Markets Lie in Wait Ahead of Central Bank Decisions

Stocks were trading in a pretty muted fashion early Monday ahead of a spate of central bank decisions due this week. European indices traded mildly higher and US futures were firmer after the S&P 500 index and Nasdaq saw their first back-to-back weekly losses since October; yields rose last week sharply on higher-than-anticipated inflation data. 

The 10-year Treasury is north of 4.3% and gold has trimmed its advance to all-time highs, back about $50 from its all-time high to around $2,145. The dollar index was broadly flat at 103. Bitcoin is about 8% below last week’s record high.

All Eyes on Tokyo

The Bank of Japan decision tomorrow morning could see the first hike since 2007. The conclusion of ‘shunto’ wage negotiations in Japan has seen the biggest pay rises in about three decades, with average gains of 5.28% being reported, paving the way for the BoJ to end its negative rates policy. 

There are strong signals coming from the central bank that there may be enough in the wage talks to justify a policy shift at its March meeting, though there is a chance policymakers may choose to wait until April. "The outcome of this year's annual wage negotiation is critical” to deciding on when the BoJ should exit negative rates, Governor Kazuo Ueda told parliament last week.

BoJ sources and leaks have not always been accurate but whether it’s March or April, the BoJ is about to pull the trigger, it seems. The yen slackened further on Monday after declining for most of last week, with USDJPY back above 149.

If central banks are all about to cut – save the BoJ – then so what? We asked this in the latest episode of our podcast, Overleveraged.

Reserve Bank of Australia

The Reserve Bank of Australia is expected to remain on hold, maintaining a hawkish tone to its language but ultimately cutting a couple of times later this year. No change is expected from the RBA on Tuesday. 

The Australian central bank left its benchmark rate at a 12-year high of 4.35% in February thanks to cooling inflation, but minutes of the meeting showed policymakers did discuss rate hikes. The RBA noted that "a further increase in interest rates cannot be ruled out”, but markets see this as a screen designed to prevent investors from pricing in too much easing this year. 

AUD to USD slipped a big figure in the last two sessions of the week on USD strength but has firmed up on Monday at the 200-day line support.

Swiss National Bank

The Swiss National Bank may opt for a cut, but surveys suggest the consensus is also June. The SNB could be the first to cut – CPI inflation fell to 1.3% in January vs a forecast 1.7%%, as it was in December. That surprise fall showed inflation undershooting the SNB’s forecasts for Q1, prompting many to speculate the central bank will cut this month. It may, however, to prefer to wait until the likely moves by the European Central Bank and Fed in June. 

U.S. Federal Reserve

The Federal Reserve will hold rates steady, but the focus will be on the updated dot plot and economic projections. A fresh dot plot will tell us a lot about how cautious members have become in recent weeks. 

Even if the hotter-than-expected inflation numbers last week haven’t drastically altered the expectations for June – there is a lot of time between now and then – it could have an important impact on FOMC members’ projections for core PCE inflation and their views on cuts for the year.

It’s more complicated than inflation data may suggest – the Fed like other central banks is about to commit to accepting permanently higher inflation. ISM employment components are in contraction, the NFIB survey suggests hiring by small firms is the weakest since May 2020 and the quits rate has slowed a lot. Plus, there are a lot of well-publicised layoffs among large employers.

The U.S. job quits rate — a metric that measures voluntary job leavers as a proportion of total employment — is back to its pre-Covid norm.

Inflation in the U.S.

Inflation has come down to a point where policy rates are currently restrictive – cutting can be explained simply as moving to a more neutral position. Currently, the FOMC thinks the neutral rate is about 2.5%, which means there are 300bps of cuts just to get too neutral. Hence why the market has been, overall, quite relaxed about these inflation numbers and continues to expect a cut in June.

As I mentioned last year, central banks are going to have to accept higher inflation and may eventually move the goalposts. 

As BofA notes: “US headline/core CPI trending to 3.6-4.0% by June when Fed expected to cut rates; implicitly Fed tolerating higher inflation (eases US debt burden); weaker policy credibility = weaker currency…why crypto & gold at all-time highs.” 

We’ve heard mutterings about allowing central banks to raise their inflation targets and I’ve been saying for a while now that CBs will either explicitly or implicitly need to accept, they are not going back to 2%. Probably the tacit acceptance will just become de facto policy. Credibility will be lost, but so what? 

And I go back to the speech by Christine Lagarde last April, which I think I repeated last week. This, I said at the time, was “a signal that we are about to go into a protracted economic (and maybe real) war and it will require the mobilisation of the state and people – developed world central banks (Fed, ECB, BoE, BoC, RBA) will act together to orchestrate fiscal spending and suppress yields”. 

Higher for longer means inflation, not necessarily rates. And remember, this is an election year.

Bank of England

The Bank of England is also seen on pause and is about 50-50 on a cut in June. No change is expected on Thursday, but the BoE expects inflation to fall to 2% in the next couple of months, leaving the path clear for the MPC to move more swiftly towards cutting rates than some peers. Or maybe not – inflation is seen falling to 2% but then picking back up to 3% later in the year.

Bank of England Governor Andrew Bailey said that the UK is “near or at full employment” and seems less worried about a wage-price spiral. Wage growth has come down, too, as a cooler jobs report saw traders bring forward expectations for the BoE to cut in June from August.

However, the minimum wage in the UK is about to go up 10% and wage growth remains relatively high at around 6%. Markets will be waiting to see if the BoE is willing to lean into the idea of a June cut or retain a slightly more cautious outlook.

My preference is that they stress the need for more evidence that inflation is coming down before moving. The Haskell and Mann camp who voted to raise rates to 5.50% in Feb will surely be silenced and if they vote to hold then I think it confirms the MPC has moved to a position of a clear easing bias. The British pound has had a good run this year, with the GBP to USD rate testing $1.29 before pulling back on renewed USD buying.

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