Hoping Powell Sheds Light in Fog of Uncertainty

Summary:

A look at the day ahead in Asian markets from Jamie McGeever.

25, no change, or maybe 50?

Every Fed meeting is the most important since the one before, but rarely in recent memory has a decision - and guidance - been more in the balance than Wednesday's.

There are no major economic indicators or policy events in Asia scheduled for Wednesday, meaning markets there will probably take their cue from the 'risk-on' tone globally on Tuesday and then go into a pre-Fed holding pattern.

The U.S. central bank delivers its interest rate verdict with inflation well above target but declining, the labor market its strongest in years but creaking, the most volatile U.S. fixed income markets in decades and lending set to slow thanks to a banking crisis that erupted barely two weeks ago.

Rates traders are putting an 80% probability on a 25 bps rate increase and 20% on a pause. There are still calls for the Fed to make a clear distinction between price and financial stability, and go ahead with an inflation-busting 50 bps hike.

The Fed's decision and latest economic projections come days after coordinated action from U.S. authorities to ring-fence domestic banks, a renewed push for broad-based reform of the banking system and coordinated global action to maintain the global flow of dollars.

The fog of uncertainty is understandably thick.

What seems clearer is that markets are on a more positive footing than they were only a few days ago, before the UBS-Credit Suisse shotgun marriage, united central bank front on FX dollar swap lines and Treasury Secretary Janet Yellen's latest remarks on strengthening banks and protecting depositors.

U.S., European and Asian stocks all rallied strongly on Tuesday, commodities rose and bonds fell - shares in First Republic Bank rose a record 30%, GameStop surged 32% and the two-year Treasury yield had its biggest rise since 2009.

Hoping Powell Sheds Light in Fog of Uncertainty_1

But if we have learned one thing from banking crises past, it is that they are never resolved in a matter of days. This has further to run, and the full economic sand market impact of the credit crunch many think is coming has yet to be felt.

Over to you Chair Powell.

Here are three key developments that could provide more direction to markets on Tuesday:

- UK inflation (February)

- Australia composite leading indicator (February)

- U.S. Federal Reserve policy decision

Source: Yahoo

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Samantha Luan

Stocks

Asian shares staged a cautious bounce on Wednesday with hopes a global banking crisis would be averted vying with uncertainty over the outlook for U.S. interest rates as the Federal Reserve holds a high-stakes meeting on policy.

Efforts by U.S. Treasury Secretary Janet Yellen to calm nerves seemed to be working with bank shares rallying overnight. Government officials were also pondering increasing the limit on deposit insurance, though there was no agreement on this as yet.

Strains were still evident among regional U.S. banks with shares of First Republic Bank sliding on suggestions the government might be involved in a rescue deal, perhaps disadvantaging shareholders.

The unease left both S&P 500 futures and Nasdaq futures barely changed. EUROSTOXX 50 futures edged up 0.2%, while FTSE futures rose 0.1%.

MSCI's broadest index of Asia-Pacific shares outside Japan added 0.9%, with Chinese blue chips up 0.3%. Japan's Nikkei firmed 1.6% led by a rebound in beaten-down bank stocks.

The still brittle mood was evident in the latest BofA survey of global fund managers which found pessimism near its worst in the past 20 years amid fears of financial risk and a flight from bank stocks.

All of which puts the Fed in a tough position as it decides whether to raise interest rates later today.

Goldman Sachs, for one, argues the banking stress will cause a tightening in lending that is essentially the same as a rate hike so a pause would be warranted.

Analysts at JPMorgan, on the other hand, stand with the majority and flag a rise of 25 basis points in part because postponing a move until May would threaten the Fed's inflation-fighting credibility.

They note the Fed could still soften its forward guidance by dropping its reference to "ongoing increases", much as the European Central Bank did last week.

QT And Dot Plots

An added complication is whether the Fed temporarily stops selling its holdings of Treasury debt, known as Quantitative Tightening, and what Fed members do with their dot plot forecasts for future rate hikes.

The latter will be a key focus as the market is all over the place on the policy outlook.

Having even priced in the risk of a rate cut last week, futures now imply an 86% chance of a quarter-point rise to 4.75-5.0%. Then again, a couple of weeks ago the market had been wagering on a half-point hike.

Investors have also swung back to expecting a further increase in May, but also imply some chance of a cut as early as July and rates at 4.25-4.50% by year-end.

How Fed Chair Jerome Powell navigates all this in his 1830 GMT news conference could well determine the course of markets for the rest of the week.

