Opinions

ECB: We see ECB rates on hold in it’s 30th April meeting. We expect the ECB will likely wait for another 6 weeks before probably delivering a rate hike, for which the bar looks increasingly low given the ongoing supply disruptions in the oil market and beyond. Energy prices have fallen from their mid-March peak but remain materially higher than before the Iran war. The latest data point to weakening activity and rising price pressures. Looking ahead, we maintain our baseline of 25bp hikes in June and September to a peak deposit rate of 2.5%. BOE on Hold: We expect the MPC to hold the bank rate at 3.75% at the 30th April meeting. We are seeing a fundamentally different economic environment currently to the previous energy shock, and with rates still in restrictive territory and evidence of cyclical weakness growing, we continue to see a hold as the optimal path. We think an 8-1 split is likely. In this outcome, Pill is the dissenting vote. A combination of cyclical weakness, still restrictive policy rate and lack of evidence of second-round effects all lead to the hold decision. Moreover, we see the downside risk to output associated with a hike as potentially a larger issue for monetary policy over the medium term than a slower return to target. The most compelling reason for a long hold from BOE throughout the REMCY26 is the fact that there is limited evidence of second round effects. Hence, we believe that BOE is on a long hold in REMCY26 although current market pricing is for 54 bps of hike in REMCY26. BOJ on Hold: We expect the BOJ to leave the policy rate unchanged at its 27–28 April Monetary Policy Meeting (MPM). There has been no communication from the BOJ that would prompt the markets to factor in a rate hike in April. For now, we expect the BOJ to retain its wait-and-see stance towards the impact on the economy and prices going into the April MPM, notwithstanding ongoing uncertainties about progress with ceasefire talks and forex market movements. Given the uncertainty in the Middle East, we think it will be difficult for Governor Ueda to commit to a rate hike in June at the press conference following the April MPM. Eventually we think the BOJ is unlikely to maintain its wait-and-see stance in perpetuity, given the risk of yen depreciation. Our main scenario remains a rate hike at the June MPM. This might be followed by a long status quo at least till Dec’26. Markets are currently pricing in 44 bps of hikes in REMCY26 which looks to us a tall ask from BOJ. We remain bearish on JPY and believe it might test the June’24 highs of 162 odd levels post the BOJ meeting on 28th April. The risk of intervention might come around 162-165 levels.

With risks to the dual mandate of Fed being balanced for now, Fed is likely to extend it's pause in the 29th April meeting. Our base case is they will wait until the June meeting for meaningful changes to guidance, but the risk is that communications skew more hawkish. We expect Powell will acknowledge some pushback within the committee on whether additional cuts are appropriate. Data since the March meeting have remained hawkish, with inflation likely to remain elevated and the labor market showing tentative signs of reacceleration. Labor data have been positive since the March meeting. The unemployment rate fell almost 20bp in March, from 4.44% down to 4.256%. Nonfarm payrolls rebounded sharply, rising 178k in March. On the other hand, inflation data remained elevated. We expect March core PCE inflation moderated only slightly to 0.26% m-o-m after back-to-back 0.4% readings in January and February. Our forecast translates into 3.2% YoY, which matches the Fed’s staff forecast revealed by Governor Waller in his recent speech. We also expect the Dec'26 core PCE to end at 3.1% YoY. US consumer spending also rebounded strongly in March, with strong tax refunds appearing to more-than offset the sentiment and cashflow drag from higher gasoline prices. It’s possible that many FOMC participants became more pessimistic about the inflation outlook during the blackout period in reaction to the recent evolution of the conflict in the Middle East. Even dovish officials such as Governor Waller, NY Fed President Williams & SF Fed President Daly, have emphasized patience. In totality, we expect a mildly hawkish FOMC statement with Powell's press conference likely to sound evenly balanced. In a parallel development, Justice Department has dropped its inquiry into the Federal Reserve's building-renovation cost overruns. With that threat ending, Powell can leave the central bank and make way for incoming chair Kevin Warsh. For Powell, there’s no further benefit to sticking around and courting confrontation with the president. Hence, the April meeting might be the last meeting for Powell as a FOMC member & Chair. We now expect Kevin Warsh’s senate ratification to be completed soon, and he might take over as Fed Chair by 15th May. Under his guidance, we might see the 1st rate cut coming in Q4CY26. While employment remains low hire low fire, inflation is too sticky to ignore. That does not augur well for inflation mandate of FOMC. But we believe that employment might worsen by CY26 end leading to an insurance cut. By that time, Kevin Warsh might have gained the confidence of FOMC members too to steer the FOMC in his direction. We have been recommending 2*10 US SOFR for some time now when it was in the range of 20-22. Currently it is at 25 and we expect it to go to 40 levels. We expect DXY to remain strong as US remains an oasis for growth unaffected by the current energy crisis as well as the return of the AI super cycle. We expect US equities to outperform European equities and see S&P 500 in the range of 6900-7400.

