As the dust settles on another Federal Reserve meeting, markets have lengthened the odds on a first rate cut in March only to double down on an easing in May.
It was a typically volatile reaction as the Fed statement dropped a tightening bias, as expected, but inserted a warning that cuts would not be “appropriate” until there was more confidence that inflation is heading back down to 2%.
The exterior of the Marriner S. Eccles Federal Reserve Board Building is seen in Washington, D.C., U.S., June 14, 2022. REUTERS/Sarah Silbiger
In his news conference, Fed Chair Jerome Powell chose to be unusually specific in saying that a cut as early as March was unlikely. Fed futures duly reduced the probability of a March move to 34%, from 60% just before the announcement and 40% on Tuesday.
Yet, Powell was also clear that the entire FOMC expected lower rates this year – it was just a matter of timing. Notably, a strong labour market would not derail the easing, he said, but the Fed would cut faster if employment weakened.
Such an asymmetric outlook only makes Friday’s payrolls report all the more important, with any downside surprise likely to shift the market back to a March kickoff.
For now, futures are pricing in about 32 basis points of cuts for May – 25 bps plus some chance of 50 bps – and 141 basis points of easing for all of 2024.
If the Fed does delay until May and inflation keeps falling, as the doves reason, it will have to be more aggressive in easing to stop real rates from becoming punishingly restrictive.
Bond investors are clearly in the dovish camp, with two-year Treasury yields now at 4.248% versus 4.359% late on Tuesday. Ten-year yields edged up a little during Asia trade to 3.946%, but that is still down from Tuesday’s 4.057%.
The drop in yields pulled the dollar down on the yen to 146.70 but didn’t offer much help to the euro, at $1.0812, as markets are still wagering heavily on an early ECB easing.
Futures are almost fully priced for a first ECB cut in April and have 144 bps of cuts pencilled in for 2024.
The Bank of England holds its first meeting of the year later on Thursday and is certain to hold at 5.25%. Again, with inflation slowing faster than expected, markets want to hear concrete talk of cuts. That leaves them vulnerable to any official pushback.
The central bank also releases its quarterly outlook for the economy and the focus will be on forecasts for how quickly inflation is seen returning to the 2% target.
As for Wall Street, the main course will be results from Apple, Amazon and Meta, with investors looking for better news after being disappointed by Alphabet Inc and Tesla.
Key developments that could influence markets on Thursday:
EU Dec CPI and unemployment rate; Global PMIs for Jan
Bank of England policy meeting and quarterly policy report; Riksbank policy meeting
ECB speakers include President Lagarde, chief economist Lane, Governor Herodotou and member Centeno
U.S. Jan ISM manufacturing survey, S&P PMI, weekly jobless claims, Q4 productivity and labour costs, Dec construction spending
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