Fed expectations back a 25bp hike in the wake of CPI data

Global banks, including the US regional banks, rebounded sharply on Tuesday.  

As such, the past days’ banking stress has been rapidly contained after the US government put in place the necessary measures to restore confidence. 

The return of confidence in the banking sector sent the US bond prices lower, and the yields higher. But the big jump in US yields was the countercoup of a historic slump and didn’t prevent the S&P500 from recording a 1.65% advance on Tuesday. Nasdaq 100 rallied 2.30%. 

A collision between a Russian jet and a US drone over the Black Sea – denied by Russia, and the US inflation report came to tame a part of the joy over the banking relief.  

US futures hint at a flat open. 

US inflation cements 25bp hike expectations 

The US inflation data came in line with expectations on a yearly basis. The headline inflation fell from 6.4% to 6% as expected, and core inflation eased from 5.6% to 5.5%, as expected.  

Yet, the uptick in core inflation on a monthly basis to 0.5% - a five-month high, and the stickiness of services inflation above the 7% mark, revived the Federal Reserve (Fed) hawks on fear that we may no longer see inflation trend lower in the coming months, if the Fed stopped tightening now and here.  

Discomfort regarding the US inflation data, combined with the gently waning stress in banks, brought the expectation of a 25bp hike back on the table.  

Note that, if we hadn’t had the SVB debacle, that expectation would’ve easily been stuck around 50bp. And this is something that we could see reflected in the Fed’s March dot plot.   

Today, investors will keep an eye on US PPI data and the Empire Manufacturing index. 

ECB will likely stick to 50bp hike 

The EURUSD is drilling above its 50-DMA, 1.0730, in the run up to Thursday’s European Central Bank (ECB) meeting.  

Many wonder whether the ECB will soften its tone in the wake of tensions across bank stocks over the past week.  

But the chances are that the ECB will maintain its plan to raise the rates by 50bp at tomorrow’s policy meeting, and the divergence between a more dovish Fed due to the US banking stress, and a confidently hawkish ECB could help the euro recover against the greenback, and bring the 1.10 target back in sight.  

Budget day

In the UK, the Chancellor of Exchequer will make a budget statement to the MPs in the House of Commons today. 

At today’s statement, there will likely be no tax cuts despite a terrible cost-of-living crisis, however the government will likely keep the £2500 per year limit on energy bills for three more months, instead of letting them run to £3000 from April.  

The latter would be good news for inflation as inflation in Britain is worse than in Europe or in the US. Goldman Sachs predicts that if the government kept the limit at £2500, inflation in Britain would fall to 1.8% in the Q4, which is below the Bank of England’s (BoE) 2% target.  

On the investment side, Jeremy Hunt will likely announce measures to boost investment in the UK, including generous tax incentives to attract businesses back to the UK to make sure that growth in Britain catches up its European peers, now that Sunak’s government seemed to have eased a part of the Brexit headache that prevented investors from full heartedly invest in the UK.  

What’s important for investors today is how the UK will boost growth, how it will finance it, and how the bond markets will react to the budget statement. There will probably not be an unexpected reaction, or a meltdown as was the case in September with Liz Truss’ budget disaster. The confidence in Sunak’s government is strong and the actual government’s sense of budget discipline should ensure a smooth budget day.  

On the currency front, Cable jumped above the 50-DMA as a result of a broadly weaker US dollar on the US banking stress, but a correction in the dollar’s value will likely keep the topside limited at 1.22 and encourage a correction toward the 100-DMA, which stands a couple of pips below the 1.2050 mark.