Week Ahead
Chair Powell will be in the hot seat this week as he delivers the semi-annual monetary policy report to the Senate Banking Committee (Tuesday) and the House Financial Services Committee (Wednesday). Although these appearances will pre-date the remaining key data releases before the March FOMC meeting – this Friday's February employment report and next Tuesday's CPI – Powell will importantly have the opportunity to define the Committee’s reaction function to upcoming prints.
Most important will be whether the Chair takes the opportunity to prefer sticking with a 25bp hike in March or if he leaves the door ajar for returning to a faster pace this month. If Powell does not slam the door shut on the potential for a larger hike, markets could put substantially more weight on a 50bp hike at the March meeting in response to last month’s hotter data. But ultimately, the heavy calendar over the next few weeks will be critical for determining how that settles.
US Markets
Against the running bearish consensus, US stocks traded higher Friday, ringing in a solid gain for the week as investors digested news of improving business sentiment, mixed consumer activity, and another rise in United States 10-Year Treasury yields (for the week, at least) that is having less of an impact on stocks than it did a year ago. Unlike last year, where policy shocks drove market shifts through most of the year, this year's price action has been driven as much by improving global growth as by tighter global policy. Indeed, that is a more digestible mix for stock market operators.
And while inflation is still the market’s number one focus this time, investors are more concerned about what the Fed might do than what inflation may mean for the broader economy. In October, when the S&P 500 hit a recent low, concerns were raised about the potential that runaway post-pandemic inflation could usher in another period of unanchored inflation expectations -- similar to what we experienced in the 1970s. Unanchored inflation expectations can be much more disruptive to long-term growth than anything the Fed might do over the next six months with its monetary policy.
And while markets are gravitating towards a 25bp point of view for the March FOMC, options markets could be too complacent about that assumption( pricing 27-30bp), providing investors with cheap options to hedge hawkish risks -- especially in a month that remains filled with catalysts from next Friday's Payrolls report to another CPI and PCE inflation report, and even China's Two Sessions meeting.
ASIA
After a brief hiatus, several data releases out of China this week ( the so-called data dump) are likely to end growing skepticism over the strength of its post-reopening recovery. Last week, China reported strong PMIs, while property sales data portends well for the “Return of the Dragon” view.
NPC
The reaction of the RMB will likely depend on which scenario plays out during the NPC. On the more constructive end, if the government were to fire on all policy cylinders, this would likely be very positive for risk assets. It would drive strong RMB appreciation, and strong policy stimuli would likely turn risk sentiment around, particularly for Asian FX. On the other hand, if the government were to maintain the status quo, i.e., a marginal increase in fiscal stimuli, the market would likely remain cautious about China's recovery. As a result, RMB would likely continue to underperform and remain at the mercy of the USD outlook.
In equities, the sell-off from overbought levels we think is essentially over. And I now recommend investors add positions before the NPC, as mainland investors remain cashed up and long-only underweight, especially outside of the internet space. This sets the market up to rally even in a mildly favorable policy scenario. Should any structural reform be announced, that would likely be favorable to a more sustained rally.
CROSS ASSETS
FOREX
YEN is stronger as 10-year Kuroda's come off the boil and speculation has increased around another BoJ policy tweak at Governor Kuroda’s last meeting this week. The Bank of Japan will hold its Monetary Policy Meeting on March 9-10. The meeting will be the last under Governor Haruhiko Kuroda's decade-long stewardship.
And while traders had positioned that the BOJ likely wanted to avoid making yield curve control (YCC) adjustments that could have a wide-ranging impact on bonds and the forex and equity markets, they are now turning more cautious, knowing that Kuroda can be full of surprises.
In addition, if no adjustments are made this week, it would not be surprising to see market expectations increase enormously that the new BOJ leadership under the government's nominee, Mr. Kazuo Ueda, could amend YCC at its first MPM in April.
OIL
Oil prices are higher as traders re-embrace the China demand boom and flattish non-OPEC supply view, which should put markets in deficit in Q2. The restart of China data releases after the CNY pause, alongside the likely pro-growth tone to the Two Sessions policy event, could offer an even better macro setup for oil.
The next hurdle for the market will be China’s critical monthly activity indicators, such as industrial production, retail sales, fixed asset investment, and trade data, which have not yet shown a robust recovery. While this could be due to seasonal distortions around Lunar New Year and as mobility only really normalized towards the middle of February, oil traders still need to see that the economic recovery proof is in the pudding.
GOLD
Gold remains in a US dollar-driven rather than a rates-driven regime and continues to find dip buyers as a hedge against still-high inflation and an uptick in geopolitical risk premium. In addition, despite US 10-year UST testing 4 %, the 2's vs10's ( -.89 %) inversion won't go away, anchoring gold above downside technical levels. Suggesting gold remains a viable medium-term hedge against recession fears.