A bruising multi-day selloff in government bonds is showing signs of exhaustion this morning as investors train attention on Nvidia’s first-quarter results after the closing bell—an event that has become one of the most reliable positive catalysts for risk appetite in global markets. US equity futures are pointing to a tentative recovery after three days of losses, and the dollar is surrendering some of the gains achieved in recent sessions as rising Treasury yields have widened rate differentials against the euro and other major currencies. Oil prices are down roughly 2% amid a relative lull in Iran war headlines, and foreign exchange markets are settling into narrow ranges, with many traders waiting on the chipmaker’s numbers for their next directional cue.

Canadian monetary tightening expectations were left virtually unchanged yesterday even as underlying inflation eased by more than forecast last month. All-items annual consumer price growth accelerated to 2.8% in April from 2.4% the prior month, but inflationary pressures were almost entirely confined to the gasoline and food categories, with an average of the core measures preferred by the Bank of Canada slipping to 2.05%—near a five-year low and only marginally above the central bank’s target. This would appear to give policymakers room to await further clarity on the macroeconomic implications of the war with Iran before moving on rates, but after a short-lived reversal, overnight index swaps are still pricing in a cumulative 48 basis points of tightening by December, little changed from pre-release levels.

Traders seem convinced the Bank of Canada would rather hike into weakness than risk losing its inflation anchor for the second time in five years. There is some evidence for this: Governor Tiff Macklem warned in testimony before the House of Commons earlier this month that if energy prices remain elevated, policymakers “will not let their effects become persistent inflation,” adding that “there may be a need for consecutive increases in the policy rate”. But conditions have shifted markedly from those that prevailed in the aftermath of the pandemic: in contrast with 2022, policy rates are already near neutral, consumers are not sitting on excess savings and pent-up demand is low, home values are declining, businesses are pulling back on investment, and labour markets are extremely soft. With the economy operating well below capacity and facing significant downside risks, the likelihood of a broader inflation shock seems low, and we think policymakers will opt to stay on hold for now—slightly increasing downside risks for the loonie in the absence of a sustained retreat in the US dollar.

The British pound dipped very briefly lower this morning after a data release showed inflation cooling more than anticipated last month—a reaction that suggests investors think the worst is yet to come. According to the Office for National Statistics, headline consumer prices rose 2.8% in the year to April, undershooting the consensus 3% estimate and slipping from 3.3% in the prior month as year-ago base effects, a cap on regulated household bills, and government policy offsets reduced the annual rise in energy prices. Few expect the relief to last—regulatory caps will be lifted in the coming months, and market prices are clearly oriented higher—and the data comes after a raft of labour market indicators yesterday pointed to a softening in conditions, with wage growth slowing, employers shedding jobs, and vacancies falling to a five-year low.

There are no first-tier data releases on today’s calendar, but this afternoon’s Federal Reserve minutes could help refine market views on the central bank’s reaction function ahead of Kevin Warsh’s arrival. A number of officials have expressed growing alarm over the threat posed by soaring energy prices and a steady unanchoring in inflation expectations since the April meeting, and we think the record will show some of this was foreshadowed in the discussion surrounding tweaks to the official statement. Three policymakers—Beth Hammack, Lorie Logan, and Neel Kashkari—dissented in favour of removing language that hinted at future rate cuts, and others were probably close to joining them. Against this backdrop, a hawkish pivot is possible at the June meeting—with or without Warsh’s approval**.

*For now, markets are ignoring Stein’s Law: “If something cannot go on forever, it will stop”.

**Someone should open prediction market contracts on how soon after the first meeting Trump will turn on Warsh, and what nickname he will bestow. “Wishy Warshy” looks like an obvious possibility.