Market Brief: When Carry Met Rally

CalendarMarch 19, 2024
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We’ll have what they’re having. North American equity futures are setting up for a solid open after Nvidia Corp. unveiled a significantly faster artificial intelligence processor, Treasury yields are stable on hopes the Federal Reserve will leave its dovish forward guidance intact in tomorrow’s decision, and risk appetite is improving in currency markets as conditions for the global carry trade remain supportive.

The Bank of Japan ended a decades-long experiment with unconventional monetary policy last night, and markets shrugged. Policymakers voted by a 7-2 margin to lift the key target for short-term rates to a range of 0-to-0.1 percent, stop capping the yield on 10-year government bonds, and end purchases of assets such as stocks, real-estate investment trusts and corporate bonds. In a press conference, Governor Kazuo Ueda noted that the Bank expects to achieve the 2-percent inflation target within two years, but that it would keep buying bonds in an effort to keep yields stable, saying “Accommodative financial conditions will likely continue, and these accommodative financial conditions will firmly support the economy and prices”. The decision, which was widely expected, resulted in a weakening currency as traders took profits and bet on a continuation of the “carry trade” in which speculators borrow yen and invest in higher yielding jurisdictions elsewhere. We expect the exchange rate to appreciate modestly in coming months as other major central banks begin to ease, but policy rate differentials between Japan and other countries remain vast.

Australia’s dollar is back on the defensive after the country’s central bank dropped forward guidance that had previously threatened further rate increases. The Reserve Bank left benchmark lending rates at a 12-year high and said it isn’t “ruling anything in or out” - somewhat softer than February’s warning that a “further increase in interest rates cannot be ruled out”. With inflation pressures ebbing gradually as the economy slows, markets now expect the first rate cut to come in September.

Today’s US agenda is quiet, but Canada’s February consumer price data could give currency traders something to chew on. Markets expect stubbornness in the Bank of Canada’s preferred core measures as global disinflationary processes slow and domestic services-sector costs hold firm, but the policy implications should be modest: officials seem well prepared for a more gradual easing in price pressures. Speaking to the press just after the March meeting, Bank Governor Macklem said “Looking ahead, we continue to expect inflation will be close to 3 percent through the middle of the year before easing in the second half”.


Still Ahead

WEDNESDAY

British inflation is on a clear downward trajectory, with markets expecting the increase in consumer prices to slow to 3.5 percent year-over-year in February, down from 4 percent in the prior month. Core price growth should remain somewhat more elevated, coming in at roughly 4.5 percent, down from 5.1 percent previously - not yet near the Bank of England’s comfort zone, but clearly headed toward it. (03:00 EDT)

A record of the Bank of Canada’s early-March meeting could deliver insight into the factors that led policymakers to rule out easing in April, and might provide some colour on the quantitative tightening debate playing out behind the scenes. In the post-meeting press conference, Governor Macklem said “Governing Council remains concerned about the persistence of underlying inflation, and we want to see a further deceleration in core inflation in the coming months” - language that clearly anchored rate cut expectations further out - and noted that overnight repo operations were reducing stress in funding markets, saying “Our view on our QT (quantitative easing) strategy hasn't really changed significantly”. (13:30 EDT)

The Federal Open Market Committee will almost certainly leave the Fed Funds target in the 5.25-to-5.5 percent range for a fifth consecutive meeting and its forward guidance should remain basically unchanged, but the “dot plot” summary of economic projections could generate some drama. Most observers expect officials to pencil in a total of three rate cuts in the remainder of the year - the same as in December - but after a series of hotter-than-anticipated data releases, a significant minority think the number could be reduced to two. Markets could experience a relief rally if this fear goes unrealized. (14:00 EDT)

THURSDAY

The Bank of England is overwhelmingly likely to leave its policy rates and forward guidance unchanged for a fifth consecutive meeting, but officials could continue to edge in a more dovish direction. Monetary Policy Committee members are gradually moving toward Swati Dhingra’s position, with slower inflation and wage growth numbers helping to silence calls for still-higher rates. (08:00 EDT)

Officials at the Banco de Mexico could vote by a narrow margin to cut key interest rates for the first time in three years, but should stick with guidance that sets out an extremely gradual easing trajectory ahead. With inflation subsiding at a rapid clip, Mexican real interest rates are the highest in Latin America, imposing a speed limit on the economy, while also helping support the carry trade that has made the peso one of the world’s best-performing currencies in the last few years. (15:00 EDT)

FRIDAY

Markets think Canadian retail sales contracted by -0.4 percent in January, consistent with Statistics Canada’s preliminary estimate. Softness in gasoline prices probably played a role, but a pullback in vehicle purchases likely did much of the heavy lifting. (08:30 EDT)

Author

Karl Schamotta

Karl Schamotta

Chief Market Strategist

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