Will the Fed still dare to hike rates on Wednesday?

Emily Nicol
Chris Scicluna

Will the Fed still dare to hike rates on Wednesday?
With markets febrile amid persisting uncertainties about the stability of US regional banks and aftershocks from Credit Suisse bondholder losses, it should not be a surprise if the FOMC decided on Wednesday to leave the Fed’s monetary policy unchanged while it waited for financial conditions to calm. However, the US dataflow, including last week’s somewhat troubling CPI report, suggests that more action is required to tame inflation. And with US authorities and their G7 colleagues having taken swift action to try to support financial stability – including yesterday’s decision to offer daily 7-day US dollar operations at least through the end of April to support smooth functioning of US dollar funding markets – on balance our economist colleagues at Daiwa America still expect the FOMC to press ahead this week with a hike of 25bps in the federal funds rate target range to 4.75-5.00%. Current market pricing attributes a roughly 50% probability of such a hike.

On Wednesday, the FOMC will also publish its updated economic projections, including a new dot plot. Earlier this month, Fed Chair Powell signalled that the new plot would show a higher level of rates than the December plot, which showed the median dot for year-end at 5.125%. Despite risks that financial conditions will now tighten significantly, the new plot might still signal higher rates. Our colleagues in Daiwa America would not be surprised with a median dot for end-23 of 5.625% (i.e. a target range of 5.50-5.75%). However, the range of FOMC member projections might be expected to be significantly wider than previously, reflecting the heightened uncertainty.

Data-wise, the US calendar is much quieter this week. No top-tier reports are due today, with February existing home sales figures due tomorrow and new home sales due Thursday. And durable goods orders data for the same month are due Friday. With the volatile aircraft component expected to show little change after big swings in the prior two months, and manufacturing activity moving sideways or inching lower, our colleagues in NY expect overall bookings to increase only modestly (circa ½%M/M), with most or all of the advance reflecting higher prices rather than real activity.

BoE monetary policy decision also not clear cut, although we expect a final 25bps hike
The BoE’s latest monetary policy announcement will follow on Thursday. While the MPC again hiked Bank Rate by 50bps at the previous meeting in February, its updated forward guidance and economic projections – which suggested that inflation will fall significantly below the 2% target from Q224 on – made clear that the end of the tightening cycle might be near. Notably, its guidance suggested that news with respect to services prices and wage settlements would be key to determining the future path of rates. And, on both counts, we think the data would justify a slowing in the pace of hikes, or even no hike at all this month. There are signs that inflation expectations are moderating too. Wariness at possible adverse spillovers from recent stress in certain US banks and Credit Suisse, and associated financial market turbulence, would also call for caution on interest rates. And at face value, the confirmation in last week’s Budget statement that increased government support will avoid a further rise in household energy bills in April will mean that inflation will fall more sharply than previously projected next quarter. However, the significant relaxation of the overall fiscal stance in the Budget – with net public borrowing in the coming fiscal year set to be £18.6bn higher than would otherwise have been the case if policy had been left unchanged – would call for additional monetary tightening. So, we expect the MPC merely to slow the pace of rate increases on Thursday to 25bps, taking Bank Rate to 4.25%, where we still think the current tightening cycle will conclude.

UK inflation, retail sales, consumer sentiment and flash PMIs all due
It will also be a busy week ahead in the UK for economic releases, with updates on inflation (Wednesday), retail sales, consumer confidence and the flash PMIs (all Friday). Having peaked in October at a 40-year high, inflation looks to set to return to single digits in February. We forecast a fall of 0.4ppt in the headline CPI rate, to an eight-month low of 9.7%Y/Y, with the core rate easing 0.2ppt to 5.6%Y/Y, the lowest level in a year. In terms of economic activity, surveys suggest that retail sales rose modestly for a second successive month, albeit leaving the average level in the first two months of Q1 still about ½% below the Q4 average. The GfK survey (Friday) is also expected to post another modest increase in consumer confidence in March to the highest level in a year albeit still low by historical standards. Finally, after the PMIs surprised significantly on the upside in February – with the headline composite output PMI jumping 4.5pts, the most in a year, to 53.0, the highest since June – we expect some adverse payback this month.

ECB Watchers’ Conference on Wednesday to be watched closely
Following last week’s ECB monetary policy announcement, President Lagarde will give an update on the view of the Governing Council this afternoon at the European Parliament. And Lagarde, Chief Economist Lane and dovish Executive Board Member Panetta are all also due to speak publicly in Frankfurt on Wednesday at the annual ECB Watchers’ conference. Lagarde suggested that we might expect to hear a more thorough assessment from her of how recent financial market developments might affect the transmission of monetary policy.

Data-wise, the focus in the euro area will be on the first economic sentiment survey results for March, including the ZEW investor indices (tomorrow), the Commission’s flash euro area consumer confidence index (Thursday) and the preliminary PMIs (Friday). While the PMIs have pointed to a steady recovery since the start of the year, we might expect to see some modest softening in March. But given recent market turbulence, however, we expect the ZEW survey to point to a deterioration of both current conditions and expectations. Ahead of the surveys, today will bring euro area goods trade figures for January. This morning’s German PPI inflation data for February saw prices at the factory gate decline for five consecutive months, by 0.3%M/M, to leave the annual rate down 1.8ppts to a seventeen-month low of 15.8%Y/Y. Once again, this was driven by energy (-1.4%M/M), with the annual rate of this component down 4.6ppts to 27.6%Y/Y. Indeed, while intermediate goods inflation maintained a downwards trend in February (down 1.4ppts to 8.6%Y/Y), capital goods inflation ticked slightly higher (7.7%Y/Y) and consumer goods inflation moved sideways (16.9%Y/Y).

Japanese inflation set to fall back sharply in February on government energy support measures
In Japan, the data highlight this week will be February’s inflation release on Friday. Consistent with the results from the forward-looking Tokyo CPI and reflecting the government’s household energy bill support measures, headline CPI inflation is expected to have fallen sharply last month, by 1.1ppt to 3.3%Y/Y. Admittedly, when excluding energy and fresh foods, the BoJ’s preferred core CPI measure is forecast to rise 0.2ppt to 3.4%Y/Y, which would mark the highest rate since 1982, while the internationally comparable core rate (excluding all food and energy) is expected to rise above 2%Y/Y for the first time since 2015. The back end of the week will also bring the latest survey indicators for March, with the Reuters Tankan survey (Thursday) and flash PMIs (Friday). 

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