Amid Sticky Inflation, Fewer, Later Rate Cuts Expected

For the week ending 12 April 2024

As of midday on Friday, global equities were lower on the week amid renewed fears that the war in the Middle East could widen and that future interest rate cuts will be smaller and later than anticipated. The yield on the US 10-year Treasury note rose 13 basis points from a week ago to 4.51% after Wednesday’s stronger inflation data and traded as high as 4.585% earlier in the week. West Texas Intermediate crude oil held near recent highs above $87 a barrel while Brent crude hit its highest level since October over concerns Iran may directly attack Israel in coming days. Volatility, as measured by the Cboe Volatility Index (VIX), extended its gains, reaching 17.8.

MACRO NEWS

Three’s a trend

After three hotter-than-expected CPI readings in a row, investors scrambled this week to adjust their expectations for rate cuts by the US Federal Reserve downward. Ahead of Wednesday’s data, markets had expected between two and three rate cuts before year end, with the first likely in July. After the 0.4% month-over-month rise in both headline and core March CPI, the market is now pricing in only between one and two cuts, with the first not fully priced until September. That’s a remarkable swing since early January when markets were pricing nearly seven quarter-point rate cuts. While Thursday’s producer price data was less worrisome than the consumer data, market pricing was little changed compared with post-CPI price action. US 10-year Treasury note yields spiked more than 20 basis points in the immediate CPI aftermath and remain elevated at 4.51%. In the wake of the data, Fed officials mostly emphasized that the central bank is in no hurry to adjust policy and has time to wait for more data. The next key inflation data point is core PCE on 26 April.

ECB sets stage for June cut

The European Central Bank held rates steady at its meeting Thursday, but ECB President Christine Lagarde acknowledged that a few members of the Governing Council were already prepared to lower interest rates at this week’s meeting, though a large majority wanted to wait until June when they will have more data. A move to lower rates is not dependent on the Fed, she said.

Biden pledges closer ties with Japan and the Philippines

After a meeting with Japanese Prime Minister Fumio Kishida and Philippines President Ferdinand Marcos Jr., US President Joe Biden vowed closer military ties between the three countries to counter China’s increasing influence in the Pacific. In recent days, China has taken aggressive action toward Philippine boats around the Spratly Islands, over which China claims control despite a 2016 ruling by an international tribunal rejecting China’s claims. President Marcos has nearly doubled the number of bases in the Philippines US troops have access to and is holding talks with Japan on allowing the presence of Japanese forces on Philippine soil. Biden said Thursday that any attack by China on aircraft, vessels or the armed forces of the Philippines will invoke a mutual defense treaty.

FOMC minutes confirm slower QT pace

Minutes of the March meeting of the FOMC show that policymakers judged that the central bank was “well positioned to respond to evolving economic conditions and risks to the outlook, including the possibility of maintaining the current restrictive policy stance for longer should the disinflation process slow.” With the inflation picture darkening since the meeting, markets are taking the Fed at its word that rate cuts are less likely than they were several weeks ago. Officials favored cutting the $60 billion monthly runoff of Treasuries on the Fed’s balance sheet by roughly half “fairly soon,” but expect to maintain the $30 billion monthly cap on mortgage-backed securities.

QUICK HITS

Bloomberg reported Friday morning that Israel is bracing for a potential direct attack from Iran as early as Saturday in retaliation for last week’s Israeli attack on Iran’s consulate in Damascus.

Fitch Ratings downgraded the outlook for China’s sovereign debt on Wednesday to negative from stable, citing increasing risks as the government tries to pull the economy out of a real estate-driven slowdown.

At the request of Ukrainian President Volodymyr Zelensky, the Swiss government will host a two-day, high-level conference in June aimed at achieving peace in Ukraine, it said on Wednesday, although Russia has made clear it will not take part in the initiative.

Amid higher US bond yields following this week’s upside inflation surprise, the Japanese yen fell to 153.32, its lowest level against the US dollar since 1990. The currency’s slide is raising the odds of the Bank of Japan raising its policy rate above zero in the months ahead.

The US budget deficit widened to $1.07 trillion in the first half of FY 2024, up 4% year over year.

Producer prices in China continue to deflate, falling 2.8% year over year in March while consumer prices rose a scant 0.1% over the same period.

The International Monetary Fund warned this week that private credit could heighten systemic vulnerabilities given the limited oversight of the asset class.

The Biden administration proposes to cancel up to $20,000 in unpaid interest for student loan borrowers who owe more than their initial loan amount. Individual borrowers who earn $120,000 or less and married couples who earn $240,000 or less would be eligible to have that interest wiped from their balance. An earlier Biden plan to forgive certain student loans was invalidated by the US Supreme Court.

Investors allocated $65.6 billion to active ETFs in the first quarter, more than 50% higher than the previous record of $41 billion in the fourth quarter of 2023. Assets under management in the vehicles rose to $758 billion, according to Morningstar.

Consumer confidence in Japan rose for a sixth-straight month in March and reached its highest levels since May 2019.

The Bank of Canada held rates steady at its meeting Wednesday. Governor Tiff Macklem told a press conference that policymakers are seeing what they need to see on inflation but said they’d like to see the trend continue to gain confidence that price stability can be maintained. Swaps markets have fully priced in a July rate cut.

Within days, President Biden is expected to formalize a ban on the production of oil and gas on roughly half the 23 million acres that were set aside in the past on Alaska’s North Slope to serve as an emergency oil reserve. Leaseholders in the region are expected to fight the ban. Administration officials argue the changes are necessary to balance oil development with the protection of sensitive landscapes that provide habitat for polar bears, migratory birds and caribou.

The US government has proposed raising tens of billions in funding for Ukraine, secured by the future profits generated by Russian state assets frozen by western countries, the Financial Times reported.

A report authored by former Fed chair Ben Bernanke for the Bank of England found significant shortcomings in the BOE’s baseline economic model. Outdated software and a variety of makeshift fixes kept the bank’s staff from producing alternative scenarios swiftly, the report said. Bernanke was commissioned to undertake the review after the BOE, like most central banks, failed to anticipate the inflation surge that resulted from the economic shocks of the pandemic era and the war in Ukraine. Bernanke encouraged the BOE to give markets clearer guidance on rates but stopped short of advocating for a Fed-style dot plot, something he introduced during his tenure at the US central bank.