The week that was
US equity markets sold off into the end of the week as rising inflation prospects and slightly weaker activity data weighed on sentiment. Feb CPI data continued to show strength in shelter costs combined with now resurgent energy prices. Energy markets have convincingly broken higher on the back of tight inventories, Opec resolve and ongoing geo-political tensions. These tensions are also keeping shipping costs elevated which are visibly now feeding into rising import costs for US producers as evidenced by recent data on PPI. China’s deflation has also suddenly ended with the prospect of renewed stimulus efforts potentially adding to re-emerging inflationary pressures. As China ceases to be a global dis-inflationary force and surging energy prices begin to re-exert meaningful upward pressure on headline inflation, central banks will find themselves unable to ease policy and instead will need to convince markets that they remain resolved to bring inflation back to 2%.
The Federal Reserve will be meeting this week and releasing their most updated economic projections in light of recent activity and inflation data. Upward revisions to their inflation forecast will be warranted, especially for this year. Our estimates based on the most recent 6 month trends in CPI and PCE make it more likely that inflation will be closer to 2.8% this year relative to the Fed’s projection of 2.4%. This reality has started to dawn on markets and will become apparent in the Fed meeting this week as they begin to push back on rate cut expectations. There is still a chance however that the Fed stops QT, citing technical factors. The combination of pushing back on rate cuts and stopping Bond sales would further invert the US treasury yield curve potentially sending a negative signal to equity markets that tend to see inverted curves as a recession signal.
Over in Japan, we expect the central Bank to shift away from its decade long experiment with negative interest rates and yield curve control as it becomes clear that Japan no longer requires this extreme prescription of ultra easy policy. Inflation is sticky above 2% and wage negotiations are handily coming in higher that market expectations. Japan needs to immediately begin tightening financial conditions and we expect it to do so at Monday’s meeting. Some modest appreciation in the Yen should be expected on the back of the announcements, we remain concerned at the viability of long-term JPY strength however given the recent yield spike in the US.
In addition to the key BOJ and Federal Reserve meetings scheduled for this week, the Bank of England also meets to discuss monetary policy and we keenly anticipate ECB Lagarde’s speech on Wednesday. On the global data front we are set to receive retail sales and IP data out of China tomorrow as well as key releases on US housing, and UK as well as Canadian CPI and Retail sales later on in the week.
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