As the conflict in Ukraine remains frozen for now, markets have started shifting their attention also to other topics, especially monetary policy signals. Despite volatile oil prices rising again to USD/bbl 120 after Russia demanded Rouble payments for gas, positive risk sentiment sent yields higher and equities held up. Bund yields rose above 0.5% for the first time since 2018 and 10Y US Treasury yields are now trading around 2.4% after hawkish comments from Fed chair Powell, which seemed to prepare the ground for a more aggressive monetary policy tightening ahead. EU leaders agreed on more joint gas buying going forward, although an embargo on Russian energy imports remains off the table for now amid German opposition. G7 leaders agreed to crack down on Russia’s ability to sell its gold reserves to support its currency and the US announced expanded sanctions against more than 400 Russian individuals and companies.
Norges Bank (NB) continued with its gradual policy tightening and hiked rates by another 25bp this week, but we think the NB rate path will prove too aggressive and pencil in fewer hikes and an earlier top in policy rates (read more in Reading the Markets Norway – NB firms tightening signals but maintains ‘gradual’ pace, 24 March).
In contrast, the Fed’s new mantra seems to be “get to neutral as fast as possible”, and a range of FOMC members this week talked about front-loading rate hikes, with none ruling out a 50bp at this point. With inflation still high and the Fed behind the curve, we see an increasing probability that the Fed will tighten more and faster than we have pencilled in (i.e. risks are skewed towards the Fed hiking by 50bp in both May and June or 75bp in one go). Tighter monetary policy (and financial conditions) and the commodity price shock increase the risk of a global recession 1-2 years down the road, which is also reflected in the ongoing flattening of the US yield curve.
In Research Russia – EU embargo on Russian energy could be a game-changer, 23 March, we took a closer look at the economic implications from the war in Ukraine on Russia. The ‘Fortress Russia’ policies have already significantly weighed on households’ living standards and the war ensures that weakness will persist for years to come. On a positive note, PMI figures for March suggested that the hit to the euro area economy from the Ukraine war might have been less than feared, calming immediate recession fears. That said, growth momentum in both manufacturing and services slowed and future output expectations have become more clouded amid renewed supply disruptions, weakening export orders and sharp rises in input prices.
While Ukraine war developments will remain in focus amid signs of a stalling Russian advance, next week central banks will also get more data to assess the state of the labour market and inflation pressures. The US labour market report for March is due on Friday and we look for a decent report with jobs growth around 450k. In the euro area, flash HICP figures for March are released and we expect to see a further rise in headline and core inflation (to 6.5% and 3.0%, respectively) as higher input costs are still working their way up through the pricing chain, keeping pressure high on ECB to normalize policy. We see some downside risks for Chinese PMIs released on Thursday, following recent headwinds from COVID-19 outbreaks, property sector stress and the rise in commodity prices.
Full report in PDF.
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