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Markets Retreat on Expected Fed Hawkishness

Markets are trading with a negative bias as traders brace for a hawkish message from Jerome Powell during this morning’s Congressional testimony. If the Federal Reserve chair joins his colleagues in arguing that there’s no rush to start cutting rates, investors will begin betting on an upward shift in the central bank’s policy projections. It would take only two officials turning more cautious to lift the median March “dot plot” toward showing just two rate cuts this year, down from the three previously expected. Treasury yields are holding steady, and the dollar is little changed against most of the majors.

The dollar dropped during yesterday’s session after the Institute for Supply Management’s composite services index unexpectedly slipped to 52.6 in February from 53.4 in the prior month, with a pickup in order volumes and activity levels proving insufficient to offset softness in the employment and prices paid subindices. Friday’s non-farm payrolls report should help clarify whether the apparent cooling in labour markets is real, but it could take longer to assess the sustainability of inflation’s early-year resurgence.

‘Super Tuesday’ left currency markets essentially unmoved. Joe Biden and Donald Trump easily trounced their rivals, with Nikki Haley expected to withdraw from the race later this morning. Implied volatility levels in the currencies most exposed to a return of trade war dynamics remain remarkably low, suggesting that abundant liquidity conditions could be nullifying the market response… for now.

The pound is ticking lower as Chancellor Jeremy Hunt unveils a 2024 budget focused on delivering a series of pre-election spending initiatives. In a Parliamentary speech (still ongoing), Hunt said inflation is expected to fall below the central bank’s 2 percent target in “just a few months’ time, nearly a whole year earlier than previously forecast,” with Office for Budget Responsibility projections pointing to a 0.8-percent expansion in the economy this year. “Of course interest rates remain high as we bring down inflation,” he said “But we can now help families not just with temporary cost of living support but with permanent cuts in taxation. Lower tax means higher growth, and higher growth means more opportunity, more prosperity, and more funding for our precious public services”.

The Bank of Canada is due to release its latest rate decision in less than two hours. Fireworks are unlikely. Officials could acknowledge recent progress toward achieving price stability – inflation fell more than expected in January – but will likely reiterate a need for more data before concluding that risks have receded. With the economy slowing, but not crashing, and external demand remaining resilient, the short-term growth outlook remains unusually uncertain. Labour demand is strong and wage growth remains elevated. And housing markets look poised on the edge of a melt-up. We think the Bank will wait until the April Monetary Policy Report before shifting to a dovish bias.

Market positioning could play a significant role in the reaction to Powell’s testimony and the Bank of Canada’s decision. Given that investors seem well prepared for a push-back from the Fed chair against early year rate cut hopes, it could prove difficult for him to out-hawk expectations. Tiff Macklem might face a similar challenge, with the overwhelming majority of observers positioned for a neutral and balanced message. Risks are tilted to the dovish side.


Still Ahead

WEDNESDAY

Jerome Powell’s semi-annual Humphrey-Hawkins testimony could contain distinct hawkish notes, along with an aroma of caution. We expect him to echo some of the themes found in Governor Waller’s ‘What’s the Rush’ speech in late February, warning markets not to expect rate cuts until inflation shows conclusive signs of reaching target, while also indicating that a rapid-fire easing cycle remains unlikely. Markets will be prepared for this, but some position adjustment could take place, particularly if the chair suggests that easier financial conditions are working at cross-purposes to the Fed’s objectives. Prepared testimony is typically issued about an hour and half ahead of the Semi-Annual Monetary Policy Report to the House Financial Services Committee at 10:00. (08:30 EDT)

The Bank of Canada is almost-universally expected to stay on hold on March 6, and an April move remains unlikely, but evidence of softening inflation pressures and a deterioration in consumer demand across the economy should translate into a more dovish outlook in the accompanying statement and press conference. Recent data releases have illustrated surprising resilience in labour markets and top-line growth, but borrowing burdens are still rising, intensifying pressure on the country’s over-indebted private sector and driving final domestic demand into negative territory. A slowdown in labour markets looks like the next shoe to drop. We think the odds still favour a first cut in June, but we’re increasingly convinced the Bank could outpace the Federal Reserve in delivering rate cuts through the back half of the year – a view that could, if more broadly held, ultimately put downward pressure on the Canadian dollar. (10:00 EDT)

The number of US job vacancies likely dropped in January as hiring jumped, but both the vacancy-to-unemployment ratio and the quits rate probably remained well below pre-pandemic levels – suggesting that the second half of the Federal Reserve’s mandate isn’t yet imposing constraints on the expected policy path. (10:00 EDT)

THURSDAY

A raft of speeches and appearances have convinced us that the European Central Bank’s policy committee is not prepared to begin easing policy in March, with a June move remaining far more likely. Inflation in the bloc failed to retreat as much as had been hoped in February, employment markets remain strong, and consumer surveys are pointing to a modest improvement in sentiment. Updated staff projections, released after the meeting, should bear the imprint of downward revisions in inflation and growth forecasts however, helping to set the stage for an eventual pivot to rate cuts. (08:15 EDT)

FRIDAY

After January’s blockbuster 353,000-job print, February’s non-farm payrolls report could look rather disappointing. Markets think roughly 170,000 positions were added in the month, with the unemployment rate holding at 3.7 percent and hourly average earnings softening to near-zero-percent levels after a suspiciously-strong 0.6-percent gain. Revisions could also make a serious dent in the prior month’s data. But with job growth continuing to outpace an expanding workforce, the labour market’s apparent momentum remains strong. (08:30 EDT)

Canada’s labour market may have added jobs in February, but faster population growth likely pushed the unemployment rate higher. Consensus estimates seem to be aligned with a 20,000-position monthly gain – down from 37,300 in January – but conviction is understandably extremely low after a long series of surprises. We’re more confident in a rise in the unemployment rate, with a move up to 5.8 percent from the previous 5.7 percent looking likely as population growth continues to outpace the economy’s job creation engine. (08:30 EDT)

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