Bond investors will be hoping he can instil some calm given the wild volatility of recent days. Two-year Treasury yields were hesitating at 4.14%, having made a remarkable round-trip from 5.085% to 3.635% in just nine sessions.

European bonds have gone along for the ride. German two-year yields overnight recording the biggest daily jump since 2008 as markets went back to pricing in more ECB hikes.

That jump helped lift the euro to a five-week high of $1.0789 overnight, and it was last holding firm at $1.0770.

The dollar went the other way on the yen, where yields are still tightly controlled by the Bank of Japan, and rose to 132.50. Safe-haven demand for yen had seen the dollar as low as 130.55 early in the week.

In commodities, the mild improvement in risk sentiment saw gold ease back to $1,943 an ounce and away from Monday's top around $2,009.

Oil prices eased a touch in early trade, having rallied 2% overnight. Brent dipped 22 cents to $75.12 a barrel, while U.S. crude fell 27 cents to $69.40.

Source: Reuters

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Justin

Central Bank

Already facing uncharted territory, the Federal Open Market Committee’s job is only getting tougher. It faces innumerable conundrums: assessing the economic outlook and how recent financial turmoil impacts that, the rate decision, financial stability considerations and communicating decisions. This FOMC meeting from 21-22 March will come with a new dot plot – it may end up heightening confusion.

What to make of the economic outlook?

In the period prior to Silicon Valley Bank developments, the US economy was running hotter than expected. Continued strong labour markets underpinned growth relative to expectation, with forecasts of a US recession often being pushed towards end-2023. Inflation, despite having come down for months, was proving stickier than expected on the downside – getting to 2% was viewed as a more difficult and protracted task. Expectations about the terminal rate had shifted to 5.5% from around 5%, and the Fed Funds rate – after peaking – was viewed as on hold for the remainder of 2023.

Will financial turmoil impact this outlook?

Then along comes the SVB upheaval, major deposit shifts, a collapse in US Treasury yields and plummeting market expectations regarding the Federal Funds rate outlook for the rest of the year. But will the turmoil persist and how might it affect the real economy? This is obviously a huge unknown.

If markets steady in time without much real impact, the FOMC’s outlook for the rest of the year could revert to its pre-SVB thinking on inflation/labour market dynamics. But if volatility persists, including deposit flight from community and regional banks, credit contraction might be in the offing. The FOMC’s timing is smack in the middle of peak volatility and uncertainty and it has little more insight than anybody else.

What to do with the Fed Funds rate?

While a few weeks ago a 50-basis point hike seemed a good bet, now it appears the FOMC faces a coin toss between not hiking and raising by 25bp. Good arguments can be put forward for both.

No rate hike would give the FOMC time to assess the situation, without precluding action when more information becomes available. A pause would further allow authorities to assess the lagged impact of the rapid rate hikes that have already taken place.

In contrast, a 25bp hike would respond to sticky price data. The Federal Reserve must keep its eye on inflation. If the FOMC pauses now, will it be harder to explain resumed rate hikes if needed? Moreover, while financial stability concerns are relevant to the macro outlook, especially if credit contracts, financial stability per se is not part of the Fed’s dual mandate of maximum employment and price stability.

Financial stability considerations and the Fed

Fed officials have long emphasised that monetary policy and financial stability considerations should be separated. Monetary policy should be guided by the dual mandate. Financial stability should be tackled with strong micro and macro prudential policies. Of course, if the financial stability upsets the growth and employment outlook, it relates to the attainment of the dual mandate.

Separation is nice in theory, but it may come up short in practice. Rate cuts/hikes and financial stability are interrelated. The US’s financial stability tools are inadequate. The Financial Stability Oversight Council is weak and overpopulated. The Dodd-Frank ‘designation’ process has been gutted. The US does an inadequate job overseeing non-bank financial intermediation, particularly given the labyrinthian regulatory structure that undermines accountability. The SVB collapse shows again that a ‘small’ bank can potentially trigger systemic contagion and it appears that on-the-ground banking regulators missed obvious red flags.

How to communicate amid the confusion?

Fed Chair Jerome Powell will have the unenviable task of explaining the FOMC’s decisions. Whatever those may be, the case for acting one way or another is arguably balanced and actions will easily be second-guessed. If the Fed pauses, it may be accused of paying too little attention to inflation. If it hikes, given the circumstances, it will be accused of overdoing it, as Senator Elizabeth Warren has already charged.

