The narrative in financial markets seems pretty clear. Inflation needs to be addressed and given that supply-side factors show no signs of easing, central banks are going to have to take the steam out of demand by tightening monetary policy. Whether that slowdown turns into a soft-landing or a recession remains to be seen. In response, equity markets remain under broad-based pressure as growth forecasts are cut and the risk-free rate rises.
So far the Fed remains firmly set on its hawkish course. Richmond Fed President Thomas Barkin summed things up well yesterday when he said that the Fed should raise rates as fast as possible without breaking anything. It does not seem that the Fed considers the 21% year-to-date decline in the S&P 500 as representing anything being broken and the Fed's current rhetoric is that the US economy can handle higher rates. Expect this message to be communicated again today when Powell delivers his semi-annual testimony to the Senate. The Fed's terminal rate priced for 2023 is currently near 3.60% (off a recent high at 3.90%) and could go higher again on Powell's testimony.
Canada reported stronger than expected April retail sales (1.3% excluding autos, twice what the median projection in Bloomberg's survey anticipated, and the March series was revised to 2.6% from 2.4%). On tap today is May CPI and it is expected to have accelerated. The year-over-year pace is projected to have increased to 7.3% from 6.8%. The market is pricing in more than a 90% chance of a 75 bp hike at the July 13 Bank of Canada meeting. It has the year-end rate slightly north of 3.50%. It had reached almost 3.70% at the start of last week, following stronger than expected employment data. The surge in US equities helped lift the Canadian dollar to three-day highs yesterday, and the pullback today is taking a toll. The US dollar approached 1.29 yesterday but is back near 1.30 today. A move above 1.3020 would signal a retest on last week's high near CAD1.3080. Observe the USD/CAD chart.
It seems that EUR/USD is happy to trace out a 1.0400-1.0600 range for the time being, with a downside bias on the back of Fed testimony today. In Europe, growth forecasts continue to be cut and concern is growing about a sudden stop in gas supplies. Investors are also probably wary of events in the Baltics where tension over Russia's outpost at Kaliningrad is growing. Equally, doubts about how hard the European Central Bank can really stamp on the monetary brakes will keep the euro on the soft side.
UK May CPI came in as expected at 9.1% year-on-year and looks unlikely to have much of a say on Bank of England pricing. That pricing remains very aggressive, with the policy rate still priced above 3.00% (assuming 175bp of hikes) for the December meeting this year. As per comments from BoE Chief Economist Huw Pill yesterday, the BoE remains prepared to act more forcefully. It is not a very fashionable view, but we suspect GBP can stay a little more supported than most expect over the near term.
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