Caution on Ceasefire

MACRO FRAME

The ceasefire framing has shifted from relief to skepticism. Meanwhile, March’s labor data supports the case for a Fed hold in the near-term.

STOCK INDEX FUTURES

US equity index futures are giving back some of Wednesday’s ceasefire-driven gains, with the overnight tone best described as cautious consolidation rather than renewed risk-off. The two-week US-Iran truce remains intact but is seen as shaky. Oil traffic through the Strait of Hormuz remains at a standstill, while rising tensions over Israeli strikes in Lebanon threaten Iranian cooperation in talks. Attention is pivoting to tomorrow’s March CPI print, though markets have reason to discount the reading if oil prices retreat in the coming days.

Meanwhile, PCE data for February showed both headline and core came in at +0.4% on the month, compared to January’s +0.3%/+0.4% prints and in line with expectations. Core PCE slipped to 3.0% YoY from 3.1%, though remains well above the Fed’s 2% target. Elsewhere, Q4 GDP was revised lower from +0.7% to +0.5%. Q4’s preliminary reading was +1.4%, marking steep downward revisions resulting from declines in government spending and exports. The government shutdown was estimated to have subtracted roughly 1.0 percentage point from Q4 GDP growth on its own, a significant distortion in the headline number. Real final sales to domestic purchasers was also revised down slightly, suggesting the underlying demand picture was softer than earlier readings implied. Real GDI came in at +2.6% vs. GDP at +0.5%, producing an average of +1.5%. The wide gap suggests the GDP read may be understating true economic activity, GDI captures the income side of the same transactions and is often viewed as a more reliable signal in quarters with significant data distortions (like this one).

Watch point: While the de-escalation supports equities, the conflict still presents real risks to future gains as US troops continue to move to the region.

CURRENCY FUTURES

US DOLLAR: The USD index slipped 0.20% to 98.93 overnight as focus remains centered around developments in Iran, while this morning’s data showed that inflation remained sticky in February ahead of the rise in energy prices. Price direction in the currency market largely remains centered around developments in the Middle East, as negotiators from both sides are set to meet on Friday. Oil traffic through the Strait of Hormuz remains at a standstill, reflecting broader confusion among details of the ceasefire and responsible for the rise in energy prices overnight.

While the oil shock and safe-haven demand are dollar positive, the underlying macroeconomic fundamentals make the case for a resumption of the dollar’s downward trend once hostilities in the Middle East are officially over. Despite rising inflationary pressures driven largely by energy prices, the dollar has lost its interest rate differential support it once drew from hawkish Fed expectations, support that has since been repriced away. With the labor market softening materially, the underlying case for a Fed rate cut later in the year remains intact.

Watch point: Despite a stick February PCE reading, a move up from the Fed is out of the picture as the Fed is well positioned in its policy rate for the time being, though a weak labor market leaves the door open for easing.

EURO: The euro is up 0.18% to $1.1685, getting a lift from a weaker dollar overnight despite weak domestic data out of Germany. Industrial production in Germany fell 0.3% MoM in February, missing forecasts of a 0.9% rise as a drop in pharma and electronics activity dragged on the reading. Automotive’s +1.7% was the lone bright spot in manufacturing proper, consistent with the +3.8% jump in automotive new orders reported yesterday.

The ceasefire has dramatically shifted expectations for near-term tightening, with odds of an April hike priced at 39%, sharply below Tuesday’s 61% probability of a rate hike. Meanwhile, markets have priced out the possibility of a third hike by year-end, with 59 bps of total tightening expected vs. Tuesday’s 75 bps. The path to further tightening from the ECB will hinge on the effectiveness of the two-week ceasefire and whether it brings lasting peace. The critical risk factor is  the persistence of the energy shock.

Watch point: March’s inflation data confirmed that headline inflation was dragged higher by rising energy prices, while other components were reassuring to the broader inflationary picture. A rate hike at the ECB’s April meeting is unlikely, while the case for further tightening depends on the effectiveness of the ceasefire.

