News & Analysis


Markets were allowed to drift unchecked by the economic calendar yesterday. This saw momentum in US short-term interest rate markets continue in a hawkish direction, with traders assigning just 50% odds of a June rate cut at one point in the session. While the move in US rates has since retraced, the dollar continues to trade with a firming bias, assisted this morning by an underwhelming hike from the Bank of Japan and the RBA’s removal of its hiking bias (more on this below). Looking ahead to today, we expect the dollar to trade on a stronger footing against both G10 and EM currencies as yields continue to hover around YTD highs and markets brace for a potential breakout to the upside should either the Fed’s updated dots or Chair Powell strike a less confident tone relative to that earlier in the month.


Today’s major events have taken place in the APAC session overnight, where the Bank of Japan hiked interest rates by 10bps to call an end to eight years of negative rates and abandoned its yield curve control policy, while the Reserve Bank of Australia removed its explicit hiking bias in favour of a more neutral policy stance. Despite the BoJ beginning to normalise policy, markets were left underwhelmed as the Bank undermined any hawkish signal with dovish twists on its balance sheet operations and its forward guidance, noting that it “anticipates that accommodative financial conditions will be maintained for the time being.” Meanwhile, Governor Ueda sounded dovish within his press conference, leading us to believe that the Bank is unlikely to compound today’s move with a further hike until October at the earliest. This led to some, albeit moderate, short USDJPY positioning to be shaken out, resulting in the pair rallying 0.8% on the decision. The Aussie dollar finds itself own by a similar amount today too after the RBA also dovishly surprised markets with its forward guidance, shifting from an explicit hiking bias to a more neutral stance. Governor Bullock reiterated the guidance from the policy statement, noting that the Bank is “not ruling anything in or anything out” and characterised this incrementally dovish tweak in guidance as a “response to some data that makes us more confident about the path we are on”, most likely the downwards surprise in January’s inflation reading. This has brought forward consensus expectations of a rate cut from the RBA, with the implied probability of an August cut rising around 20 percentage points to 97.5%. Given the dovish policy developments, both currencies are now somewhat vulnerable to further depreciation should the Fed cast a less confident tone at tomorrow’s meeting. While for USDJPY, we think upside is limited, the same can’t be said for the downside potential for the rates and growth sensitive Aussie dollar, which could find itself at the bottom of the G10 pile come tomorrow evening.


A continued rally in US yields has pushed EURUSD towards the lower end of its recent range to start the week. The pair is now approaching levels that we believe are more in line with short-term interest rate differentials, which are currently at their widest levels of the year at 137 basis points. We see little reason for this dynamic to change either in the immediate futures, even as today’s ZEW expectations data and Q4 labour costs are in focus for euro traders. The first of these should tell a broadly similar story to other recent data points. In other words, leading indicators for the economy should continue to improve, even as measures of current conditions largely underwhelm. Labour costs however, might grab the attention of markets, not least given the ECB’s focus on wages and their pass through to inflation as a basis for not cutting rates until June at the earliest. Whilst we suspect it would take a large slide in the reading from its Q3 level of 5.3% for the ECB to consider an earlier cut, such an eventuality could take place considering the weak growth rates in the eurozone at the turn of the year. Even so, we continue to see Wednesday’s Fed meeting as the key risk event for rate differential expectations, and for EURUSD. If our baseline scenario holds and the Fed strikes a more cautious tone on rate cuts, all that would be needed would be Eurozone PMI data on Thursday showing that the Eurozone economy remains stagnant despite the recent improvement in forward looking indicators. Such an outcome should see EURUSD struggling to hold above the 1.08 level. However, we believe the downside room from there remains limited, largely because the risk of an ECB cut in April is likely to remain constrained by the central bank’s own guidance, at least for now.


A quiet start to the week for sterling belies a busy UK data calendar, starting on Wednesday. For now, this has seen the pound trade broadly in line with other G10 currencies, with a subdued day of price action on Monday giving way to an uptick in the dollar this morning. Tomorrow however, UK CPI comes into focus, with a broad cooling expected to be seen across price growth indicators. Whilst it is likely to be headline readings that grab market attention, we would suggest keeping a close eye on wage sensitive services components, in particular, retail, leisure and hospitality. Given that these sectors are disproportionately staffed by minimum wage staff and with wages in turn forming a large portion of input costs, we will be looking for any indications that firms are beginning to pass on price increases in advance of April’s rise in the National Living wage. Admittedly, the February data may be too early to see this play out. But we would also note that a number of firms chose to give out pay rises to employees in advance of the official April 1st increase date, suggesting that any passthrough could also come earlier. As such, while the absence of any uptick in price pressures in tomorrow’s data would not be conclusive, a rise in price growth across wage sensitive sectors would likely be cause for concern at the Bank of England. All told, we think this biases sterling risks for both tomorrow, and the BoE’s rate announcement on Thursday to the upside, though a broadly in line print this month, and neutral rhetoric from the MPC remains our base case at present.


As noted in yesterday’s morning report, the February inflation report due this afternoon is likely to be key for both the BoC and the loonie. In the case of the former, a rise in the reading as expected by markets could go someway to vindicating the Bank’s hawkish pivot earlier in the month. A further softening, in contrast, could see April rate cuts bets begin to be priced in once again, having been almost entirely extinguished following this month’s policy meeting. As such, this suggests an asymmetric reaction is likely from markets. Barring a sharp reacceleration in price pressures, market expectations for the BoC should remain unmoved, as should the loonie. But if traders were to start reconsidering an April rate cut on weaker than expected data, this could drag the loonie sharply lower later today. Even if headline readings do print in line with market expectations, we would caution against reading this as a sign that disinflation is only progressing slowly. A notable feature of recent readings has been the sharp cooldown in ex-shelter price growth, more indicative in our view of price pressures in the broader economy, and a measure that has recently cooled sharply. Ex-shelter inflation is worth keeping an eye on not just for this reason, however, but also because it could make a notable appearance in the BoC’s meeting minutes published tomorrow. It was significant that Governor Macklem shifted focus away from this measure at the March meeting with little explanation. If it turns out this measure remains a focus for the Governing Council, this could further undermine the hawkish tone of the March meeting, suggesting that further upside risks could be in store this week for the loonie.


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