January PMI surveys went from a moderating downturn with intensifying price pressures (EMU) over a recovery in the private sector gaining momentum coupled with higher input costs related to the Red Sea crisis (UK) to the Goldilocks combination of rapid output growth with cooling price pressure (US). The latter nevertheless came with the important disclaimer that cost pressures will need to be monitored closely in the coming months as supply delays have intensified while labour markets remain tight. Core bond markets reacted especially to the UK and the US outcomes. In the UK because the data together with sticky inflation suggest that the BoE doesn’t even have to start thinking about thinking to start cutting policy rates. It showed in a bear flattening move with UK Gilt yields adding up to 4 bps at the front end of the curve. In the US, markets especially responded to size of the positive surprise which suggests a positive start of the year following already a stellar Q3 2023 and a likely decent Q4 (release today, consensus expects 2% Q/Q annualized). US yields added 4 to 5 bps across the curve in a more parallel shift higher. German Bunds were yesterday’s outperformers with German yields ending up to 1.5 bps lower. The dollar profited only in the second half of yesterday’s dealings from the PMI-driven interest rate support. Earlier on, the greenback was overwhelmed by an impressively bullish market sentiment which sent the EuroStoxx50 up to 2.2% higher in the close with the index escaping the corrective downward trend channel in place since the start of the year. Strong Q4 corporate earnings and massive fiscal and monetary support from Chinese authorities buoyed stock markets. EUR/USD closed at 1.0885 from a start at 1.0854 (intraday top 1.0932).
The ECB will keep the key parameters of its monetary policy unchanged today. ECB President Lagarde set the tone at last week’s World Economic Forum in Davos where she (together with her colleagues) pushed back against aggressive market pricing of policy rate cuts. She labelled “summer” as a potential start, whereas markets still attach a 70% probability to an April move. This is highly unlikely as ECB chief economist Lane for example pointed out that key Q1 wage data won’t be available by then. We expect Lagarde to echo this view, with the ECB for the moment sticking to forward guidance saying that future decisions will ensure that policy rates will be set at sufficiently restrictive levels for as long as necessary. From a market point of view, we think that such outcome would be only marginally negative for bonds with the long end even the most vulnerable. Any EUR-gains would be capped.
News & Views
The Bank of Canada yesterday left its policy rate unchanged at 5% while continuing quantitative tightening. The economy has stalled since the middle of 2023 and the BoC expects growth close to zero in Q1 2024 before picking up in H2 2024. Full year forecast for 2024 (0.8%) and 2025 (2.4%) are broadly unchanged. The BoC now reckons the economy to be operating in modest excess supply. Labour markets conditions have eased, but wages are still rising 4% to 5%. The BoC pinpointed shelter costs as the main reason for inflation staying above target. It expects inflation to hold near 3% in H1 2024 before gradually returning to 2% in 2025. The persistence of underlying inflation is a major concern, but the BoC dropped guidance that it is prepared to raise rates further. Governor Macklem kept a balanced approach at the press conference. The discussion is shifting to how long the policy rate needs to be kept at the current level if the economy evolves as expected. It remains premature to discuss reducing the policy rate. The money market discounts a first 25 bps rate cut in June. The Canadian dollar closed the session with a substantial loss (USD/CAD 1.3525 vs 1.343 before the BoC decision).
The US Federal Reserve announced to raise the rate on bank loans under the Bank Term Funding Program (BTFP) that was launched last year during the US banking crisis, but will retire on March 11. From now on the rate for borrowing under the program will be ‘no lower’ than the rate on the reserve of balances on the day that the loan is made. The rate on reserve balances (currently 5.4%) moves in line with the Fed fund target rate while pricing of loans under the BTFP until now was based on lower markets rates which already are discounting Fed rate cuts later this year. The Fed wants to further prevent this arbitrage.