Weekly focus – Rate cut expectations pushed back further

It has been a volatile week for risk markets, once again mostly driven by expectations regarding the first rate cuts by the big central banks. Euro area PMIs came out much stronger than expected, and service sector output prices increased, raising a question of whether the ECB was too complacent when they basically pre-committed to a rate cut in June. US Q1 GDP missed expectations but mostly because of a decline in exports, while PCE inflation on a quarterly basis ticked up more than expected. As a result, markets have yet again pushed back rate cut expectations and the first Fed rate cut is currently not fully priced in until November.

The pricing of 'higher for longer' in the US together with elevated energy prices remain a drag for the Japanese yen which continued to weaken this week. On Friday, USD/JPY broke a new high above 156.50 level after a dovish hold by the Bank of Japan and April inflation data surprising to the downside. Soon after the meeting the pair suddenly corrected sharply lower. The short-lived move was likely an intervention by Japanese authorities, yet a futile one as JPY quickly reversed the gains. The weakness in JPY is a reason we expect Bank of Japan to hike rates once more this year, most likely in July.

Geopolitical risks remain on the agenda. While the situation in the Middle East seems to have calmed for now, Russia's war in Ukraine is gathering renewed attention. The US finally approved a new USD 61 billion support package for Ukraine, which should bring almost immediate relief for Ukraine on the frontline. We do not expect the dynamics to change drastically, though. The US support will enable Ukraine to keep on fighting, but significant advances seem to be challenging for both sides at the moment. Also this week, Belarusian President Lukashenka claimed to have prevented a drone attack from Lithuania, raising concerns of some kind of a false flag operation by the Kremlin-Minsk axis.

Next week, focus on the US rates market is likely to remain as both the Fed meeting and a plethora of interesting macro releases are due. In line with market consensus, we do not expect any changes on monetary policy. Hence, focus will be on Powell's verbal guidance as well as on any hints on the Fed's plans to taper the pace of QT. Just ahead of the rate decision, ISM Manufacturing index and ADP private sector employment report will be released for April alongside JOLTs labour turnover data for March. On Thursday, we will get the Q1 preliminary productivity data, and on Friday, the April jobs report rounds up an interesting week.

In the euro area, focus will be on April flash inflation data. German and Spanish inflation prints will set direction on Monday, while the euro area data will follow on Tuesday. Inflation has declined in recent months but the underlying momentum in service inflation has picked up. We expect inflation to remain unchanged at 2.4% y/y due to food inflation and rising energy inflation while core inflation should decline to 2.6% y/y. The key thing to look out for is service inflation which has gained momentum recently and remains sticky on the back of recent wage increases. sEuro area Q1 GDP data is out on Tuesday. We expect that the economy grew 0.2% q/q driven by the service sector while the manufacturing sector declined slightly as indicated by industrial production data and PMIs.

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