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Hawkish Fedspeak Forces Modest Market Retreat

Traders are staying in their foxholes this morning after a flock of Fed officials delivered a remarkably unified message on rate cuts, warning markets not to expect easing to begin for many months yet. Speaking at the Peterson Institute in Washington yesterday, Governor Waller counselled patience, saying “In the absence of a significant weakening in the labour market, I need to see several more months of good inflation data before I would feel comfortable supporting an easing in the stance of monetary policy”. At a separate event, Cleveland’s Loretta Mester said “I need to see a few more months of inflation data that looks like it is coming down,” and Boston’s Susan Collins agreed, acknowledging “very mixed” data, and warning “It’s going to take longer than I had previously thought” to begin cutting rates.

The US dollar is edging higher, Treasury yields are steady, and North American equity markets are in the red. Minutes from the Fed’s early-May meeting are due for release this afternoon, but will likely be overshadowed later in the day when Nvidia – a chip company with a market capitalisation bigger than Canada’s annual gross domestic product – reports what is expected to be a 242-percent gain in revenue after the closing bell. A surprisingly positive result could bolster global risk appetite and drive high-beta currencies higher, while a disappointment could have the opposite effect.

The likelihood of a rate cut at the Bank of England’s June meeting plunged to less than 20 percent this morning after inflation slowed less than expected. The pound followed short-end gilt yields higher when the Office for National Statistics said its all-items price index climbed 2.3 percent in the year to April – down from 3.2 percent in previous month, but slightly above market estimates and the Bank’s own projections which had been set at 2.1 percent. Services costs were little changed at 5.9 percent, below the prior month’s 6 percent, but well above the 5.5 percent that had been forecast. But the market reaction looks overdone: labour demand – and wage pressures – are showing clear signs of easing, and the services sector should see continued normalisation in the months ahead. With another inflation report due before the June decision, and August remaining a live meeting, a mild reversal is possible in the coming days.

Japan’s yen remains weak despite a pop in government bond yields. The ten-year government bond yield broke the 1-percent threshold last night for the first time since May 2013 as expectations for further rate hikes from the Bank of Japan diminished demand among investors, but the exchange rate failed to make material headway against the US dollar as rate differentials remained gapingly wide. Japan’s commodity terms of trade – which reflect the ratio between export prices and import prices – look set to worsen once again as global raw materials costs push higher and the yen declines. This could bolster the case for tighter policy settings in the months ahead, supporting market expectations for a rise in the benchmark rate to 0.50 percent from today’s 0.10 percent.

Yesterday’s Canadian inflation report largely met expectations, but the details pointed to a sustained decline in underlying price pressures. The share of categories experiencing year-over-year price declines climbed above the number seeing above-target increases for the first time since early 2021, the Bank of Canada’s preferred core inflation measures slowed to an average yearly pace of 2.75 percent, and our preferred measure – the CPI-X index, which excludes the eight most volatile categories, including gasoline and mortgage interest costs – fell to 1.6 percent, indicating ongoing weakness in domestic demand.

Although a June rate cut is clearly possible, we think the Bank of Canada is slightly more likely to move in July, with officials looking for more evidence of economic weakness before easing monetary conditions. This may be a distinction without a difference: the market-implied likelihood of a rate cut at the Bank of Canada’s June meeting is now holding at around 59 percent – up from the 40 percent odds prevailing ahead of yesterday’s release, but down from 64 percent at the end of March. A drop in the central bank’s policy rate remains fully incorporated in market pricing for the July meeting, and both two- and ten-year US-Canadian rate differentials remain well off their April highs. We remain of the view that a more aggressive Canadian easing cycle has long been embedded in the exchange rate, with near-term moves more likely to be dictated by shifts in US economic conditions than by changes in how markets see the Bank of Canada’s policy trajectory.

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