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Central Bankers Turn Dovish, Markets Rally

Financial markets are in an ebullient mood after Federal Reserve officials said they still expect to cut rates three times this year, with disinflationary forces expected to resume in coming months. All three major North American equity indices closed at record highs and risk appetites roared back yesterday when Chair Powell avoided pushing back on easier financial conditions, and said recent price readings “haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes bumpy road toward two percent. I don’t think that story has changed”.

Markets tend to focus on the shark closest to the boat, and stability in the 2024 dot plot appears to set the stage for a move in June. Market-implied odds on a cut are sitting above 65 percent, up from pre-meeting levels. But the outlook for longer-term rates has risen: with background inflation estimates grinding upward, policymakers now see just three rate cuts in 2025, down from the four forecast in December, and the eventual “neutral” rate – at which growth remains strong and inflation stays subdued – is expected to sit near 2.6 percent, up slightly from 2.5 percent in December. We think this dynamic could anchor borrowing costs above the levels that prevailed ahead of the pandemic, impacting the degree to which asset prices can continue to outperform developments in the real economy over the long run.

The Swiss National Bank surprised observers with a rate cut this morning, foreshadowing similar moves from other major central banks, and driving the franc to a four-month low against the dollar. In a statement setting out the decision, President Thomas Jordan said “For some months now, inflation has been back below 2 percent and thus within the range we equate with price stability. According to our new forecast, inflation is also likely to remain in this range over the next few years,” but we suspect recent strength in the country’s real effective exchange rate – up circa 7 percent year over year – played a role in motivating the pre-emptive move. Jordan again warned the central bank is “willing to be active in the foreign exchange market as necessary”, but narrowing rate differentials should help mitigate the currency’s gains relative to the euro, and reduce the need for outright intervention.

The Bank of England left its main policy rate unchanged a day after new data showed inflation falling to a two-and-half year low even as it remained well above target. With inflation now projected to fall to slightly below the 2 percent target in the second quarter, members of the Monetary Policy Committee turned more dovish. Eight voted to keep rates stable, and one – very likely Swati Dhingra – opted for a cut. At February’s meeting, two of nine members voted for a hike, one for a cut, and six for a hold. Gilt yields are tumbling and the pound is slipping as we go to print, but the Bank remains the only real rival for the Fed’s projected yield trajectory among the majors, meaning that losses should be relatively limited.

Ahead today: a quiet data calendar will see the US release weekly jobless claims numbers, and S&P Global deliver its latest manufacturing and services sector purchasing manager indices. In Canada, central bank Deputy Governor Gravelle will address a business crowd in Toronto, but market implications should be limited. By moving to a press conference after each decision, the Bank has limited the likelihood of inter-meeting policy upsets, and traders will likely stay committed to selling the greenback against its rivals through much of the day – and perhaps throughout the second quarter. We expect the loonie to grind higher in the short term.

The Banco de Mexico looks likely to cut rates this afternoon, joining its Latin American counterparts in beginning to ease policy as inflation rates fall. Core inflation dropped to 4.6 percent last month, and the central bank removed a sentence from its statement that previously committed to holding rates “for some time,” replacing it with more open-ended language that permits rate adjustments “depending on available information”. This is unlikely to materially diminish the currency’s appeal to carry traders – a strategy in which speculators borrow in yen and lend in peso that has earned roughly 44 percent in the last twelve months – and we expect the Banxico’s guidance to set out a gradual easing trajectory ahead, helping to preserve the extremely wide rate differentials currently on offer.

Still Ahead


Officials at the Banco de Mexico could vote by a narrow margin to cut key interest rates for the first time in three years, but should stick with guidance that sets out an extremely gradual easing trajectory ahead. With inflation subsiding at a rapid clip, Mexican real interest rates are the highest in Latin America, imposing a speed limit on the economy, while also helping support the carry trade that has made the peso one of the world’s best-performing currencies in the last few years. (15:00 EDT)


Markets think Canadian retail sales contracted by -0.4 percent in January, consistent with Statistics Canada’s preliminary estimate. Softness in gasoline prices probably played a role, but a pullback in vehicle purchases likely did much of the heavy lifting. (08:30 EDT)

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