Fed to wait and see and energy shock clouds economic outlook

In focus today

• Focus remains on the Middle East, particularly on Iran's response to Israel killing its top security chief and the potential repercussions for global energy markets.
• The main event will be the FOMC meeting tonight. We and markets expect no monetary policy changes. Markets are still pricing in one more rate cut later in the year, while we call for two. US February PPI data will be released in the afternoon ahead of the rate decision. 
• In the afternoon, focus turns to the Bank of Canada meeting at 14:45 CET - where we, in line with consensus, expect the policy rate to remain on hold at 2.25%. Note that this is an interim meeting without a new Monetary Policy Report, so focus will be on the tone of forward guidance.
• We also receive final February inflation data for the eurozone ahead of ECB's policy rate decision tomorrow. Inflation figures are expected to confirm flash estimates.

Economic and market news

What happened yesterday

In the conflict in the Middle East, the Israeli military (IDF) killed Iran's top security chief, Ali Larijani, a key figure in Iran's political and military establishment, along with Gholamreza Soleimani, leader of the Basij militia within the IRGC. In response, Iran launched missile strikes on Tel Aviv overnight. Mojtaba Khamenei reiterated that he rejects proposals for reducing tensions or agreeing to a ceasefire, declaring that peace would not be pursued until the US and Israel "accept defeat and pay compensation".

The political pressure on Trump intensifies as Joe Kent, the director of the US National Counterterrorism Centre, resigned in protest of the Iran war. Trump stated on Tuesday that the US will end its military operation in Iran "in the near future" but emphasised that withdrawal is not yet imminent.

In the Oil market, the biggest news overnight was a deal between Iraq and the Kurds to reroute some oil via pipeline through the Kurdish region and further to Turkey. On the margin, it will relieve a little of the pressure on the oil market and Iraqi economy. The oil price was fairly steady overnight just above USD100/bbl. 

In Germany, the ZEW index surprised in March with the assessment of the current situation rising in contrast to consensus estimates while expectations for future growth fell much more than expected. The assessment of the current situation increased to -62.9 (cons: -68.0, prev.: -65.9) and expectations declined to -0.5 (cons: 39.2, prev.: 58.3). The decline in expectations was historically large and of similar magnitude as the decline last year after Liberation Day and in the first months of Covid. The decline in growth expectations highlights the dilemma that the ECB faces of lower growth expectations amid higher prices.

Equities: Equities moved higher again yesterday, with a familiar intra-day pattern: sentiment improved through the European and US cash sessions. On the surface, price action pointed to stronger risk appetite, equities higher, cyclicals outperforming defensives, min vol underperforming and VIX drifting lower.

However, the cross-asset signal remains more nuanced. Oil prices did not decline yesterday, which breaks the typical geopolitical "risk-on = lower oil" relationship.

This suggests that markets are not pricing a full de-escalation scenario. Instead, investors appear to be gradually adapting to a prolonged conflict backdrop, supported by increasing evidence that oil supply, while constrained, continues to flow out of the Middle East.

Within equities, the US session in particular saw a more pronounced cyclical rotation. Notably, consumer cyclicals have started to recover after massively underperforming the last 6 months. This morning, the positive tone continues across Asia, led by South Korea (+5% at the time of writing). US and European futures are also higher. Importantly, oil is declining this morning, providing an additional tailwind for risk assets compared to the previous session.

FI and FX: EUR/USD shifted back above 1.15 yesterday amid declining UST yields and cautiously recovering risk sentiment. We do not expect tonight's FOMC meeting to be a game changer for EUR/USD, as the Fed remains in a comfortable position to just wait-and-see how the war in Iran evolves. Before that, we expect the BoC to stay on hold. The CAD remains resilient among G10 currencies against the USD, supported by Canada's net-energy exporter status. However, risk-off sentiment and broader USD strength have kept USD/CAD rangebound between 1.36-1.37. Yesterday, our tactical trade to face recent NOK strength hit its stop, and we stay on the sidelines for now in Norway, awaiting the central bank meetings and the Regional Network survey tomorrow.