The Fed sent a dovish signal, as the median ‘dot’ continues to signal no rate hike through 2023. However, we expect it is a matter of months before the Fed starts to move in a more hawkish direction, as the Fed, in our view, seems too pessimistic on the economic outlook and the labour market recovery. Such a shift may already come in June but no later than in September when the post-COVID recovery is on its way. We now expect the Fed to start discussing tapering in Q4 21 and actual tapering in Q1 22. For more details see Fed Monitor: Review – cautious now, hawkish later, 17 March. For a discussion of the risk of US inflation and potential market acrimony one can read the latest Armchair Strategist – Inflationary interlude or something sinister? 17 March.
The Bank of Japan presented its policy review. As expected, it caused no revolutions to the policy framework but it came with a few adjustments. Most notably perhaps the implicit tolerance band of +/-20bps on the 10yr JGB target was increased slightly to +/-25bps. With Japan as the last of the G7 to kick-start its vaccine programme, the pandemic will weigh on domestic demand for longer than other places and we expect it will take long before BoJ sees room to significantly withdraw stimulus.
A new type of Cold War brewing. If anyone had hoped for a smoother relationship between US and China under the Biden administration the Alaska meeting on Thursday put cold water on that hope. It is clear the relationship between US and China will be very difficult in the years to come and a kind of new cold war has started, which will gradually lead to some decoupling between the two powers. For more on a new kind of Cold Water please refer to Research China: At the foothills of a new cold war, 31 July2020.
Next week we have March flash PMIs on Wednesday. With regards to Europe they will likely continue to show the same picture of a two-speed economy with manufacturing in the lead and decelerating services activity. But in light of last month’s decline also in the Chinese PMIs, we wouldn’t be surprised for some of the manufacturing expansion pace to abate compared the February.
The German Ifo is published on Friday and will also paint a similar story of a divided economy, but in light of the continued German lockdown it will be important to watch if business expectations maintain their uptrend from last months or show some signs of weakness. This week Merkel’s panel of economic advisers already warned that the recovery could be endangered by a continued lockdown.
For the US we also have flash PMIs on Wednesday, which will probably remain elevated. There are a number of Fed speakers that will be interesting in light of some of the dots moving to indicate an earlier interest rate lift off.
