In its weekly analysis of the market, Standard Chartered believes the Federal Reserve is waiting for a few more inflation data points to confirm that the disinflationary trend is continuing. This message was apparent from this week’s Fed projections and comments. Meanwhile, it noted the Swiss National Bank surprised markets with a 25bps rate cut, becoming the first G10 central bank to ease policy in the current cycle. Also, the Bank of England signalled a dovish shift in its policy stance, with two remaining hawkish members of the nine-member rates committee turning neutral. Earlier in the week, the Bank of Japan struck a dovish tone even after hiking rates for the first time in 17 years and said it would stay accommodative and continue purchasing government bonds.
All-in-all, this week’s round of central bank meetings suggest Developed Market policymakers are turning more supportive of growth and less concerned about inflation. SC believes this turn in the policy outlook, in the face of still-elevated inflation in the US and Europe and rising wages in Japan, is positive for risk assets in the next 6-12 months.
Fed waiting to cut: The Fed’s revised projections sustain the ‘goldilocks’ view of the world where central banks stand ready to ease policy to support growth even if inflation stays above its 2% target. Even though fewer Fed policymakers expect more than three rate cuts this year, the Fed’s new median projections maintained three rate cuts for this year, despite bumping up growth and core inflation estimates for this year. In particular, the Fed’s estimate for US core PCE inflation for end-2024 was revised higher to 2.6% from 2.4%, and end-2025 estimate was maintained at 2.2%. This suggests the Fed is ready to cut rates several times well before inflation falls to its 2% target.
When will the Fed start? Based on Fed Chair Powell’s comments, the Bank believes the 6-month annualised rate of change of US core PCE inflation would be a key metric to watch. This rate briefly fell below 2% in December, before rising above this threshold in January. February’s PCE inflation data will be keenly watched next week. A couple of months of sub-2%print for the 6-month average rate would likely trigger the first Fed rate cut. Hence, SC expects the first Fed rate cut in June. However, with the upward revision to the Fed’s end-2024 core inflation and growth estimates, it now expects a total of three rate cuts this year, instead of five estimated previously.
Bullish US, Japan equities: The Fed appears to be more tolerant of inflation staying above its 2% inflation target before starting to cut rates. Meanwhile, the BoJ’s dovish stance should keep the JPY as one of the world’s weakest currencies for now, sustaining profit growth at Japanese exporters. This scenario is likely to sustain the US- and Japan-led global equity rally. Hence, we would continue to average into these two markets.
Headwind for Developed Market government bonds: Meanwhile, a Fed more tolerant towards above-target inflation raises the risk that long-term bond yields stay elevated for longer. This arguably creates more of a headwind for DM government bonds.
The above macroeconomic backdrop also argues for a rangebound USD, especially given the synchronisation in Developed Market rate cut expectations. After this week’s BoJ policy shift, USD/JPY is approaching November’s 33-year high of 151.72. The move is backed by USD strength amid still-elevated interest rate differential between the US and Japan. Japan’s interest rates remain close to historical lows, despite the BoJ’s modest rate hike. However, the USD/JPY pair is close to overbought and close to levels where authorities have intervened in the past. We see 146 as near-term technical support. The Bank expects the BoJ to follow through with another modest rate hike in Q2. Hence, over the next 6-12 months it sees modest downside risk for USD/JPY amid gradual, albeit limited, rates convergence between the Fed and the BoJ.
