tools to address price stability and financial stability. Also take a close look at the new projections (dots) of the governors on the Fed rate path going forward. We expect a big majority of the Fed governors to put the end of year level for the policy rate well beyond 5.0%, a scenario that also rejects current market pricing of Fed rate cuts in H2. Such a scenario might support a further rise in US short-term yields and help put a floor for the dollar.

News & Views

Czech National Bank deputy governor Zamrazilova is pushing back against the idea of policy rate cuts this year. The CNB’s core approach is keeping interest rates elevated for a longer period of time. Before any rate cut debate can start, she wants inflation to fall back in single digit territory and review Q2 wage growth and household consumption data (published in September). “We definitely won’t start lowering rates until we see some easing of these persistent economic imbalances stemming from the tight labor market and loose fiscal policy”, she added. The Czech currency is expected to remain strong, reflecting strong bank-asset quality as well. EUR/CZK today declines from 23.85 to 23.70. CZK swap yields rise by up to 16 bps at the 2y tenor and 11.5 bps at the 10y.

Belgian consumer confidence dipped slightly in March, from -8 to -9 and thus staying below the long term average (1990-2022) of around -7. Household confidence faltered after four consecutive months of improvement (-27 low in September & October). Households have revised downwards their expectations of the general economic situation over the next twelve months (-16 from -13) and expressed growing fears of a rise in unemployment (19 from 16). On the personal level, households have stepped up their saving intentions (4 from 1), while expectations of their own financial situation remain basically the same (-4 from -3).