In the blink of an eye, the first quarter of 2024 draws to a close. In these first three months of the year, we have witnessed many different narratives, from the specter of inflation’s resurgence to the ominous predictions of a Chinese economic collapse and even whispers of a third world war: yet, as usual when it comes to narratives that become too popular among those who, though loud, have no exposure to risk, none of these has materialized.

I would like to use this occasion to reflect a bit on my own forecasts outlined in the December Portfolio Update. If you recall, I anticipated the ECB to begin cutting rates in April, the Fed to initiate cuts in June, and the BoJ to hike by 10bps in April. Although I adjusted my forecast for the ECB last month, now expecting the first cut in June rather than April, the BoJ’s rate hike caught me slightly off-guard. I foresaw it happening, just not so early. Also, the “FX trade of the year” has yet to be opened, but we’ll talk more about that in the Japan section.

Before diving into the detailed analysis of individual countries, let’s first glance at the performance of currencies thus far. The chart below utilizes internal trade-weighted currency indices, which may slightly differ from those available elsewhere due to their calculation method. Nevertheless, they offer a convenient snapshot for quick reference.

United States

The United States’ economy can be described with one single word: strong. The GDP growth may be slowing down, but it’s still positive and in any case higher than what the other developed economies are showing: it’s not a surprise then that equities are doing so well. The final revision to the 2023 Q4 GDP was revised up to 3.4% from 3.2%, and the first quarter GDP is expected to ease but still at a srong pace of 2.3% according to their latest estimates. Looking ahead, we should expect growth to fall in the second quarter, although it will remain positive: I have my current forecast at 1.3%, while my friend @SheepTrades expects it at 1.0%.

Moving to inflation, the latest CPI report exceeded expectations, with Core CPI rising 0.4% MoM and 3.8% YoY. The market reacted with concern, seeing the persistent uptrend from January to February as more than just a seasonal blip. Despite this, the BLS noted that increases in shelter and gasoline prices accounted for over 60% of the monthly rise. Furthermore, during the FOMC meeting, Powell downplayed the report as a mere “bump.”

Similarly, the PPI also surpassed expectations in February, with headline producer prices surging 0.6%, well above both forecasts and the previous 0.3% pace: this increase was driven by energy price hikes, particularly in gasoline, as well as rising food prices. Core PPI increased by 0.3%, slightly lower than January’s 0.5% but still above expectations. Notably, transportation and warehousing services, along with airline passenger services, were significant contributors to the core figures.

Finally, we have the PCE, which rose by 0.26% MoM. This wasn’t entirely surprising, especially considering Powell’s hint during the FOMC press conference that the PCE figure would likely fall below the consensus of 0.30%. The report presented a mixed picture, with the YoY figure of 2.8% being promising as it marks a three-year low and moves closer to the Fed’s target. However, the 6-month annualized rate at 2.9% suggests a moderate acceleration.

Overall, if the Fed remains unconcerned about the elevated data from January and February, there may be little reason for us to worry. The trend toward disinflation persists, albeit at a slower pace.

Shifting our focus to the labor market, although I may sound repetitive, it continues to exhibit extreme resilience. As depicted in the chart below, claims have hovered around these levels for more than six months. While there are indications of a potential rise in claims in the coming months, the current situation remains calm, and there is absolutely no cause for concern.

In other words, the claims data still remains at a level consistent with a tight jobs market, even in face of the Fed hikes.

This perspective is reinforced by additional labor market reports. In February, ADP reported 140k jobs added, up from 111k in January, signaling sustained solid job gains. While it fell short of the analyst consensus, it still represented an acceleration in job additions compared to January. Moreover, the increase in job-changer wage growth to 7.6% from 7.2% marks the first uptick in over a year. The JOLTS report also reflects a robust labor market, with job openings experiencing a slight decrease while layoffs remain low. The NFP similarly supports this view, though it also indicates a rise in the unemployment rate from 3.7% to 3.9%. While an increase in unemployment is never ideal, it’s worth noting that this level remains historically low. Additionally, the Fed’s year-end median forecast for unemployment is 4.0%.

Federal Reserve

In its March meeting, the Fed held rates at 5.25-5.50%, as was widely expected. The updated economic projections continue to see three rate cuts this year, though it sees fewer rate reductions in 2025 and 2026 than it was forecasting in December. Also, although it’s interesting only for academic reasons, it raised its view of the neutral rate to 2.6% from 2.5%. On the inflation front, it revised its view for Core PCE higher this year, despite seeing fewer rate cuts, and continues to see inflation back at target in 2026. The important takeaway from the updated SEP is that despite the inflation forecasts being slightly higher, the Fed still intends to cut three times this year. In other words, this lowers the bar for incoming inflation data to meet their expectations and keep a June cut on track. Also, the GDP forecast was raised to 2.1% from 1.4%. All in all, these forecasts continue to point to a soft landing, and the economic data released so far agrees.

