Tuesday, Feb 20, 2024

diverging interest rates, disappointing stimulus, Iran's CBDC sanctions

“The greatest obstacle to discovery is not ignorance–it is the illusion of knowledge.” – Daniel J. Boorstin  ||  

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IN THIS NEWSLETTER

• Heading for an interest rate split?

• China: targeted, and disappointing, stimulus

• What sanctions against a CBDC developer say about the US dollar

WHAT I’M WATCHING

Heading for an interest rate split?

After last week’s US inflation surprise (with prices increasing by much more than expected), signs are still flashing that the battle against inflation in the US is not over, and yet the consensus commentary continues to couch the Fed’s recent rates decisions in terms of reluctance rather than prudence.

On Friday, US producer prices for January came in much higher than the consensus forecast of 0.1% month-on-month, with an increase of 0.3% (vs a 0.1% drop in December). Most of the increase was driven by the services sector, and core PPI (which excludes food and energy) beat similar expectations by jumping 0.5% month-on-month, the highest increase since last July. Even Friday’s latest release of the University of Michigan survey of consumer inflation expectations for one year out came in higher than expected, with a slight uptick to 3.0% from 2.9%. Not that material, but not heading in the right direction.

(chart via Investing.com)

And freight costs are likely to start biting, unless things calm down fast in the Middle East. For now, unfortunately, there doesn’t seem to be much reason for them to do so. This is likely to feed through to prices and earnings – Bloomberg recently reported that mentions of the Red Sea and geopolitics in earnings calls is climbing.

(chart via Bloomberg)

While Fed officials keep repeating the “patience” message, the CME futures-priced probability of a rate cut before May is still around 40%, which is bewildering. Last week, SocGen published a note that suggests the next move for the US federal funds rate could be up. If price indices keep on coming in higher than expected and economic growth stays relatively strong, it’s not out of the realm of possibility.

Minutes out earlier today from the latest rate-setting meeting of the Australian central bank showed the committee actively considered a rate hike before deciding on a pause. And economists expect New Zealand to hike again, possibly as soon as next week.

Meanwhile, last week the European Union lowered its 2024 growth forecast to an insipid 0.8% (and we can expect further downward revisions ahead), while inflation is showing signs of being more under control. The bloc has less reason to wait on lowering interest rates.

This portends likely currency volatility ahead. With the US holding at best, and other economies possibly hiking while the European Union cuts, yield-seeking funds will move. This is even without taking into account the potential impact of an interest rate hike from Japan.

It’s possible the fund flows will be orderly, and we will merely see a repricing of currencies. Let’s hope so – it’s not so much currency movements that worry in the short term, it’s sharp currency movements.

How would this impact crypto?