Outlook: We get retail sales and consumer sentiment today, but watch out–the data is a minefield. Sales can rise on inflated prices alone, and picking out what is a true rise vs. a price-only one is well-nigh impossible. Then there are the exclusions, like gasoline, and in addition, some lingering base affects. Last March we had just got the vaccine and sales were still soft, especially in services. Don’t forget the ex-autos idea. Bottom line, efforts to create a “controlled” number–controlled for special factors–are not convincing and all too subjective. As the rest of the world starts copying the Fed (although to be fair, some were ahead of the Fed, like New Zealand and Norway), we see more and more forecasts of rate hikes. The latest is the UK, after yesterday’s high inflation readings. Sterling obediently rose, as did the CAD, finally, on actual action. Gains in other bond yields coupled with a backlash against an overshooting in the YS 10-year was a dollar negative yesterday. The question is whether we get a reality check from the ECB, which is expected to do and say absolutely nothing of use with respect to forward guidance. This looks like they don’t know what to do and are paralyzed by conflicting objectives. Overall, a majority of financial managers expect Europe to get recessionary as the year wears on, according to the BoA/ML survey–with corporate earnings following suit. And yet the euro itself is bouncey. We deduce that it’s the dollar that is soft and not the euro that is firm. Bloomberg in one of it summaries writes that “Global bonds rallied amid market confidence that central banks are on track to tame inflation.” Bloomberg has splendid headline writers that sell newspapers, so to speak, but is that really true? Nobody knows how high inflation can go–remember Kiplinger’s 10%--but Fitch just gave us pause. See the chart from the Daily Shot–oil has already peaked at over $110 and the next year should see $90-100. We don’t know the assumptions and reasoning, but Fitch is hardly a bunch of loonies or wishful thinkers–they have to put ratings on companies and countries in this sector. We choose to give Fitch credibility despite the events of 2008. Meanwhile, the IEA said watch out, the impact of sanctions on Russian oil won’t hit the market until May. It also named falling Chinese demand, the emergency release of strategic reserves and OPEC output increases are all moderating factors that will bring “balance” in Q2. This sounds like utter bilge but we lack hard data to refute. China can buy and stockpile, as it has done before. OPEC refused outright to raise output and some members wouldn’t even take a meeting with Biden. The strategic releases are said to be a drop in the bucket. Anyway, looking at core producer prices is scary enough. See the chart from Trading Economics. Removing energy and food, the rise is still significant at a record 9.2% y/y (from 8.7% and beating the forecast of 8.4%). We guess the pullback in US yields is a normal response to having overshot to the upside once the bond boys belatedly got the message that the Fed means business. It’s a blip. Let’s not overthink it. The Fed still leads and the dollar will reflect that. Foreign Affairs: Ukraine may have taken out of service the lead flagship Russian warship in the Black Sea. This is more symbolic than militarily meaningful but bravo. The US and Ukraine are able to fend off Russian hacker cyberattacks, although the news is spotty. The US is giving even more aid. Finland and Sweden are about to request membership in Nato. As a sign of how screwed up the Republican party has become under Trump, some Republicans say they would oppose those memberships. Serious Tidbit: JP Morgan CEO Dimon said some serious dirt can hit the economic fan even if it’s not still a remote possibility and so far most metrics are hunky-dory. The bank is setting aside $900 million in reserves against possible loan defaults if the worst happens. The interesting thing is that a year ago, it “freed up the $5.2 billion it had reserved for potential loan losses in the pandemic’s early months.” (WSJ) The implication is that the Russian war/oil price issue is less than 20% as bad as the worst case that could have arisen from the pandemic. Fun Tidbit: TreasSec Yellen warned China against joining with Russia to form a bipolar financial system. A lot of people thought she was talking about the dollar losing reserve currency status. Some of the foolish commentary is hilarious (but also bothersome because it puts on display the lack of understanding of money, the financial system, what a reserve currency is in the first place, the status of gold...