Powell faces the challenge of how to position the Fed for forthcoming meetings when the outlook faces so many unknowns. He may be pressed on whether the Fed failed in its supervisory role, whether blanket deposit guarantees should be issued and the deposit cap upped and whether quantitative tightening should proceed. While trying to maintain options and keep the Fed’s eyes on inflation fighting, the potential for missteps and market volatility will be even greater than usual, which is the last thing the Fed wants.

Source:Mark Sobel

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Justin

Central Bank

Economic

Taken by surprise by the resurgence of inflation, the European Central Bank started raising rates last summer and is still in the process of doing so. At her press conference on 16 March, President Christine Lagarde started her remarks with: ‘Inflation is projected to remain too high for too long.’ She then announced a 50 basis point increase in interest rates, the seventh in a row.

This firm stance, after a week of tremors in the global banking sector, was supported by an overwhelming majority of governing council members; only ‘three or four’, she said (out of 26), voted against her proposal. This was a remarkable demonstration of consensus and resolve by a very large committee.

Out of the spotlight, meanwhile, there is a huge elephant in the monetary policy room: the central bank’s balance sheet. Years of massive expansion have deposited a staggering €4tn of idle liquidity in the pockets of euro area banks. Until that stash of cash goes away, the ECB can only raise rates by subsidising the deposits it receives from banks. The remuneration on its deposit facility was raised from minus 0.5% last July to 3%, on a riskless basis. It will probably go beyond that. This is a hefty subsidy to bank shareholders: except for them, nobody today can access a risk-free rate of 3% in the open market.

This is a dangerous course. The assets the central bank holds against these deposits yield returns far below the funding cost. Calculations by Daniel Gros, a senior fellow of the Centre for European Policy Studies, show that this is enough to wreck the accounts of the ECB and its constituent national central banks in the years ahead. Bundesbank President Joachim Nagel must have felt some embarrassment recently as he announced to the German public that the losses of the German central bank last year do not cover provisions. This is an accounting euphemism to say that the central bank may need financial support from the government, and indirectly from the national taxpayer.

Economic textbooks say that central banks cannot go bankrupt, but this is another euphemism. It is easy to think of situations where the central bank and the money it issues – the euro in this case – loses support and reputation among public opinions and political circles, some of which in Europe edge towards populism. When this happens, the loss of central bank independence is just around the corner.

The only way for the ECB to stay clear of danger is to keep its deposit facility rate low. But this is compatible with the intended monetary policy course only if the bank liquidity and the central bank’s outright portfolio of securities – two amounts which are roughly equivalent – are reduced in parallel, and fast. The ECB has started scaling down its securities holdings at a pace of €15bn a month on a net basis. This is not sufficient. Other things being equal, it would take some 27 years to reabsorb all the liquidity that is around through this channel alone. The ECB cannot afford to wait that long.

One way to accelerate the process is to re-activate a long-term liquidity-management instrument introduced by the ECB in 2014, the so-called ‘targeted long-term financing operation’, but in reverse. The new reverse long-term operation would auction out rights to swap central bank deposits for long-term securities on a long-term basis according to the maturity of the bonds. Auction participation would be voluntary but incentivised. Banks deciding not to swap out their central bank deposits would be penalised by a lower deposit rate. Swap rights could be calibrated by taking into account the balance of each bank at the deposit facility

Calculations suggest that an auction mechanism so designed would induce profit-maximising banks to swap away large amounts of their deposits in exchange for temporary (but long-term) government bond holdings.

Regardless of the specific mechanism chosen, one thing is clear: a coherent package of measures and incentives lowering the deposit rate and reducing bank liquidity alongside the central bank’s portfolio is the only way the ECB can maintain monetary control and salvage, together with its own accounts, its operational flexibility and independence. The issue is urgent. Most national central banks of the euro will soon present their accounts for 2022. At that time, the monetary policy elephant and its impact on European taxpayers will be apparent. The ECB would be better off having answers when this happens.

Source:Ignazio Angeloni

To stay updated on all economic events of today, please check out our Economic calendar

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Justin

Central Bank

Economic

Slower inflation boosts the case for a 4.5% peak in rates

Headline inflation in Canada rose 0.4%MoM, below the 0.5% expected, resulting in the annual rate of consumer price inflation falling sharply to 5.2% from 5.9%. The core measures of inflation broadly performed as expected but are now below 5%YoY. Gasoline prices were the main downward influence, falling 1 %MoM, meaning that the YoY rate for this component is now -4.7%. The main upward influences were clothing prices, which jumped 1.9%MoM after three consecutive monthly declines, while “household operations” saw prices rise 1.1%MoM, but again this follows three months of relatively soft or negative price changes.