During the press conference, Powell made several noteworthy statements. First of all, he downplayed the significance of the recent hotter inflation data, referring to it as “bumpy” and attributing it to seasonal factors affecting inflation readings this year. However, he acknowledged that these reports had not bolstered anyone’s confidence, proving right the prudent approach with regards to rate cuts. Secondly, Powell emphasized that the Fed does not claim to predict higher rates in the long term, expressing his belief that rates will likely not return to the exceptionally low levels seen previous, although he noted the considerable uncertainty surrounding this outlook. Lastly, regarding the SEP’s GDP forecast, Powell highlighted that the improved growth trajectory was facilitated by recent increases in labor supply, emphasizing that the resilient employment landscape should not be seen as an argument against rate cuts.

Meanwhile, there were no alterations to the Fed’s plans for balancing sheet runoff. However, Powell stated that policymakers believe it will be suitable to gradually reduce the pace of tapering “fairly soon.”

Europe

The latest data from Europe this month painted a mixed picture, with some disappointing trends emerging. Despite hopes for a rebound in the manufacturing sector, the reality was quite different: indeed, the March PMI report confirmed the sector’s weakness, particularly in Germany, with both output and new orders seeing declines. Interestingly, France and Germany are currently experiencing comparable levels of economic fragility, albeit with some nuances. In March, Germany saw a slight improvement in its output index, whereas France continued its downward trajectory. However, the economic downturn in France is more pervasive, with both its manufacturing and service sectors contracting. In contrast, Germany’s manufacturing sector is the primary driver of negative growth, while its services sector is largely stagnant.

In any case, the situation is concerning, as both countries are falling behind the rest of the eurozone. If we consider the fact that these are the two biggest economies in the economic union, and that Germany has been in a technical recession for a while now, the case for a European recession starts to make a lot of sense, despite not being crowded yet.

However, despite these challenges, there are still reasons to be optimistic. First of all, companies are maintaining a positive outlook regarding future production. Secondly, the index of stocks of finished products has increased for the second consecutive month, nearing the point of equilibrium: reaching this threshold would signify that destocking is no longer a hindrance to production. Shifting focus to the service sector, it has further expanded, marking the second consecutive month of growth—excellent news. Similarly, the rise in new business for the first time in nine months is notable and aligns with the continued improvement in business expectations.

European Central Bank

As expected, the ECB opted to keep the rates at the previous level, reaffirming that “rates will be set at a sufficiently restrictive levels for as long as necessary” in their guidance. Some people were disappointed because they expected the ECB to suggest that discussions on the policy normalisation process had already begun, but as I said in December already, it was absurd to expect anything happening in the first quarter. The accompanying macro projections did provide some relief to the doves, as the inflation forecasts for 2024 and 2025 were lowered, aligning the latter with the ECB’s inflation target. However, from a growth perspective, the forecast for 2024 was reduced to 0.6% from 0.8%, while the forecast for the following year remained steady at 1.5%.

During the presser, Lagarde noted that despite inflation continuing to get lower, it’s still too elevated due to wage pressures, and therefore the ECB is not yet “sufficiently confident” when it comes to meeting the target. It was also highlighted how the policy decision was unanimous, that there was no discussion over rate cuts, and that the Governing Council has begun discussing dialing back its restrictive stance. Similarly to what it was said for other central banks in the previous updates, the ECB will not wait until 2% is reached to cut rates.

Later in the month, Reuters reported that policymakers overwhelmingly favor June for the first rate cut, a sentiment echoed by subsequent remarks from Governing Council members. This aligns with the views presented in my February Portfolio Update. However, the same article mentioned that some policymakers have floated the idea of a second cut in July to sway a small group still advocating for an April start. Since the June cut has been fully priced in, any mention of this in the coming ECB minutes won’t be new information for the markets, and therefore it will be likely irrelevant. However, any further detail on the subsequent cuts will be tradable. Keeping everything else the same, the ECB cutting faster than the Fed should be bearish EUR.

Japan

It finally happened: the BoJ exited its negative interest rate policy and abandoned YCC, in which it will now guide the overnight call rate in the range of 0%-0.1% and will apply a 0.1% interest to all excess reserves at the central bank.