EU CPI (Mar) – 21/04 – with the ECB starting to taper its asset purchase program, pressure is increasing for the central bank to outline a plan for raising rates as EU CPI hits new record highs at 7.5%. This is a huge jump on the 5.9% we saw in February and serves to highlight the challenges facing the European Central Bank. PPI prices are also trading at record highs and while core prices are lower when food and energy are stripped out at 3%, this is little comfort to EU consumers who need to eat and move about. Businesses are also struggling as they have to contend with the same challenges when it comes to economic output. EU CPI is expected to be confirmed at 7.5%.         UK Retail Sales (Mar) – 22/04 – UK consumer spending saw a strong rebound in January, after the -0.4% slowdown seen in December. Not only did fuel sales recover, but we also saw a strong rebound in household goods and furniture, with high street sales showing a decent pickup, as 2022 got off to a decent start with a 1.9% rise. This slowed in February as retail sales slipped back by -0.3%. On the plus side, we saw non-food sales post a decent gain with clothing sales rising 13.2%, while fuel sales also rose as the relaxing of Plan B restrictions saw an uplift to travel. Online sales fell back as did food store sales as more people went out to bars and restaurants. On an annualized basis sales rose by 7%. The decline in February was a little surprising given that other retail sales measures have looked more resilient with BRC retail sales numbers for February looking strong. The picture for March is likely to remain equally as challenging especially with consumer confidence looking weak and at their lowest levels since November 2020. The latest BRC retail sales numbers for March showed that like-for-like sales declined -0.4% in a sign that consumers were already starting to hold back.   France/Germany flash PMIs (Apr) – 21/04 – recent PMI numbers would appear to beg the question as how accurate the numbers are, when compared to the corresponding manufacturing and industrial production numbers and various business surveys, which have shown marked slowdowns in manufacturing, as well as services activity. In March we saw manufacturing activity for Germany slow to 56.9 from 58.4, and France to 54.7 from 57.2, still fairly decent numbers. Some have put this down to manufacturers restocking inventory in order to get ahead of sharp increases in prices in April, along with a similar pattern playing out on the services sector. This begs the question whether this can be sustained into April and given the further squeezes being seen in energy prices one has to question whether a decent Q1 performance can be sustained into Q2 as we look ahead to this week’s April flash PMIs.   Germany IFO Business Climate – (Apr) – 20/04 – against a backdrop of rising costs and factory shutdowns, along with its key export markets of Russia being shut down, and the Chinese economy undergoing a self-induced covid-19 circuit break the most recent March German IFO survey was an absolute shocker. Economic activity in March cratered in the face of surging energy and producer prices, with the Institute claiming that sentiment in the German economy had collapsed, a trend that so far hasn’t been reflected in recent flash PMI numbers. Business climate fell to 90.8 and its lowest level since January 2021, while on the expectations index sentiment fell from 98.4 to 85.1, the biggest single-month fall since March 2020.        Rio Tinto Q1 22 – 20/04 – has been one of the better performers on the FTSE100 so far this year, with the shares up over 20% year to date. At the end of last year Rio Tinto posted record profits of just over $21bn, a 116% increase on 2020, as well as announcing a huge total dividend of $10.40c a share, an 87% increase on last year. This shouldn’t really be a surprise given the big rises we’ve seen in commodity prices over the last 12 months with copper, iron ore and aluminium in huge demand. In terms of the outlook Rio expressed uncertainty about the outlook for iron ore pricing, along with higher production costs at its Pilbara operation, although the outlook for aluminum and copper was more positive due to their roles in the transition to renewables. The company is coming under pressure from investors to cut the level of indirect emissions after a number of investors expressed concerns about the levels at the recent AGM. In October last year the miner announced a $7.5bn plan to reduce emissions by 2030 without giving too much...