At the 8 March Bank of Canada policy meeting, officials outlined their view that “weak economic growth for the next couple of quarters” and increasing “competitive pressures” will bear down on inflation and allow it to “come down to around 3% in the middle of this year”. Today’s data should give them more confidence in this happening and reinforce the market view that 4.5%, reached in January, will be the peak for the policy rate.

Headline annual inflation rates (YoY%)

Rates to move lower before year-end

Back in January, the BoC indicated that “it expected to hold the policy interest rate at its current level, conditional on economic developments evolving broadly in line with the MPR outlook”. This guidance is likely to remain in place at the next BoC meeting on April 12, with the BoC likely to sound even more cautious in the wake of US and European banking woes. Canadian banks are looking relatively resilient right now, but they too are likely to become increasingly wary given the fallout from what has happened. We should expect to see some modest tightening of lending standards which means access to credit will become more restricted throughout the economy.

We still think the next move in the BoC policy rate will be downwards and that the first cut is likely to come before the end of the year. Canada’s greater exposure to interest rates rate hikes via a high prevalence of variable rate borrowing means consumer activity should slow through 2023. High household debt levels in Canada - equivalent to more than 180% of disposable income versus 103% in the US – mean that Canada is especially exposed to the risk of a housing market correction in a rising interest rate environment. Falling inflation rates will give the BoC the room to respond with looser monetary policy, especially with the Finance Minister Chrystia Freeland suggesting her upcoming budget will “exercise fiscal restraint” to help in the battle against inflation.

Source:ING

To stay updated on all economic events of today, please check out our Economic calendar

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Thomas

Political

Thailand dissolved its parliament on Monday, paving the way for what could be a bitterly-fought election in May between rival political forces at the heart of a tumultuous 18-year struggle for power.

Below are some key issues around the election.

Which parties are the main contenders?

The opposition Pheu Thai party, controlled by the billionaire Shinawatra family, will go up against parties aligned with the Thai establishment and with the military that ousted Pheu Thai's last government in a 2014 coup.

Prime Minister Prayuth Chan-ocha, who led that coup as army chief and has been in power ever since, will run with the new United Thai Nation party, while another retired general, Prawit Wongsuwan, a well-known political dealmaker, will lead the Palang Pracharath party, which has headed the ruling coalition since 2019.

Other parties that could be central to alliance-building after the election are the opposition Move Forward party and coalition members Democrat Party and Bhumjaithai.

Which will win most seats?

Pheu Thai is the favourite to win the most of the 400 constituency and 100 party-list seats available and has scored well in pre-election opinion polls.

Pheu Thai and its earlier incarnations have won every election since 2001 and remain popular among the urban and rural working classes in the north and northeast, largely due to populist policies like minimum wage hikes, rural micro loans and cheap healthcare.

Though successful in winning millions of votes, the policies have been hugely controversial, considered wasteful by many Thais and among the pretexts for coups and judicial rulings that removed three Shinawatra-backed governments.

Who are the top candidates for prime minister?

The frontrunner is Pheu Thai's Paetongtarn Shinawatra, the daughter and niece respectively of two former Thai premiers toppled in military coups. Though Paetongtarn, 36, has limited political experience, she has led opinion polls since last year, with more than twice the backing of her nearest contenders.

Others include Prayuth and three deputy prime ministers, Prawit, Bhumjaithai leader Anutin Charnvirakul, who is also health minister, and Democrat Party leader Jurin Laksanawisit, who is also commerce minister.

What are the election issues?

Most parties are promising welfare programmes like a minimum wage increase, better payments for the poor and elderly and price guarantees for agriculture goods.

A lively debate around cannabis is likely to play out during the campaign after Thailand became the first Southeast Asian country to decriminalise its use last year. Cannabis has been promised as a cash crop for a country where about a third of the labour force works in agriculture.

However, new rules had to be rushed to rein in recreational use because regulations restricting it were not in place. A cannabis bill failed to pass before parliament was dissolved, leaving the issue in legal limbo as recreational use surged, benefiting quick-acting businesses but angering some conservatives.

Will the monarchy be a campaign issue?

Youth-led protests that began in 2020 broke a longstanding taboo around questioning the role of the monarchy in Thailand, where the constitution states the king is "enthroned in a position of revered worship".

The Move Forward party has campaigned on reforming a law that punishes royal insults with up to 15 years in jail. Activists have urged opposition parties to scrap it, but the topic remains sensitive among many Thais and most parties oppose or want to avoid talk of reform.

How will the PM be elected?

