I suspect the comments from Bullard today and the strong S&P Global US PMIs are a clue on what's coming next week. Bullard didn't completely give up his hawkish bent and the services PMI was particularly strong.
It's far too soon to take our eyes off of banks but -- like Bullard -- I think there's an 80% chance that bank issues blow over.
Where will that leave the market?
I think that leaves a 3.77% two-year note yield too low. The Fed funds market is pricing in 6 bps at the next meeting, or about a 27% chance of a hike. That would bring Fed funds to 4.75-5.00% and given policymakers forecasting to keep it there, it's tough to see a bigger disconnect unless economic data sinks.
And that brings us back to the PMIs, which indicated the economy accelerating, not slowing down. The week ahead features:
- The Dallas Fed (Monday)
- Consumer confidence (Tuesday)
- Richmond Fed (Tuesday)
- Pending home sales (Wednesday)
- US GDP third reading (Thursday)
- PCE (Friday)
- U Mich sentiment (Friday)
PCE is the big one and the market would love to see some disconnection from the higher numbers in the CPI data or a stumble in earnings but I think what the latest Fed episode has told us is that the Fed is in no rush to halt hikes, let alone cut.
So what will sustain 3.78% on two-year notes --- and USD/JPY at 130.80 by extension -- if the bank worries blow over?
Typically, the right bet is to go with the market and not Fed forecasts but the Jan-Feb period proved that's not always the case. However I do believe that the Fed is laser-focused on inflation and won't blink at the first signs of a recession. Given the lags in data, we might not even have clear signs of that before September, so pricing in 100 bps of cuts from there by year-end is going to take some real economic pain. Lately, the market is circling commercial real estate as a catalyst and I'm sympathetic towards that but with the slow rollover of 5-year leases, it will likely be a slow-motion event.
Finally, there is some support for USD/JPY down to 127.00, which makes a return to 138.00 and beyond a more attractive risk-reward proposition.