Euro has been struggling to find demand since the beginning of April. ECB is widely expected to leave key rates unchanged. A hawkish shift in ECB's policy outlook could trigger a steady rebound in EUR/USD. EUR/USD is already down more than 2% in April amid the apparent policy divergence between the Federal Reserve and the European Central Bank (ECB). The European economy is widely expected to suffer heavier damage from a protracted conflict between Russia and Ukraine than the US economy, and the Fed remains on track to hike its policy rate by 50 basis points in May. The shared currency needs the ECB to adopt a hawkish policy stance in order to stay resilient against the greenback. In March, the ECB left interest rates on the marginal lending facility and the deposit facility unchanged at 0.00%, 0.25% and -0.50% respectively. The bank further announced that monthly net purchases under the Asset Purchase Programme (APP), which were initially planned to end in the fourth quarter, will amount to €40 billion in April, €30 billion in May and €20 billion in June before ending in the third quarter.  The accounts of the ECB’s March meeting revealed earlier in the month that a large number of the governing council members held the view that the current high level of inflation and its persistence called for immediate further steps towards monetary policy normalization. Hawkish scenario The ECB could decide to adjust the monthly purchases to open the door for a rate hike in the second half of the year if needed. The bank might keep the purchases under APP unchanged at €40 billion in April but bring them down to €20 billion in May to conclude the program by June. Even if the policy statement refrains from offering hints on the timing of the first rate increase, such an action could be seen as a sign pointing to a June hike. In a less-hawkish stance, the bank may choose to leave the APP as it is but change the wording on the QE to say that it will be completed in June rather than in Q3. ECB President Christine Lagarde’s language on the timing of the rate hike will be key if the bank decides not to touch the APP. During the press conference in March, Lagarde noted that the rate hike would come “some time” after the end of QE. If Lagarde confirms that they will raise the policy rate right after they end the APP, this could also be seen as a hawkish change in forward guidance.  Dovish scenario The ECB might downplay inflation concerns and choose to shift its focus to supporting the economy in the face of heightened uncertainty by leaving the policy settings and the language on the outlook unchanged.  The euro is likely to come under heavy selling pressure if the bank reiterates that the APP will end in the third quarter as planned. That would push the timing of the first rate hike toward September and put the ECB way behind the curve in comparison to other major central banks. According to the CME Group FedWatch, markets are pricing in a more-than-60% probability of back-to-back 50 bps hikes in May and June. Conclusion The ECB is likely to respond to the euro’s weakness, aggressive tightening prospects of major central banks and hot inflation in the euro area by turning hawkish in April. For EUR/USD to stage a steady rebound, however, the bank may have to convince markets that they are preparing to hike the policy rate by June. On the other hand, there will be no reason to stop betting against the euro if the bank chooses to leave its policy settings and forward guidance unchanged.  EUR/USD technical outlook EUR/USD closed the previous seven trading days below the 20-day SMA and the Relative Strength Index (RSI) indicator stays below 40, suggesting that bears continue to dominate the pair’s action. On the downside, 1.0800 (psychological level, March low) aligns as first support. With a daily close below that level on a dovish ECB, EUR/USD could target 1.0700 (psychological level) and 1.0630 (March 2020 low). Key resistance seems to have formed at 1.0900 (psychological level, static level). In case this level turns into support, a steady rebound toward 1.1000 (psychological level, 20-day SMA) and 1.1100 (static level, psychological level) could be witnessed. 