A party with at least 25 seats can nominate a prime ministerial candidate to be put to a vote of both lower and upper houses. The winner must receive more than half of the 750 votes from the bicameral legislature.

That will include 250 senators appointed by the military after the 2014 coup, who are expected to support candidates backed by the military or its allies.

Source: Reuters

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Devin

Political

With Brexit, the devil is always in the detail.

New legislation published Monday enacting British Prime Minister Rishi Sunak's much-heralded Windsor Framework makes clear that unionists in Northern Ireland will be able to object to new EU laws — but won't hold the power to veto them.

Careful reading of the draft regulations enacting into law the so-called Stormont Brake shows that the power to block the introduction in Northern Ireland of any new EU goods standards — essential for Northern Irish exporters to observe if they want to maintain barrier-free trade with neighboring Ireland and the wider EU — will lie exclusively with London, not Belfast.

And the legislation shows the U.K. government ultimately reserves the right to override any unionist objections, citing "exceptional circumstances."

Such caveats have proven a dealbreaker for some unionists already highly skeptical of the prime minister's claims to have allayed their chief concerns over the much-maligned Brexit trade protocol that keeps Northern Ireland subject to EU goods rules.

"These opt-outs render the Stormont Brake useless," said hardline Democratic Unionist MP Sammy Wilson.

He complained previous U.K. assurances that the Stormont Brake would deliver an effective "unionist veto," promoted particularly by Northern Ireland Secretary Chris Heaton-Harris, have been proven "totally incorrect" now that he's had a chance to read the published rulebook.

The Democratic Unionists announced Monday they would vote against the Windsor Framework (Democratic Scrutiny) Regulations when they are put to a U.K. House of Commons vote Wednesday, ending weeks of speculation about their intentions.

The DUP, with only eight votes in a 650-seat House of Commons due to give overwhelming support to the regulations, cannot stop the law from being enacted — though its opposition may prove influential in convincing Euroskeptic Tory MPs to follow suit.

But Democratic Unionist leader Jeffrey Donaldson, eyeing the need to minimize internal party splits and potential losses in local council elections in May, emphasized that his party would not indefinitely block the revival of power-sharing at Stormont — and hopes in coming weeks to coax the U.K. government to deliver more of the DUP wish list.

Donaldson stressed that a Wednesday vote against the Stormont Brake did not mean that the DUP was rejecting the wider Windsor Framework, merely maintaining a critical stance in hopes of edging the U.K. government closer to unmet DUP demands.

Under the new regulations, unionists — a minority in the mothballed Northern Ireland Assembly — would have sufficient numbers to file a formal objection against the local introduction of any new EU law changing goods standards. The regulations specify that 30 members from at least two parties will be sufficient for any "petition of concern" to the U.K. government to be heard.

This means, in practice, that lawmakers from the Democratic Unionists (25 seats) and the moderate Ulster Unionists (nine seats) must file any objection jointly. Given that the Ulster Unionists, unlike the DUP, opposed Brexit and are more positive on maintaining barrier-free trade with the EU, even attaining this two-party, 30-signature threshold can't be presumed.

Any successful unionist petition would trigger a review of the proposed law's local impact in Northern Ireland in the U.K.-EU Withdrawal Agreement Joint Committee. It meets regularly to manage and resolve post-Brexit trade tensions.

While any EU law challenged by a unionist petition wouldn't go into immediate force in Northern Ireland pending these few weeks of deliberations, the London-Brussels dialogue might well result in an agreement that the law doesn't risk sufficient disruption to Northern Ireland trade to merit a British government veto.

Any joint U.K.-EU agreement to proceed with rolling out that EU law would then be subject to a formal vote at the Northern Ireland Assembly at Stormont.

Passage would require "cross-community consent" — Stormont jargon for a vote that fails unless both the British unionist and Irish nationalist camps agree.

But this stipulation doesn't mean the unionist minority would wield a veto over U.K. decision-making. Instead, as the regulations detail, the U.K.'s secretary of state for Northern Ireland would not be legally bound by the Stormont vote.

The Stormont Brake rules specify that the secretary of state could announce in the House of Commons that the EU law will apply despite unionist objections. In this scenario, the U.K. government could justify its decision by citing "exceptional circumstances," or its own judgment that the EU law "would not create a new regulatory border between Great Britain and Northern Ireland."

The regulations state that such a barrier must be seen to "materially divert trade or materially impair the free flow of goods."

"For weeks, the Windsor Framework has been oversold," Wilson said. "Now the wildest assertions are being laid bare as its details are examined and publicly revealed."