War fears among investors are declining despite horrible pictures from Bucha, new Western sanctions on Russia and no progress in Russia-Ukraine peace talks. We are definitely beyond “peak financial stress” (the VIX index is much lower than in early March). The war is first and foremost a humanitarian crisis but it seems like investors believe the global economy can cope with the negative shock. Instead, investors are focusing on monetary policy and how much central banks will tighten, as elevated commodity prices increase already high underlying inflation pressure. Still, war headlines are important to monitor over the coming weeks although we doubt there will be any real progress in peace talks. Also keep an eye on possible EU sanctions on energy imports from Russia.
This week’s FOMC minutes from the March meeting supported our view that the Fed is about to front-load rate hikes in order to get the Fed funds rate quickly back to neutral. “Many” participants supported one or more 50bp rate hikes, as the Fed is behind the curve amid the highest inflation rates in 40 years and a very tight labour market. We continue to expect the Fed to hike by another 225bp this year, see Fed Update: Quickly back to neutral by front-loading rate hikes, 30 March. At the next meeting in May, the Fed is likely to announce the beginning of QT (cap USD95bn per month).
Significant tightening of monetary policy in the US also increases the risk that the US falls into recession within 1-2 years, which is becoming an increasingly important topic in financial markets. The US yield curve is very flat (and the 2s10s spread was inverted at some point), which is usually considered a strong signal that recession risks are on the rise. Based on the UST 2s10s spread, markets are pricing in a nearly 40% risk of a recession over the coming year.
Yet another challenging meeting awaits ECB on 14 April, as inflation continues to surprise to the upside and the economic outlook is increasingly uncertain. While we expect ECB to re-confirm previous guidance to end APP during Q3, the press conference will be interesting. While we do not expect Lagarde to directly mention a September rate hike as a possibility, similar to other voices in the GC, we believe she will keep the door open as a way to respond to high inflation pressures. We discussed further in ECB Preview: Lagarde to bring September into play – we revise our ECB call, 8 April. We now expect the ECB to hike in September and December (vs. December and March 2023 previously).
In New Zealand, RBNZ meets on Wednesday 13 April. We see risks as tilted towards a 50bp rate hike given the global inflation pressures.
While Western central banks are tightening, the story is quite different in China, where we may see more easing soon (maybe reduction in RRR and/or rate cut). This week, China’s state council said there was a need for more monetary easing “at an appropriate time”. More easing from China would also support the global economic outlook, as China is usually contributing to one-third of total global GDP growth.
Finally, watch out for the first round of the French presidential elections on Sunday.