The Reserve Bank of Australia has surprised investors with a hawkish shift. Australia is expected to have created 40K new jobs in March.  AUD/USD is trapped between Fibonacci levels, employment to be a ‘make it’ or ‘break it’. Australia will release its March employment figures early on Thursday, and this time, the market will be paying more attention than usual to the report. The Reserve Bank of Australia, in its latest meeting, surprised investors by turning hawkish. Policymakers are now open to hiking rates before year-end and announced they will keep a close eye on upcoming inflation and jobs data. Job creation vs wage growth The country is expected to have added 40K new positions in the month, while the Unemployment Rate is foreseen contracting to 3.9% from 4.0%, while the Participation rate is seen increasing to 66.5%. Back in February, Australia added 121.9K full-time positions, quite an impressive figure in the lockdown´s aftermath. Governor Philip Lowe acknowledged that the Australian economy remains resilient in the post-decision statement, which also noted that “inflation has increased sharply in many parts of the world. Ongoing supply-side problems, Russia's invasion of Ukraine and strong demand as economies recover from the pandemic are all contributing to the upward pressure on prices.” The Board also noted that growth in labor costs has been below rates that are likely to be consistent with inflation being sustainably at target, adding that it would assess upcoming “important” data on inflation and labor costs to set its policies. Australia releases its Wage Price Index on a quarterly basis, and the release of the Q1 figure is scheduled for May 18. The latest release showed that the seasonally adjusted  Wage Price Index rose 0.7% QoQ and 2.3% YoY. It was the highest reading since Q2 2019, although previous to the pandemic, wage growth had stagnated to on average 2.2%, well below the record high of 4.3% QoQ from 2008. Clearly, the RBA is much more concerned about wage growth than job creation. However, the latter is directly linked to economic growth and stability. It’s rather a matter of the RBA wishing to avoid unemployment, which would be an even bigger problem, than it being concerned about the possibility of extensive hiring pushing real wages lower. AUD/USD possible scenarios The AUD/USD pair has retreated from a multi-year high of 0.7660 and trades in the 0.7420 price zone ahead of the event. The corrective decline has met buyers around the 38.2% retracement of the 2022 rally at 0.7395, an immediate support level. A discouraging report may push the pair below it, favoring an extension of the current bearish corrective decline towards the next Fibonacci support level at around 0.7310. On the other hand, upbeat figures could push the pair above 0.7500, the 23.6% retracement of the aforementioned rally, leading to sustained gains towards the aforementioned 2022 high.

The global tightening cycle is in full swing with half point interest rate hikes from the Bank of Canada and Reserve Bank of New Zealand. Expectations for changes by both central banks did not stop the Canadian and New Zealand dollars from reacting strongly to these adjustments. The Canadian soared dollar after the rate decision while the New Zealand dollar plunged. Their diametrically opposite movements underscores the importance of policy guidance.   To the surprise of many investors including ourselves, the Canadian dollar sold off ahead of the rate decision, hitting a bottom about an hour before the Bank of Canada raised interest rates by 50bp for the first time in 22 years. This was the bank’s largest single move in more than two decades. According to Governor Tiff Macklem, “the economy can handle higher interest rates, and they are needed.”  Like many countries around the world, Canada is struggling with high inflation – the last consumer price report from February showed prices growing at its fastest rate in 30 years. Russia’s invasion of Ukraine drove prices even higher in March. Although a half point hike and end to bond purchases were widely anticipated, Macklem’s guidance sent the loonie soaring. He said “we are prepared to move as forcefully as needed to get inflation on target” and that rates should return to the “neutral range of 2% and 3%.”  Canada should brace for another 100 to 200bp of tightening this year.    The New Zealand dollar plunged despite a similar size rate hike from the Reserve Bank. The half point move from the RBNZ was a surprise as economists had been looking for a quarter point hike. However according to the RBNZ, “The committee agreed that their policy ‘path of least regret’ is to increase the OCR by more now, rather than later, to head off rising inflation expectations.” Even though they said “it is appropriate to continue to tighten monetary conditions at pace,” investors interpreted today’s move as a dovish hike and a sign of the central bank slowing down.  They have raised interest rates for four straight meetings since October as inflation surged to 5.9 percent.    Tomorrow, the focus turns to the European Central Bank who is not expected to change monetary policy. Although high inflation is also a problem in the Eurozone, growth is hampered by sanctions on Russia, supply chain issues and the shock of higher food and energy costs on consumers.  The rise in long term rates across Europe should help to cool prices. Even if the ECB can’t raise rates this week, there are steps that can be taken in that direction. The most important of which is addressing their Quantitative Easing program. Previously, the ECB said rates won’t increase until asset purchases end. The choice now is to end QE immediately or to shift guidance by suggesting that rates could increase as QE is unwound. We expect the ECB to raise interest rates this year but the move may not happen until the late third or early fourth quarter, leaving the central bank far behind its peers.   The U.S. dollar is trading strongly, particularly against the Japanese Yen ahead of Thursday’s retail sales report. With prices and wages rising, consumer spending growth is expected to accelerate. The focus will be on core prices – if spending ex autos and gas beats, USD/JPY could extend its gains. Even if it doesn’t expectations for a half point hike at the next FOMC meeting will remain intact. 

