There has been a significant shift in recent weeks. As the US economic data for January flooded through with a swathe of upside surprises there has been a big re-pricing of expectations for Federal Reserve rate hikes. Traders are increasingly convinced that more hikes are on the way.
The question is, will February data show a continuing trend, or was January just a one-off month? The first couple of weeks in March will therefore be crucial for setting the tone for the whole month.
The ISM surveys, Eurozone inflation, central banks, and US Nonfarm Payrolls will mean it will be a massive two weeks for forex traders. It will determine whether the USD rebound can continue.
- ISM surveys jumping again: ISM Services jump-started the USD rally in February.
- Eurozone inflation: Sticky inflation for the Eurozone would be risk negative.
- Central banks turning more hawkish again: The recent trend has been for central banks to lean with a hawkish bias
- Nonfarm Payrolls strong again: The strong payrolls data ramped up the USD rebound last month.
It is all about the hawks in March
Trends in major markets have been set over recent weeks. Central banks, worried about inflation, are leaning hawkish. They are therefore moving to keep interest rates higher for longer, driving a USD recovery and a negative bias for risk appetite.
- Higher government bond yields, driving negative risk appetite
- The USD is the outperformer on major forex
- The equity bull run is being questioned.
Much of whether these trends continue will be down to the February major economic data that is announced in the next couple of weeks.
ISM data will be the early driver
ISM Services data lit the blue touch paper for the USD rally in February. The ISM Manufacturing was a little subdued last month, so could this now play catch up with the services data?
On the 1st March, ISM Manufacturing is forecast to improve to 47.8. This suggests the manufacturing sector remains in contraction. However, a jump back above 50 would certainly jolt the markets.
If manufacturing and services were both above 50 and back in expansion, it would point to a decisively resilient economy, but one in which the Fed hawks would feel compelled to hike further.
- Market reaction: Positive ISM data would drive Treasury yields higher and a positive USD. It would also likely be risk negative as the prospect of higher interest rates.
Eurozone flash inflation
Downside surprises have been a consistent feature of recent months in the Eurozone. Forecasts suggest another move lower on headline Eurozone HICP to 8.2% (from 8.6% and core Eurozone HICP to 5.2% (from 5.3%).
However, traders will be keeping a keen eye on just how sticky inflation proves to be for the euro area.
Inflation trends have proved to be stubbornly sticky (most notably in the US) leading several central banks to warn of the need for rates to be higher for longer.
The February Eurozone inflation data will significantly impact the European Central Bank staff projections for the next ECB meeting (16th March). If inflation (especially core HICP) also proves to be sticky for the Eurozone, this would likely drive a hawkish bias.
- Market reaction: Any upside surprise to core HICP would be EUR positive. However, could also be USD positive too, due to the risk-negative implications of ever higher rates for another major central bank.
Three major central banks update monetary policy
March is a huge month for major central bank monetary policy meetings. In the next couple of weeks, there are three banks to look out for:
- Reserve Bank of Australia (RBA) on Tuesday 7th March
- Bank of Canada (BoC) on Wednesday 8th March
- Bank of Japan (BoJ) on Friday 10th March
In the minutes of the last meeting, the RBA agreed that further hikes were likely. The board even discussed a 50 basis points hike. This opens the door to upside surprises in the March meeting.
It will also be interesting to see how the Bank of Canada reacts to sticky inflation trends. The BoC suggested a pause was on the cards in the last meeting. With other central banks leaning back hawkish again, there is the risk of an upside surprise.
- Market reaction: The prospect of higher interest rates has driven a negative risk reaction, leading to AUD underperformance. Also with JPY being left behind as US Treasury yields rise. Any hawkish surprises could drive a similar reaction.
It is the final meeting for outgoing BoJ Governor Kuroda. Such a staunchly dovish governor is highly unlikely to do anything to rock the apple cart. There are very low expectations of anything other than the status quo.
Nonfarm Payrolls coming in hot again
This will be the big one. The upside surprise drove an acceleration of the USD recovery in February. Upside surprises for US jobs growth and average hourly earnings (i.e. wage growth) play into the Fed’s hawkish positioning.
If there is a continuation of firm US labour market data in the Nonfarm Payrolls report, there would likely be a significant reaction on US Fed Funds futures.
A 50 basis points hike in March would suddenly become a very real possibility. According to the February FOMC minutes “a few” members thought that a 50bps hike could have been needed.
These are widely reported to have been Loretta Mester and James Bullard, neither of whom has a vote on monetary policy in 2023. However, if there are two impressively strong US jobs reports in a row, 50bps may not be out of the question.
At the very least, markets would position for this, along with a potential terminal rate moving from the c. 5.25% levels currently, towards 5.50%.
- Market reaction: Another strong payrolls report would send yields sharply higher and drive USD strength. Risk appetite would suffer further and would drive a correction on equity markets and gold.
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