The Fed may find itself in the challenging scenario in which their dual-mandate goals are in tension

Markets

Fed Chair Powell sent a clear signal to markets in a keynote speech for the Economic Club of Chicago. He started by pointing out that the level of the tariff increases announced so far by the new Administration is significantly larger than anticipated. The same is likely to be true of the economic effects, which will include higher inflation and slower growth. The Fed’s obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem. As the central bank acts to meet that obligation, they will balance their maximum employment and price-stability mandates, keeping in mind that, without price stability, it cannot achieve the long periods of strong labor market conditions that benefit all Americans. The Fed may find itself in the challenging scenario in which their dual-mandate goals are in tension. If that were to occur, Powell suggests that they consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close. During the Q&A he stressed on multiple occasions that the Fed’s goals aren’t in tension right now with the labour market still being strong. That’s a very strong hint that the Fed is well positioned to wait for greater clarity before considering any adjustments to its policy stance. Over the course of the year, Powell thinks that both metrics (unemployment & inflation) will on balance move away from target. Taking in mind that they’ll see how far away each is from target, this also suggests in first instance a clear focus on inflation. We feel strengthened in our base case scenario of a long pause, stretching at least into September and probably even into December. US money and interest rate markets turned a blind eye to Powell’s message yesterday. The Fed fund futures forward curve still suggests a 75% probability of a 25 bps rate cut in June with a cumulative 100 bps of rate cuts discounted by March of next year. Daily changes on the US yield curve yesterday ranged between -8.6 bps (3-yr) and -3.9 bps (30-yr). Powell’s message did leave traces on stock markets, pushing key indices to losses of 1.75% (Dow) to 3% (Nasdaq). They already started on the backfoot after US President Trump threw in Nvidia as a bargaining chip with China in the trade war. EUR/USD closed at 1.1399 from a start at 1.1283.

Focus shifts to Frankfurt today where we expect the ECB to cut its policy rate by another 25 bps to 2.25% and dropping any reference to a restrictive policy rate. Those settings allow for the central bank to, like the Fed, turn into wait-and-see mode as the tariff story develops. The 90-day pause in the worst case reciprocal tariff narrative stretches beyond the central bank’s June meeting, arguing against extending the rate cycle. As in the US, inflation is above target with both tariffs and fiscal stimulus being deployed posing upside risks which in the short-run outweigh downside growth risks. We are aware that this view goes against current market thinking of multiple additional ECB rate cuts, bringing the deposit rate towards 1.5%-1.75% by year-end but stick with our call. This dovish positioning nevertheless calls for asymmetric risks today. The front end of European yield curves might underperform, further supporting the single currency.

News and views

The Bank of Canada left its policy rate unchanged at 2.75% yesterday. It’s the first pause since it embarked on an easing cycle in June 2024. The central bank offered no guidance for future policy, only that it will proceed carefully. The BoC considers two scenarios. In the first one, uncertainty is high but tariffs are limited in scope. Canadian growth weakens temporarily and inflation (2.3% in March) remains around the 2% target. In the second scenario, a protracted trade war causes a recession this year and inflation rises temporarily above 3% in mid-2026 before returning to target. Some 40% of a rate cut was priced in going into the meeting yesterday, triggering minor CAD appreciation after the status quo decision. Money markets expect less than two additional rate cuts for this year.

Australian labour market numbers for March were strong but slightly underwhelming. Employment grew by 32.2k (vs 40k expected) after February’s 57.5k drop, almost equally split in full time and part time jobs. The 2.2% annual employment growth was slightly above the 20-year pre-pandemic average of 2. The unemployment rate barely budged with rounding effects pushing the figure up from 4% to 4.1%. The same effects lifted the participation rate 1bp to 66.8%. First quarter inflation in New Zealand rose by 0.9% q/q to 2.5% y/y, up from 2.2%. Both were slightly above consensus but remain within the 1-3% central bank target range for a third consecutive quarter. Rent was the largest contributor. The 3.7% increase was the first sub 4% reading since 2021. Non tradeable CPI, a gauge for domestic price pressures, accelerated from 0.7% to 1.1% q/q, as did tradeable CPI from 0.3% to 0.8%. Despite the inflation quickening, markets expect the central bank to further cut rates at the May meeting (to 3.25%).

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