EUR/USD - 1.0823 Euro's selloff from 1.1184 (Thur) to 1.0837 on Mon and yesterday's break there to a fresh 1-month bottom at 1.0822 in New York on continued usd's strength due to rally in U.S. yields suggests early correction from Mar's 22-month bottom at 1.0807 has ended and downside bias remains for re-test of 1.0807, break would recent downtrend to 1.0760.later. On the upside, only a daily close above 1.0903 signals a temporary bottom is in place and risks stronger retracement towards 1.0933/38, break, 1.0961. Data to be released on Wednesday New Zealand food price index, RBNZ interest rate decision, Japan machinery orders, Australia consumer sentiment, China trade balance, imports, exports. U.K. PPI output prices, PPI input prices, RPI, CPI, DCLG house price, Italy industrial output. U.S. MBA mortgage application, PPI and Canada interest decision.

Outlook: We get CPI today, expected up substantially to 8.4% from 7.9% the month before. We can blame post-lockdown demand, supply chain cost pushes, and the Russian invasion of Ukraine. But also important is the New York Fed’s survey showing expectations for the future. While the public expects today’s data to be grim, by March 2025, it expects inflation at only 3.7%. This is down from 3.8% in February! And see the ZEW data above–Germans also expect a massive drop in inflation. Wishful thinking? Are we being snookered or is this realistic? Judging from Fed resolve, yes, it’s realistic. As for being snookered, it all depends on the Russian war and what happens in the oil/gas industry. Nobody is willing to forecast that right now. Today we woke up to the US contemplating higher ethanol content in gasoline, which reduces reliance on oil but also raises smog (and may not work if the sources of ethanol, like corn, are supply-constrained). If the public is right, we may well have a real return on fixed income for the first time in years. Say what you will about the motivation to save, a decent return on a safe investment will not go unnoticed. Right now, a savings account at Goldman Sachs yields 0.5%, and that includes a recent increase. Remember that while many folks have an interest in equities because they have IRAs and pension funds, the majority of Americans have no equity trading accounts, aka no skin in the game. And often deep suspicion of the stock market, some of it justified. But US government bond are still considered the safest thing on earth. Nobody is saying so, but positive real yield on government paper may seduce some crypto fans away. Not the get-rich-quick gang, of course. We have been complaining about the disconnect between the real economy and the bond market for a long time. This shows up most dramatically as a deeply negative real rate, and that was true even before inflation started to get a grip last year. (Another is the insane situation in some European countries–was it Denmark?–where the bank paid you to take out a mortgage with them. At least we didn’t get negative rates in the US.) Normalcy is hardly about to descend upon us, but here is a nice chart from the Daily Shot showing that TIPS–Treasuries protected against inflation–are nearing zero. Yippee! It’s progress. We are likely going to get some churning and burning on release of CPI and a couple of Fed speakers today, but beware the Tuesday pullback. The dollar index is a dreadful indicator (and mostly the euro, anyway) but it’s what we have. Hitting over 100 is an invitation for a sell-off or at least some profit-taking. This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes. To get a two-week trial of the full reports plus traders advice for only $3.95. Click here!

