Fixed income was at the centre of a highly volatile week across asset classes amid uncertainty over the direction of central bank policy and risk aversion stemming from the collapse of SVB in the US. The divergence in monetary policy settings has started to widen as the Bank of Canada went on pause - something the RBA indicated was now on its radar - while the Fed opened the door to reaccelerating rate hikes and with the ECB to hike by 50bps next week. Meanwhile, the Bank of Japan left all settings unchanged at Governor Kuroda's final meeting in charge.
Fed weighing up the data
Early on in the week, markets had taken their cues from Fed Chair Powell's testimony to Congress where he signalled a higher peak rate was likely and a willingness to reaccelerate the pace of rate hikes if supported by "the totality of the data". This pushed up the yield on the 2-year tenor above 5% but it subsequently fell sharply to close the week around 4.6%. Uncertainty over the wider impacts of the SVB situation and a mixed payrolls report drove the move lower. Next week's CPI report, however, could prove to be the deciding factor on 25 or 50bps as the Fed's next hike.
A 311k rise in nonfarm payrolls in February was well clear of expectations (225k) and confirmed the underlying strength from the January report, which was revised only modestly lower to 504k (from 517k). An uptick in the participation rate to 62.5%, with the prime-age rate (83.1%) lifting back to its pre-pandemic high, was the other notable point of strength. The softer elements were a lift in the unemployment rate from 3.4% to 3.6% and average hourly earnings undershooting on the month-on-month (0.2% vs 0.3%) and annual pace (4.6% vs 4.7%). These components in addition to a decline in job openings in January (11.2m to 10.8m) are seemingly giving the market the impression that cycle tights in conditions have been seen.
RBA tightening cycle draws closer to a pause
A pause in the tightening cycle in Australia is back on the table - rates pricing indicating the April meeting is a line ball call - after the RBA watered down its hawkish narrative this week. Once again, the Board hiked rates by 25bps to 3.6%, but it softened its policy guidance by removing the reference to "further increases in interest rates" and signalled a more data dependent outlook (reviewed here). The expectation now is that a "further tightening of monetary policy" will be required to return inflation to the 2-3% target, with the data to determine "when and how much further interest rates need to increase".
The most notable development since the February meeting appears to have been the RBA's assessment of the labour market. While still describing the labour market as "very tight", conditions are noted to have "eased a little", but the crucial observation was that following recent data on labour costs, the view was that there was "a lower risk of a cycle in which prices and wages chase one another". The slowdown in Q4 GDP growth was also highlighted, reflecting pressures on household budgets from the cost of living and rate hikes.
In a speech the following day, Governor Lowe confirmed the shift in tone, noting that with rates now at a restrictive level, the Board was "closer to the point where it will be appropriate to pause interest rate increases". The Governor cited encouraging signs on inflation, both globally and in domestic goods prices, as indicating Q4 was the peak in Australia. The RBA remains cautious about the inflation trajectory from here, but the Governor said the intention remained to keep the economy "on an even keel" and to preserve the labour market.
On the data front, trade data for January was out this week, the trade surplus remaining elevated at $11.7bn but narrowing as import spending reaccelerated (reviewed here).
All in readiness at the ECB
Attention in Europe turns to next week's ECB meeting where the Governing Council is expected to deliver on its guidance for a 50bps rate hike. Beyond the March meeting, the ECB is leaving its options open, but the updated set of economic projections will give the Governing Council the chance to outline how it will calibrate policy going forward. Substantial falls in energy prices point to downward revisions to the inflation outlook and an earlier return to the 2% target than 2025; however, the resilience of growth in the euro area carries upside risks to inflation.
Resilience has also been a key theme in the UK economy, which appears to have extended into 2023 as the monthly GDP indicator for January came in on the topside of expectations at 0.3%. Dire forecasts last year for a deep UK recession look now to be a materially lower risk due to the combination of fiscal support lowering energy prices and ongoing strength in the labour market.