The Market's Hawkish Repricing

For the second week running, this week's chart is all about rate expectations. With the debate over when, and by how much, the FOMC will ease policy continuing to rage.

In fact, last week produced further 'goldilocks'-esque economic data pointing to a soft landing Stateside, with retail sales having risen?+0.6% MoM over the festive season, as consumer sentiment (per the UMich survey) rose to a more than 2-year high, while year-ahead inflation expectations slipped below 3% for the first time since 2020. Put together, that is all music to the FOMC's ears.

That data slate has also led to a continued reassessment of the likely policy path over the year ahead. This time last week, money markets saw a 25bp Fed cut in March as a near-certainty, pricing an 80% chance of such an outcome, and a total of 170bp of easing by December. Now, however, OIS views the March meeting as a coin-flip, with continued economic resilience having dented the case for the FOMC to need to cut as soon, or as aggressively as previously priced.

Unsurprisingly, a similar hawkish repricing has been seen in Treasuries, with the 2-year having sold-off almost 25bp last week, in its biggest one-week yield rise since May 2023, making the S&P 500's and Nasdaq 100's closing at new records on Friday an even more impressive feat.?The greenback also advanced, with the Dollar Index (DXY) touching its best levels of the year around 103.70.

It's here where things become interesting as, when comparing the buck's move to both nominal 2- and 10-year yields, one sees that the two are trading in almost perfect, tick-for-tick harmony with each other. This would imply that the USD's recent rally has yet to become over-extended, and that a further hawkish repricing - recall, markets continue to price 60bp more cuts than the FOMC's dot plot implies - should add further fuel to the dollar upside, especially against lower-yielding G10s, leaving the JPY particularly vulnerable once more.?

Michael Brown | Market Analyst at Pepperstone

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