This is a shorter trading week for the Easter public holiday, however, there are some key data releases to watch out for and as we have mentioned in recent notes, the markets are being driven by fundamentals at this stage of the cycle, so keeping up to date with political and economic data is critical. The main event that the markets are digesting at the start of this week is news that incumbent French President Macron won the largest share of votes in the first round of the Presidential election on Sunday. He will now face the second-round run-off with the far-right candidate Marine Le Pen, who made a stunning comeback, winning a decent 23% of the vote. The question for French and European asset prices, will the anti-EU, anti-NATO candidate become the French version of Donald Trump, and how will the euro react? Euro’s hopes rest with Macron While Le Pen has won a large share of the French vote, the last time she had a run-off with President Macron in 2017, the gap between them was narrower, thus, the markets are pricing in for another Macron victory. This is good news for the euro and European stock prices, as Le Pen is seen as a disruptive political and economic force for the currency bloc. The euro is leading the G10 pack higher today, and the Cac 40 is outperforming the FTSE 100 and the Dax, as markets believe that although it will be close, Macron will still win on 24th April and remain as President. A snap poll taken after Sunday’s vote, suggest that Macron will narrowly beat Le Pen. The poll by Elabe, which interviewed 1,500 people, found 52% would vote for Macron in the second round, vs. 48% for Ms Le Pen. While this is within the margin of error, another poll by IPSOS found that Macron would win by 54% vs. 46%, which is a more comfortable margin of victory and one that the markets are running with. Of course, there are still nearly 2 weeks to go, and Macron will need to hit the campaign trail hard and try to ameliorate the cost-of-living crisis, which is his weak spot that has been expertly exploited by Ms Le Pen. Overall, the market reaction to Sunday’s vote suggests that a win for Macron is positive for the euro and for markets, while a win for Ms Le Pen is negative. If we see polls showing the race narrowing, or moving in Le Pen’s favour, then expect the euro and French assets to sell-off. UK growth and stagflation risks Stagflation is being mentioned in relation to the UK economy, after February GDP, which was released early on Monday, came in below expectations at 0.1%. Considering that inflation is continuing to rise, and the cost of living is surging, the market is now fearful that UK could be entering a period of low growth and high prices, a la 1970s, which is particularly corrosive for economic growth and asset prices. The decline in output in February came after a stronger bounce in GDP in January, where the economy expanded by 0.8%. Growth in February was dragged lower by industrial production (down 0.6% vs. Jan), and manufacturing, which fell by 0.4% compared to Jan. Growth was boosted by services and tourism, although the service sector’s 0.8% expansion, was slightly lower than the 0.9% expected. The non-EU trade balance also weighed on growth as it widened. Unsurprisingly, due to Brexit red tape and the war in Ukraine, our EU trade balance narrowed. While services continue to grow at a decent clip, the decline in short-term manufacturing rates are of a concern, even if annual growth looks decent. Brighter skies ahead for the UK economy? The surging cost of raw materials and energy along with the supply chain crunch, could hurt this sector further and it is one of many economic consequences of the Russian invasion of Ukraine that are impacting the UK’s manufacturing and industrial economy. This won’t be unique to the UK, we expect Europe, especially Germany, to also be impacted. However, after taking a long time to recover post the Covid pandemic, the risk is that another weak month of growth could set the UK’s economic recovery plans back again. For now, the market may put this month’s weak growth report behind it and look to a brighter future and this is why GBP/USD has started the week on a bright note and is back above the $1.30 level, although after a weak start to 2022, the pound is looking extremely vulnerable against a resurgent dollar. As one would expect, EUR/GBP is mostly trading sideways, although the euro has a bid at the start of the week. While there are reasons to short the pound, we would note...

EUR/USD - 1.0881 Euro's selloff from 1.1184 (Thursday) to a 1-month bottom at 1.0837 on continued usd's strength due to rally in U.S. yields suggests early correction from March's 22-month bottom at 1.0807 has ended and as price has fallen again after yesterday's gap-up open to 1.0934 in New Zealand, consolidation with downside bias remains for re-test of 1.0837, break, 1.0807 later. On the upside, only a daily close above 1.0934/38 would signal a temporary bottom is in place and risk stronger retracement towards 1.0961, break, 1.0988 later. Data to be released on Tuesday Japan producer prices, Australia NAB business confidence, NAB business conditions. U.K. BRC retail sales, average weekly earnings, employment change, ILO unemployment rate, claimant count, Germany HICP, CPI, ZEW current conditions, ZEW economic sentiment, France exports, imports, trade balance, current account, EU ZEW survey expectation. U.S. CPI, redbook and Federal budget.

