Risk Probably for Fed Guidance to be Still More Hawkish

Markets

There was little ‘real’ market relevant news from the conflict in the Middle East, yesterday. There was hardly any progress on ideas/strategies to secure a passage through the Strait of Hormuz. Visibility on how and when the conflict might end also remains close to non-existent. With higher energy prices the major economic fall-out, markets now might move to a position where oil prices in the vicinity of $100-105 p/b are somewhat of a short-term anchor point/new normal which is more or less priced in. In technical trading yields US yields didn’t show any clear directional trend with yields changing between +0.25 bps (2-y) and -2.6 bps (30-y). German yields at the same time ceded between 1.9 bps (2-y) and -4.2 bps (30-y). The reaction function of bond markets currently is far from unequivocal, but given market sensitivity to inflation risk premia and to a lesser extent, fiscal risk premia, a bull flattening of the curve currently probably should be seen as a sign of tentative easing of market stress. In this context, it coincided with modest equity gains for the second consecutive day (S&P +0.25% ; Eurostoxx 50 +0.53%). In the same move, the dollar corrected slightly further (DXY from 99.87 to 99.58; EUR/USD from 1.1505 to 1.1540, USD/JPY marginally lower at 159).

The starting point today is similar when looking at the situation in the Middle East. (Brent) oil ($100.8), US yields and the dollar (DXY 99.45, USD/JPY 158.75) are easing a bit further. Asian equities are recovering (Nikkei +2.77%). In the absence of ‘new news’ from the Middle East the focus later today might turn to the Fed policy decision, new quarterly projections (dots) and the assessment from Fed Chair Powell at the press conference. Of course, any Fed scenario thinking also remains highly conditional on event risk/energy price scenarios. Even so, recent developments (higher oil prices potentially pushing PCE/CPI inflation to the 3.5%+ area) might cause at least some governors to abstain from guidance on future interest rate cuts. In the December dots, 7 out of 19 Fed members already indicated interest rates staying unchanged throughout 2026. So not that much is need for tipping this balance to an unchanged median dot. US money markets still discount one additional Fed rate cut by year end (compared to 2.5 cuts before the start of the war). The risk probably is for Fed guidance to be still more hawkish compared to current market pricing, suggesting room for some further bear flattening. Such an outcome would add to overall USD strength since the beginning of March, potentially denting risk sentiment.

News & Views

February trade data published by the Japanese Ministry of Finance this morning showed export (value) rising by 4.2% Y/Y (from +16.8% in January). A significant increase of export to the EU (+14% Y/Y) offset declines to the US (-8% Y/Y) and China (-10.9% Y/Y). Towards the US, tariffs especially weighed on car shipments. When it comes to China, the timing of Lunar NY might have distorted the data. Japanese imports (value) increased by 10.2% Y/Y (from -2.6% Y/Y in January) with especially import growth from Asia (+16.2% Y/Y) and China (+33.3% Y/Y) increasing rapidly. Imports from the EU were down 2% Y/Y. On a seasonally adjusted basis, the trade balance swung from an exceptional JPY 499.1bn surplus in January to a JPY 374.2bn deficit in February.

New Zealand consumer confidence has taken a knock in Q1, albeit only a small one at this stage. The Westpac-McDermott Miller index fell from 95.5 to 94.7 with levels below 100 indicating that there are more households pessimistic about economic conditions than optimistic. Surveys were conducted during the first two weeks of March. Improving domestic conditions (improving financial positions thanks to continued strength in export commodity prices like dairy and a large drop in borrowing costs) have been over taken by more worrying global events. The outbreak of war in the Middle East sent local fuel costs already sharply higher with spillover to other costs like airfares. The longer the conflict continues, the larger the resulting disruptions to economic activity and pressure on households’ finance will be.