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The deadly game of Deal or No Deal in the Middle East has concluded its fifth week. President Donald Trump simultaneously told the world that the US military had almost completed its goals but was also prepared to undertake the total destruction of Iran if it failed to capitulate. All the while, the Strait of Hormuz remains shut to all bar a few ships and the Brent crude oil price remains solidly above the $100-a-barrel mark.
Highlights of the week: European Central Bank
With the EU now warning of a “long-lasting” energy shock and preparing for the worst, Chris Giles noted in his newsletter that the oil price is now in line with the “adverse” scenario set out at the European Central Bank’s March policy meeting. Having been at the central bank’s Watchers’ conference that followed, Chris has filled in the gaps of what the corresponding monetary policy response is likely to be if this situation persists or indeed worsens.
ECB president Christine Lagarde offered up three potential reactions, which of course all depend on the duration and intensity of the conflict, but option two appears to be the most appropriate as things stand.
“If the shock gives rise to a large though not-too-persistent overshoot of our target, some measured adjustment of policy could be warranted. The optimal response to such a deviation is smaller when the cause is exogenous supply disruptions rather than strong demand, but it is not necessarily zero,” she said.
The first postwar inflation data for the currency bloc has also arrived and showed a sharp rise in the headline measure to 2.5 per cent in March from the 1.9 per cent level in February.
With ECB rates at 2 per cent — the middle of its estimate of neutral policy — a couple of rate rises in the coming months would be a rational response to help contain inflation expectations and show the central bank is taking a proactive stance. Markets at present price three interest rate rises by the end of this year.
Escalation would bring more difficult decisions for those in charge of the purse strings in Europe. The last energy shock in 2022, which was much worse given the rise in natural gas prices, prompted big fiscal support packages. This time around, there are few signs that governments are going to come to the rescue to the same degree, and measures on the table are temporary and targeted for now. Read Elettra Ardissino’s take here.
Federal Reserve
The labour market was in focus this week with data on March payrolls and job vacancies in February. Payrolls smashed expectations, with gains of 178,000 in March versus expectations for an addition of 70,000. Volatility in the data, following a large decline in February, and the fall in the unemployment rate to 4.3 per cent make any near-term Fed cuts even less likely, especially with US inflation set to rise.
The Job Openings and Labor Turnover Survey highlighted the main concern of Fed policymakers and the reason why most still expected to cut rates this year at March’s policy meetings: low job growth. The Jolts data showed that hiring fell by about half a million between January and February, and the hiring rate at 3.1 per cent was the lowest since April 2020.
Bank of Japan
Governor Kazuo Ueda doubled down on the hawkish rhetoric as the yen hit the critical 160 level against the dollar, with a warning that currency moves were becoming more important as the “virtuous” wage-price cycle that the Bank of Japan is seeking becomes more ingrained.
The summary of opinions from the March meeting delivered a similarly hawkish message and reflected the fears that tightening might have to proceed faster given the inflationary impulse from the war in Iran. We expect the BoJ to move rates higher in April and then once more at the end of this year, which is little change to our prewar normalisation expectation. The market at present prices a 50 per cent chance that the BoJ raises rates at its April meeting.
Chart of the week
Hawkish messaging from the Bank of England at its March meeting sent market interest rates soaring. Higher swap rates have fed through into mortgage rates, which are now at levels last seen in 2023 when BoE policy rates were at 5 per cent.
Highlights of the coming week
We get minutes from the Fed’s March meeting on Wednesday, followed by inflation data later in the week with the CPI for March on Friday and the PCE data for February on Thursday. The headline CPI rate is expected to rise to 3.4 per cent from 2.4 per cent in February. Prewar PCE data is expected to show headline PCE inflation at 2.8 per cent in February.