Kevin Warsh’s Fed chair hearing in front of the Senate Banking Committee has been scheduled for 10am ET on Tuesday this week. While we expect he will maintain this narrative about the economy, recent developments have weakened the case for lower rates – labor-market data have stabilized, PCE inflation has surprised to the upside, and the war in Iran poses further upside risks to inflation. The nuance for Warsh will be how he balances a desire to lower rates over time with an economic backdrop that does not call for rate cuts at present. As of writing, we are not sure if the Senate Banking Committee hearing on Tuesday actually takes place. Senator Tim Scott (R-SC and chair of the Banking Committee) could postpone it if he thinks that would send a sharper message to Trump that without ending the DOJ investigation into Powell, there is no path ahead for Kevin Warsh's senate vote confirmation. If the hearing does take place, we expect Warsh to be quizzed on overall Fed independence, independence of the reserve banks, scope for rate cuts, change in FOMC communications, timeline on balance sheet changes & his own views on if Powell should continue at Fed as a governor. Given steadfast indications from Senator Tillis (R, North Carolina) that he will block any Fed nominees in the SBC until the DoJ investigation of Powell and the Fed has been resolved, we do not expect Warsh's nomination to make it to the Senate floor for a vote. The likelihood of this outcome was amplified this week by the president, who indicated that he has no intention to call off the DoJ investigation of Powell. These delays likely imply that the Warsh confirmation will remain stalled past May 14, when Powell's term as board chair ends. In our view, the most likely outcome is that Powell will remain Chair of the Board of Governors, and the FOMC, until Warsh's confirmation can proceed. The president stated this week that he would "fire" Powell if he remained in office beyond his official term,11 which we interpret as a signal that he intends to appoint an interim board chair from among the current board governors (likely Miran). His legal authority to do so is questionable and will likely be met with a court challenge. Even if Trump successfully inserts an interim board chair, our view is that Powell would most likely remain as chair of the FOMC. This is because the FOMC elects its own chair and, in January, designated Powell for this role, on a pro-tempore basis. To summarise, Next week’s confirmation hearing for Kevin Warsh will likely give him a platform to reiterate his views that rates should be cut, in part, as he argues for a reduction in the Fed balance sheet. No vote is likely to be taken, and Warsh will probably not be confirmed when Chair Powell’s term expires next month. We see no material policy change under a new chair who has only one vote and will need to mend fences and build credibility within the committee.

For the BOJ meeting, we expect policy rate to be left unchanged and rate hike policy to be maintained, while keeping a close eye on situation in Middle East. Currently the market is pricing in 48 bps of hike by end CY26 which looks reasonable to us. But under the new Takaichi administration whether this materialises is a different question. While the Japanese Trade Union Confederation (Rengo) will not have released its first set of results from this year's spring wage negotiations by the March MPM (they are due out on 23 March), the BOJ will have access to wage hikes at individual companies on the peak response days (17–19 March). JPY looks set to test their June’24 lows against USD around 161.7. We can expect verbal interventions at current levels too, but actual intervention might not happen before 162. Wrt the ECB meeting on 19th March, we see status quo in the 19th March ECB meeting. Financial markets are currently pricing around 47 bps of hike by Dec’26. Markets are pricing hikes in response to the upward shift in Brent crude oil and Dutch TTF natural gas futures curves, and the expected rise in HICP inflation in response. But we maintain our view that the ECB will keep rates on hold in CY26 though this view is based on an inherent assumption that events will unfold in a way that pushes Brent crude oil and Dutch TTF natural gas futures curves down to levels similar to prior to the conflict, and therefore the impact on the real economy will be limited. Wrt the 19th March BOE meeting, we maintain the view that the MPC will want to cut further towards the middle of its view of neutral territory (around 2-4%), and view cuts as most likely to occur in April and July 2026. But markets currently have priced out the two cuts and are now pricing in a 25-bps hike by end CY26 which looks stretched to us. There is a 3rd possibility also. We think a desire from the MPC to wait-and-see how inflation expectations develop risks the next rate cut being even later in the year than we expect. Our 2 cuts theory is based on the assumption that this is still not a 2022 type scenario. Households do not have the accumulated savings and pent-up demand that they had post-pandemic, and global value chain frictions (aside from those reliant on the Strait of Hormuz) are not present to the same extent. Furthermore, gas prices have not risen like they did in 2022.