BRITISH POUND: Sterling is 0.15% higher to $1.3417, well below its Wednesday high of $1.348, reflecting broader nervousness around how sustainable the ceasefire in the Middle East will be. Markets are now pricing just 39 bps of tightening by year-end. The sharp drawdown in tightening expectations is reflective of the weakness in the UK economy. Recent data has shown that economic growth remains stagnant, while business activity continues to grow at a slow pace. Additionally, slowing wage growth and a weak employment picture in the country remain favorable for policy easing by year-end rather than tightening. Before the outbreak of hostilities, markets were priced for a March rate cut given the falling inflation picture and material economic weakness. The case for policy easing out of the BoE remains subject to the effectiveness of the ceasefire and if oil prices can drop closer to pre-war levels. Given the uncertainties of the ceasefire and local elections in early May, the risk of further volatility remains. Keir Starmer’s governing Labour Party is trailing the populist Reform UK and the left-wing Green Party.

Watch point: The de-escalation between the US and Iran provides short-term support to GBP, but pre-war macroeconomic factors present a hurdle for BoE policy tightening.

JAPANESE YEN: The yen fell 0.22% against the dollar to 158.92 yen per dollar. Japan’s consumer confidence worsened in March for the first time in three months, a government survey showed on Thursday, adding to fears of the potential economic hit from the Middle East war, which would complicate the Bank of Japan’s rate-hike decision. The yen, however, showed little reaction to the data. Data on Wednesday showed average cash earnings in Japan rose 3.3% YoY, above forecasts for a rise of 2.7%. The data comes as Japan’s labor federation secured a 5.26% average wage hike for the third consecutive year in spring negotiations. February’s cash earnings represent realized growth flowing through to worker paychecks. Money markets are pricing a 53% chance of a hike from the Bank of Japan at its April meeting and are fully priced for a hike come July.

Watch point: An April rate hike could pull USD/JPY closer to 155, though the odds of such happening appear unlikely at the time being.

AUSTRALIAN DOLLAR: The Aussie is little changed at $0.7046 as  doubts about a lasting ceasefire in the Middle East restrained risk sentiment. It is a thin week on the economic calendar, lending attention to developments in Iran. Markets imply a 61% chance of another quarter-point rise in May, though that was down from near 70% last week, and see rates at 4.62% by year-end. Analysts at HSBC now expect Australia’s economy to contract in the second quarter after two rate hikes this year, and higher fuel prices to weaken consumer spending.

TREASURY FUTURES

Yields are little changed across the curve, with prices little changed in response to this morning’s data, which if not for the sticky inflationary print, would otherwise be friendly to prices.

The spread between one- and two-year inflation swaps has widened to 32.3, reflecting sentiment that the impact of higher energy prices will be transitory, much like the impact of tariffs on prices. Swaps have fallen substantially in response to the ceasefire despite the fact that tanker traffic through the Strait is still lackluster. As of April 8, AIS data confirmed no surge in transits despite the ceasefire announcement, as shipowners await clarity on security arrangements, insurance cover, and potential Iranian transit fees that could implicate US sanctions. Beyond the physical market, financial measures of longer-run inflation show little alarm. The latest New York Fed survey revealed that consumer expectations for inflation three years from now edged up only a modest 0.1% last month, while the five-year/five-year breakeven rate remains below 2.2%, broadly consistent with the Fed’s longer-run PCE target. With 2-year swaps holding near 2.5–2.75% and longer-run inflation expectations remaining well-anchored, the Fed has room to treat any near-term CPI acceleration as transitory without adjusting its current policy and leaving the path for rate cuts later in the year open. We maintain our outlook that the Fed will lower rates once, later this year.

Watch point: Following March’s labor data, an immediate case for a change in Fed policy remains unlikely. March’s CPI data is expected to show a rise in prices, though evidence of sustained inflation will be closely monitored for impacts on policy expectations.

The spread between the two- and 10-year yields is 50.80 bps, while the two-year yield, which reflects short-term interest rate expectations, is 3.73%.

 

 

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