Will the Fed and ECB tighten monetary policy further?

Markets

Yesterday’s higher than expected UK CPI data provided a wake-up call for global markets. Despite rising uncertainty on growth, monetary policy probably needs to be tighter for longer compared to what was hoped for after the financial turmoil last month. Gilts understandably underperformed Bunds and Treasuries with UK yields adding between 13.9 bps (2-y) and 8.5 bps (30-y). US and European yields followed the UK move at a distance. US yields gained up to 4.7 bps (2-y) implying some modest further curve inversion. German yields rose between 6.2 bps (2-y) and 1.9 bp (30-y). The Fed Beige Book preparing the May 02-03 policy meeting suggests that economic activity recently was little changed. Credit conditions have tightened. The rate of price increases appears to be slowing. Labour market/wage indications also showed somewhat of a more balanced picture. In a speech after the close of markets, New York Fed President John Williams basically joined the (anecdotical) evidence from the Beige Book. He admitted that inflation stays too high, but recent data indicate it might continue to slow. He also sees signs of a gradual cooling in demand for labour. Tightening of credit conditions might further weigh on activity/demand. Both the Beige Book and the Williams comments support the case for the Fed to raise the policy rate by 25 bps in May and then taking a wait-and-see approach. The impact of the repositioning in yields on other markets was modest. Equities, both in the US and Europe, finished the day little changed. The dollar rebounded, but gains remained modest and moves easily stayed within recent barriers. DXY closed at 101.97 (from 101.70). EUR/USD finished at 1.0955 (from 1.0972). USD/JPY extended its recent gradual uptrend (134.72 from 134.12). Sterling outperformed the dollar and the euro. Even so, EUR/GBP still closed north of 0.88(07).

Asian equities show modest losses this morning. US yields and the dollar are little changed. Later today, the eco calendar contains EC consumer confidence, US initial jobless claims and the Philly Fed business outlook. There are again plenty of Fed and ECB governors scheduled to give their view ahead of upcoming black-out period. We keep a close eye at the ECB comments to get some insight on the chances of an additional 50 bps step at the May meeting. We dissect Minutes of the ECB meeting in the same way. Markets probably underestimate the odds for such a move. This debate keeps EMU yields, especially at the short end of the curve, well supported. The German 2-y yield nears 3% resistance. The downside in EUR/USD at 1.0831 is currently well protected.

News and views

New Zealand inflation decelerated from 1.4% q/q in 2022Q4 to 1.2% in the first quarter of this year, going against expectations for a quickening to 1.5%. The yearly figure as a result eased more than anticipated, from 7.2% to 6.7%. The Reserve Bank of New Zealand in its February statement projected 7.3%. Food (3.7% q/q) and tobacco (4.1% q/q) were key drivers while housing & household utilities eased to a still above-average 1% q/q. Transportation costs weighed heavily (-1.3% q/q) as energy/oil prices dropped considerably. CPI excluding food, household energy and vehicle fuels increased 6.5% y/y, only marginally lower than the 6.7% 2022Q4 while non-tradeable inflation (a proxy for services inflation) quickened to 1.7% q/q. The RBNZ earlier this month hiked by 50 bps to 5.25% and said the direction of future monetary policy will be determined by the course of core inflation. New Zealand swap rates tumble between 8.9 and 12 bps with the front end of the curve outperforming. Market expectations for the terminal rate have lowered about 10 bps to 5.50%, implying one more 25 bps rate hike at either the May or July meeting. The kiwi dollar underperforms peers this morning. USD/NZD eases from 0.62 to 0.6157 currently.

The EU is preparing an emergency ban on Ukrainian grain imports to the four member states bordering Ukraine plus Bulgaria, the Financial Times reported. The move seeks to regularize unilateral moves by the likes of Poland and Hungary. They barred imports that were meant to but couldn’t be re-exported because of truck and train shortages, pressuring local prices and farmers. Problems arose when the EU following the Russian invasion introduced a wartime free-trade regime for agricultural products. Originally planned to end in June this year, the EU wants to extend it. The renewed version is likely to include stronger provisions that allow the bloc to take measures to protects its own market more rapidly.

Download The Full Sunrise Market Commentary