We expect the FOMC to leave rates unchanged at their March meeting. Communications are likely to emphasize optionality, with risks increasing to both the inflation and employment mandates. Inflation data have surprised on the upside, and forward-looking signs of price pressures are emerging. Growth and labor data have been more mixed, but sharp weakness in the most recent employment report and some weakness in credit markets will likely keep officials focused on downside risks. We can expect the DOTS to remain more or less the same but long term rate projection can move a tad higher. Core PCE and PCE projections for CY26 might also move higher by 0.1 & 0.3 bps. In our view, a majority of officials remain comfortable with the current guidance, but there is a risk that Powell will begin to reflect some of the hawkish pushback in his post-meeting press conference. Market is currently pricing in only 23 bps of cut till Dec’26 which is different from our expectations of 2 cuts of 25 bps each in REMCY26. Hence, we recommend putting on 2*10 US SOFR steepeners at current levels of 25 for profit target of 40 with stop loss at 15. This also matches with the view that US fiscal issues might come to forefront as tariff revenues evaporate & war expenditures drive fiscal higher.

Historically, oil price spikes represented a significant negative shock to the US economy. Prior to the emergence of shale in the US, the impact was primarily one sided. Higher oil prices drove up energy costs for households and businesses, exerting a clear negative impact on economic output. However, with the emergence of shale energy in the US, the impact of oil price movements on economic activity has become more balanced. Although higher oil prices continue to represent a cost shock for households and most businesses, there is now a more meaningful offset from benefits to energy producers and through the export channel. Due to these offsetting channels, the growth impact of oil price shocks is fairly modest. A $20 oil price shock, similar to that observed recently, would have a small impact on growth. The peak effect is only about a one-tenth drag on the level of output one year ahead. The impact on the unemployment rate is about half. A $60 oil price shock would have larger effects – given the linear nature of the model the impact is three times the $20 oil shock scenario. With oil prices around $120 per barrel, real GDP would be depressed by about 0.2 percentage points over a year and the unemployment rate would rise by a tenth. Unlike real GDP and the unemployment rate, an oil price shock has a significant effect on headline inflation. Conversely, given the muted impact on activity, the pass-through of an energy price shock to core inflation is generally small. A $20 oil price shock initially lifts headline PCE inflation by about 70bps in the quarter of the shock, though the impact dissipates materially with only an 11bps increase for the year following the shock. The $60 oil price shock impact scales by a magnitude of three – initially headline PCE inflation is 2ppt higher, with the impact moderating to 35bps over the year. Simulations show that oil price shocks similar to those outlined above are initially a modest dovish impulse for the Fed. With growth adversely affected and the unemployment rate pushed modestly higher, while core inflation is mostly unaffected, the Fed can focus on the labor side of the dual mandate. That said, the calculus could be somewhat different in the current environment, where supply-side shocks (i.e., tariffs) have already kept inflation well above the Fed’s target. Which bias is correct – the dovish bias implied by the Fed’s model or the market’s belief in a more hawkish impact on Fed policy? The market appears to have agreed with the “wait-and-see” bias from the Fed, with the 2-year Treasury yield rising about 19bps since last Friday – down from a peak rise of nearly 20bps. Consistent with this move, the market removed about 17bps of easing from 2026 and now only anticipates about 44bps of reductions. This is in spite of a super weak Feb Non-Farm Payroll no. Taken together, we think this historical perspective reinforces a Fed on hold for the time being until clear evidence emerges that they should adjust policy. We continue to expect the Fed to cut rates twice this year (in June & Sep) once Kevin Warsh takes over as Fed Chair. We see brent in the range of 80-100 now unless there is an off ramp by either Iran or Trump. We see this off ramp as a low probability event as both parties do not see much losses in current scenario. Iran has already lost it’s supreme leader and seen the worst of aerial attacks. Their missile and drone capabilities are impacted but still enough to create nuisance value for civilian life in middle east. As long as they can ensure this sustained low intensity warfare continues with Strait of Hormuz effectively closed for transits, pressure is on surrounding gulf countries to put pressure on Trump to pull back. But Trump does not see many losses in his calculations as long as US equities are relatively unharmed. Only if S&P500 goes below 6500, Trump might start thinking of off ramps. Till then we can expect the current standoff to continue. This implies further downside to risk assets specially equities. US rates can remain elevated and DXY strong. Precious metals have seen their best days, and we see scope for large fall there in either scenario of a sustained war (stronger DXY leads to lower Gold/Silver prices) or a ceasefire (geopolitical risk premium vanishes leading to fall in Gold/Silver prices).