The BoJ also unveiled its decision to cease purchases of ETFs and J-REITs. Additionally, it plans to gradually decrease its purchases of commercial paper and corporate bonds, with the intention to halt these purchases within approximately one year. However, the central bank has emphasized its commitment to maintaining an accomodative monetary polic environment in the foreseeable future, and will continue to buy JGBs at levels comparable to previous amounts. Furthermore, the BoJ has also outlined its monthly bond purchase strategy: in the event of a rapid escalation in long-term interest rates, the bank will respond by increasing its JGB purhcases or implementing fixed-rate operations. Additionally, the BoJ has announced plans to provide loans under the Fund Provisioning Measure, aiming to stimulate bank lending: these funds will be extended at an interest rate of 0.1% with a duration of one year.

During the post-meeting press conference, Ueda expressed a dovish stance, reaffirming the commitment to maintaining accommodative financial conditions in the near term, and reiterating the intention to sustain the purchase of JGBs at a comparable rate as before, underlining the significance of preserving an easy monetary environment, especially given the distance from the 2% inflation target in terms of inflation expectations. However, Ueda also left the door ajar for potential future tightening measures, contingent upon the trajectory of the economy and price outlooks.

None of that was enough to make the JPY gain some strength, however:a mere 10bps difference in rates isn’t substantial enough to significantly impact currency movements as the movement in rate differentials is minimal. For the JPY to appreciate, you need either more hikes by the BoJ, or to wait for the other central banks to start cutting, as I said here. If something happened for which the other central banks decided not to cut anymore, then we might have seen the “big move” in the yen already.

In other words, although I continue to hold the belief that going long on the JPY will prove to be the FX trade of the year, it lacks practicality to initiate this position before other central banks commence their rate cuts: the risk-to-reward ratio just doesn’t make it worthwhile until such actions are taken.

Australia

Once again, the RBA decided to keep the cash rate steady at 4.35%, which most people were expecting. They emphasized their determination to get inflation back to where it should be, acknowledging that it’s starting to slow down but still higher than they’d like. They also mentioned they’re keeping their options open regarding interest rates, which is a bit of a change from before when they hinted that rates might go up. But it’s not entirely surprising either, as Bullock had mentioned something similar in the last press conference.

The RBA also mentioned that the uptick in interest rates is helping to strike a healthier balance between overall demand and supply in the economy. While the Board still anticipates it will take some time before inflation comfortably settles within the target range, they highlighted promising indications that inflation is easing, despite the ongoing uncertainty in the economic outlook.

Canada

The BoC left rates unchanged at 5.00% too. Those who were seeking clues on when the bank might consider lowering rates were left disappointed, as the the BoC largely reiterated its previous guidance. The statement emphasized the council’s ongoing concern about inflation outlook risks, particuarly regarding persistent underlying inflation. It also reiterated the policymakers’ desire to observe “further and sustained easing in core inflation” while maintaining focus on the balance between economic demand and supply, inflation expectations, wage growth, and corporate pricing behavior.

In his opening remarks, Macklem said that it is still premature to contemplate reducing the policy rate, and emphasized the necessity of allowing higher rates more time to impact the economy. While recent inflation data suggests that policy measures are yielding expected results, he cautioned that future progress in inflation is likely to be gradual and uneven, with lingering upside risks. Regarding the potential for rate cuts, Macklem said once again that the central bank cannot set a specific timeline for such actions, although it won’t reduce rates at the same pace at which they were raised.

Overall, the meeting didn’t bring any new dovish sentiments, and while a rate cut in June is not fully priced anymore, it’s still largely expected.

Switzerland

I don’t typically talk about Switzerland in my portfolio updates, but this time it’s necessary: the SNB has initiated the global cutting cycle. While it wasn’t entirely unexpected for those closely monitoring the country, the SNB’s 25bps cut caught some market participants off guard, leading to a CHF depreciation and a modestly dovish market reaction overall. There were essentially three reasons behind the decision to cut rates: significant progress in addressing inflationary pressures in recent months, the expectation that inflation will remain within the 0-2% target range for the next few years, and the notable appreciation of the CHF.

As usual, the statement offered no definitive guidance on the policy trajectory but underscored the flexibility to make adjustments as needed to keep inflation within the target range. Jordan emphasized that no forward guidance was being issued, and the situation will be reassessed in June. Furthermore, it was clarified that neither currency purchases nor sales are currently a focal point.

Positions

As previously announced, this will be the last time this section will be present in the Portfolio Updates, as it makes little sense to talk about trades which have an average duration of a dozen hours in a monthly newsletter. Anyway, at the moment I am currently long EUR and AUD, both against the USD.