Investors continued to buy U.S. dollars, driving the greenback to its strongest level against the Japanese Yen in more than 6 years. The biggest driving force for USD/JPY right now are U.S. yields which have been in a relentless uptrend for the past 2 months. Today marks the seventh consecutive day of gains for 10 year yields which broke above 2.7%. To put this into perspective, just over a month ago 10 year rates were hovering under 1.8%.     Investors are convinced that the Federal Reserve will raise interest rates by 50bp at their next meeting as high prices persist. This is consistent with everything we’ve heard from Fed Presidents last week. We’ll hear from more policymakers this week and they are widely expected to reinforce the central bank’s hawkish views.  The upcoming inflation and consumer spending reports should also harden the case for aggressive tightening. CPI will be hot and retail sales will be supported by higher prices, higher wages and strong labor market conditions. The big question is how much further can USD/JPY rally? The closest resistance level is the May high of 125.86 but if this week’s U.S. economic reports surprise to the upside we could easily see the pair move to the April 2001 high of 126.85 and then 130.    In addition to these pieces of market moving U.S. data, there are also three central bank rate decisions on the calendar and two are expected to raise interest rates. The Reserve Bank of New Zealand meets first on Wednesday morning local time and they are expected to lift rates for the fourth time by 25bp. Some economists are looking for a larger 50bp hike but with supply constraints, rising prices, the lockdown in China and slower global growth, the RBNZ who has already raised rates by 75bp is likely to opt for a more conservative adjustment. By doing so, they would gain the flexibility of seeing how the market responds to Fed tightening and how the Russian invasion of Ukraine plays out.    The Bank of Canada on the other hand is wildly expected to raise interest rates by 50bp. This would be the second back to back rate hike from the BoC and the largest one month increase since 2000. Unlike the RBNZ, the Bank of Canada has only raised interest rates by 25bp and a half point move would bring rates to 1 percent. Even without the pressure of rising prices, the strong labor and housing markets support policy normalization. With inflation at a 30 year high, the BoC will most certainly step signal further tightening beyond this week’s move. Rates could easily hit 2.5% by the end of the year.     Unlike the RBNZ and BoC, the European Central Bank is not expected to raise interest rates. Although high inflation is also a problem in the Eurozone, growth is hampered by sanctions on Russia, supply chain issues and the shock of higher food and energy costs on consumers.  The rise in long term rates across Europe should help to cool prices. Even if the ECB can’t raise rates this week, there are steps that can be taken in that direction. The most important of which is addressing their Quantitative Easing program. Previously, the ECB said rates won’t increase until asset purchases end. The choice now is to end QE immediately or to shift guidance by suggesting that rates could increase as QE is unwound. We expect the ECB to raise interest rates this year but the move may not happen until the late third or early fourth quarter which leaves the central bank far behind its peers – a predicament that is negative and not positive for euro.     With the prospect of global tightening, ongoing Russian-Ukraine conflict, stress of high prices, supply chain issues and the COVID-19 crisis in China, we expect risk appetite to take a turn for the worse. The Dow Jones Industrial Average dropped more than 400 points today and while currencies held steady, a broad based sell-off may be right around the corner.  

Key Highlights EUR/USD extended decline below the 1.0950 support. It broke a key bullish trend line with support near 1.0980 on the 4-hours chart. EUR/USD Technical Analysis Looking at the 4-hours chart, the pair even traded below the 1.1000 level, the 200 simple moving average (green, 4-hours), and the 100 simple moving average (red, 4-hours). There was a break below a key bullish trend line with support near 1.0980 on the same chart. The pair traded as low as 1.0835 and is currently consolidating losses. An immediate resistance on the upside is near the 1.0915 level. The first major resistance is near the 1.0950 level (the previous support zone). The next major resistance is near the 1.1000 level. Any more gains might send the pair towards the 1.1050 level in the coming sessions. On the downside, an immediate support is near the 1.0840 level. The next major support is near the 1.0820 level. A downside break below the 1.0820 support level might send the pair towards the 1.0750 level.

