Sovereign International Daily Market Report
Bank of Japan delivers historic hike, Fed to upgrade dot plot?
Highlights:
The Bank of Japan delivered an historic shift in its monetary policy stance on Tuesday, although this failed to inspire the yen, which sank to fresh lows against its peers.
As anticipated, the BoJ ended its negative rate policy yesterday, with the committee voting 7-2 in favour of hiking its benchmark rate from -0.1% (where it has been since 2016) to a range between 0-0.1%. In tandem, the bank also abandoned its yield curve control policy, and will no longer target near zero in 10-year government bond yields. Such a momentous pivot in policy stance would typically be a currency positive, though not only was the move broadly expected, but the bank’s accompanying communications were on the dovish side. In his press conference, Governor Ueda sounded a cautious note on the Japanese economy, while saying that there was still ‘some distance’ before inflation expectations hit 2%.
Swap markets were far from fully pricing in an immediate rate hike this week, so the sell-off in the yen, which dropped to north of the 150 level on the US dollar, is somewhat counterintuitive. Clearly, however, investors are perceiving Ueda’s remarks as a signal that hikes will be very gradual indeed, with little possibility of another rate increase until later in the year. This has been reflected in market pricing, with not even 10 basis points of hikes currently priced in by the bank’s September meeting.
Could the Fed deliver an upgrade to its ‘dot plot’ on Wednesday?
With the BoJ rate announcement now out of the way, attention among investors has turned firmly to this evening’s Federal Reserve policy decision. There will be no change in rates, with the Fed primed to walk a tightrope whereby it makes it clear to markets that rate cuts are coming, without over igniting bets in favour of imminent policy easing. Chair Powell will probably repeat his line that the employment and inflation goals are moving into better balance, although he will likely stress that more evidence of a downtrend is required in the latter before the bank begins easing monetary policy.
In the absence of any material changes to the Fed’s rhetoric, market participants will take their cue from the updated ‘dot plot’ of interest rate projections. We expect the 2024 median dot to again indicate three cuts to the fed funds rate this year, as it did in December. Recent surprises to the upside in US inflation, however, means that there is now every chance we see an upgrade to the 2024 dot in line with only two rate reductions this year. This would be a clear bullish near-term signal for the dollar, as not only would this shift the expected start date for cuts from June to July or September, but we would also see a shift upwards in the implied year-end fed funds rates.
BoE in no rush to cut, but markets brace for dovish shift in vote
The next couple of trading session will also be highly important for the pound. Sterling has given back some of its gains in the past few days, falling from above the dollar. While most of this can be attributed to dollar strength, investors are also bracing for the possibility of a dovish swing in the Bank of England’s vote on rates. We don’t foresee any major fireworks from the BoE when it meets on Thursday (12:00 GMT). The MPC remains a few months away from cutting interest rates, and is not yet ready to signal that looser policy is imminent. Data on both UK inflation and wages has surprised to the downside since the last meeting, although both remain far too high for comfort and insufficient to warrant a change in guidance. There will also be no press conference, but the statement will likely stress that policy will remain restrictive, with rates to be kept ‘under review’.
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The key for markets will be the voting pattern among committee members. We are pencilling in another unprecedented three-way split, whereby one votes for a cut, two for a hike and the rest for no change. We see a distinct possibility, however, of a dovish swing, whereby one or both of the hawks shift their allegiance in favour of the majority. With markets not fully pricing in the first rate cut until August, this could pave the way for some weakness in sterling, as investors mull a start to easing at the bank’s June meeting. This morning’s UK inflation report for February (07:00 GMT) may be key in guiding the tone of the bank’s communications, with markets bracing for a rather sharp easing in the annual data.
Economic Calendar (GMT)
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