Markets are extending yesterday’s moves after another hotter-than-expected inflation report delivered a serious blow to market expectations for an imminent pivot to easing from the Federal Reserve.

Data out yesterday morning showed core price indices rising more than forecast on a monthly and annual basis in March, making it more difficult to believe that the January and February numbers were lifted by residual seasonality. Jerome Powell’s preferred “supercore” measure accelerated to 5 percent on an annualised basis as core transportation, medical, and education services prices remained stubbornly elevated.

Fixed income markets reacted badly. Swap-implied odds on a June rate cut plunged to less than 17 percent, down from more than 58 percent a day prior, and pricing for the July meeting dropped to 43 percent from almost 75 percent previously. Treasury yields popped higher across the curve, with the two year climbing the fastest since the Silicon Valley Bank collapse, the five year jumping by the most since 2020, and the ten year rivalling moves seen during the Liz Truss budget debacle of 2022.

With late 2023’s easing in rate differentials now materially unwound, foreign exchange traders bought the greenback en masse against all of its major rivals. The DXY index jumped more than a full percentage point, with losses falling most acutely on the Aussie, pound, euro, and Canadian dollar in the hours after the release. The yen dropped below the 153 threshold previously believed by some observers to be a “line in the sand” for Japanese authorities, raising the risk of intervention from the Ministry of Finance.

Later in the day, minutes taken during the Fed’s March meeting revealed that “almost all” participants judged it would be “appropriate to move policy to a less restrictive stance at some point this year” but also contained elements of a more hawkish outlook that could be used to justify a “higher for longer” stance on rates. “Some” officials warned that prevailing policy settings could prove “less restrictive than desired, which could add momentum to aggregate demand and put upward pressure on inflation,” and “Participants generally noted their uncertainty about the persistence of high inflation and expressed the view that recent data had not increased their confidence that inflation was moving sustainably down to 2 percent” – a sentiment hardly likely to have improved after the March consumer price data.

Officials also began exploring ways to slow the pace of quantitative tightening, but the discussion seemed largely aligned with the process previously outlined by Lorie Logan. In a series of speeches and interviews between February and March, the Dallas Fed chief suggested gradually reducing the speed of asset runoff would help avoid a situation in which bank reserves become too scarce and trigger market volatility. No decisions were made at the meeting, but a “vast majority” of participants “generally favoured” reducing the current $60-billion monthly cap by half “fairly soon”. We suspect the implications for exchange rates are minimal – although some observers have drawn a direct line from changes in the Fed’s balance sheet to price action in fixed income markets, more in-depth research has shown that the tightening process is far less impactful than the psychological “shock and awe” unleashed during the easing process.

The European Central Bank is likely to deliver a largely-unchanged decision shortly, with investor focus landing squarely on the post-decision press conference. With European price growth slowing more quickly than in the US, Madame Lagarde could note growing confidence in slowing inflation, while acknowledging that rate cuts are now being discussed by policymakers – a step that would help ratify market expectations for a move at the June meeting. We think officials will eventually push back against pricing for back-to-back cuts at subsequent meetings, but may want to watch developments in energy markets before doing so.

Crude prices remain elevated after the US reportedly circulated intelligence showing that Iran was preparing “imminent” missile strikes against Israeli military or government targets. Tehran is widely expected to follow through on threats to retaliate over an attack that killed a number of operatives responsible for managing Iranian proxy militias in Damascus last week, but is also believed likely to avoid actions that could escalate into direct conflict. The global Brent benchmark jumped more than a full percentage point on the news, and is trading at around $90 per barrel this morning.

Higher oil prices are still doing very little to help the beleaguered Canadian dollar, which is holding perilously close to the 1.37 threshold after yesterday’s jump in US yields triggered a violent selloff. The exchange rate dropped almost 150 basis points as the US released its substantially stronger-than-expected inflation report, and failed to gain ground when the Bank of Canada delivered a steadfastly-cautious statement and published updated projections showing the economy growing at a solid pace through 2024 and 2025.

In our view, the Bank remains likely to outpace the Fed by cutting in June, and could continue to ease more quickly over a two-year time horizon. The country’s more interest rate-sensitive economy appears destined to underperform during the current US boom, and through any eventual downturn. But this doesn’t preclude a bout of exchange rate strength: if easing expectations become more entrenched and Canadian consumers feel emboldened to go back to their spendthrift ways, the economy and the currency could yet stage a dead-cat bounce.

Still ahead: Initial jobless claims are expected to land around the 215,000 mark once again as labour markets remain tight. Producer prices – which form part of the basis for the Federal Reserve’s preferred personal consumption expenditures measure – are seen slowing to 0.3 percent in March from the overheated 0.6-percent month-over-month pace set in February. The print could reinforce conclusions drawn from the March consumer price index release, but some of yesterday’s price action could unwind if it comes in on the low end of expectations.