Outlook: The data plate is not interesting (wholesale sales and inventories) and no Fed speakers are scheduled. The original trouble-maker, St. Louis Fed Pres Bullard, said he prefers the Fed funds target at 3-3.25% by year-end. The CME FedWatch tool shows a mere 10.8% of Fed funds traders see that as likely. (www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html). We think Bullard will prevail—again. But first, bond market turmoil arising from acceptance of the Fed’s tightening plan. The 10-year yield has moved from 1.19% on Aug 8, 2021 to 1.52% at year-end to 2.50-2.68% this week. A Reader asked whether we will see a replay of 3/78 to 10/81 when the 30-year went from 8.24% to 14.49%. The answer is no, for several reasons. First, we didn’t have QE in the late 1970’s. QE artificially reduced yields and nobody knows by how much. This is a key reason why yield curve inversion today that predicted past recessions is questionable. History will not repeat exactly but some of it may rhyme. Consider that when yields were up in the stratosphere, they still delivered a real (after-inflation) return. Ed Yardeni rides to the rescue. See his chart of the 30-year. It was not a real negative for 42 years until QE came along in 2020, although falling since 1994. The 10-year shows we had negative real rates in 1974, 1979, 2008, 2012, the last one without an accompanying recession. There’s plenty to quibble about in these charts, including the criticism that the timeframes should be shifted to show lag. But quibbles miss the point that negative real returns are rare, unusual, and scare the pants off everybody, while not always driving capital to equities. Second, which inflation metric are we using? The third Yardeni chart shows quite a divergence between two inflation measures. So, if the 10-year ends this calendar year at (say) 3.5%, it will still not be delivering any real yield if inflation remains at the Fed’s forecast of 4.3% by year-end (and 2.7% by end-2023). Or worse, CPI. Let’s assume core CPI stays the same 6.4% in Feb (Trading Economics sees it rising to 6.7% in April for March, but put that aside). And let’s further assume it stays at 6.4% to year-end and does not moderate. If the 10-year yield is 3.5%, the negative yield is 2.90%. If we loosen the assumption and say inflation will be 4%, it’s still a negative. Inflation forecast are all over the place. Everyone has one—the BIS, the OECD, the IMF, private economics organizations like the Peterson Institute, even Kiplinger (with 10%, wow). The breakevens have 3.28% in the 5-year and 2.83% in the 10-year. Obviously, several somebodies are going to be wrong. Equally obviously, there is too much variability in the inflation forecasts for the upcoming Fed events to be properly priced in. As explained before, the pricing-in concept seems to be a corollary of the efficient markets hypothesis that pretty much fails empirical tests (as well as common sense). We would not get overshooting if events could be priced in properly. Besides, no one has a crystal ball. Sometimes it’s the idiots who control sentiment and it’s sentiment that determines price. In order for the 10-year to deliver a meaningful real return, with inflation at 4-5%, that mean a nominal yield of 6-7%. The probability of getting that during this year is almost zero. What about 2023 or 2024? Well, maybe. But Fed talk of the neutral rate at 2-2.5% by then is just plain silly. They are going to have to rachet that up. Now what do we do about recession? Markets expect the Fed to relent if recession arrives. The Fed says this time it won’t, but you never know. It held back on 50 bp in favor of 25 bp at the last FOMC meeting because of the Ukraine war. What can happen to change its mind again? One clue might be companies’ willingness to invest in new production capacity. Capital spending plans are a proxy for future economic growth, aka GDP. The Atlanta Fed GDPNow model puts a lot of weight on it. Capital spending affects jobs as well as input/construction prices and output prices, too. If we are getting a recession, we expect capital formation to crash. See the chart of capital spending. This is a prerequisite for recession as well as the proof if it. In the grand scheme of things, interest expense is not the top factor in the capital investment decision—it’s demand, plus the cost of inputs. As things like copper, steel and other inputs go nuts because of the war (like chips went nuts because of Covid), investment will likely fall. A corollary is capacity utilization. High numbers imply inflationary pressure from within, so to speak. This is doubly dangerous with a raging labor shortage. Some producers can get more...