Markets drift ahead of FOMC meeting as risk-off tone dominates

WHERE WE STAND – In these strange, volatile, and uncertain times, it’s nice to see a bit of normality every now and again. I allude, of course, to the typical pre-FOMC drift that was in evidence across the board yesterday.

That drift, unsurprisingly, saw most markets take the ‘path of least resistance’. A path which, in the short-term, leads lower for equities, and the dollar, and to the upside for havens such as Treasuries, and gold.

Despite that risk-off drift, there were a fair there were a fair few fundamental developments for participants to be getting their teeth into throughout the day.

Of course, the most obvious of those catalysts was the Trump-Putin call to discuss a ceasefire in Ukraine, which ended up being a bit of a nothingburger in all honesty. The two agreed that a ceasefire should begin with the halting of strikes on energy and other infrastructure for a period of 30 days, and that negotiations on that front would begin in the Middle East immediately. Beyond that, there is still considerable ground between the two sides, with a comprehensive peace deal still seemingly a long way off. Putin appears to be playing Trump like a fiddle – keeping him on the phone for 90 minutes, to effectively end up where we were before the call even started. At least ‘The Donald’ might get a Russia vs. USA ice hockey game out of all this as a consolation.  

Sticking with the States, it was interesting to see a bit of a change in tone from Treasury Secretary Bessent. Having, just a month ago, noted that the economy was “brittle underneath”, Bessent yesterday remarked that the underlying economy is “healthy”, and that there is “no reason” for there to be a recession. This seems like quite a substantial shift, particularly when data in that intervening period has actually worsened. This certainly isn’t a ‘Bessent put’ in action here, but it will be interesting to see whether other key figures in the Admin, including the obsequious Commerce Sec. Lutnick, mirror this more optimistic language in coming days.

Meanwhile, on this side of the pond, yesterday saw the German Bundestag – as expected – vote in favour of the defence and infrastructure spending bill, with the CDU/CSU, SPD, and Greens having come to an agreement on the package last week. That bill, of course, unlocks as much as 500bln EUR of additional defence spending, while also marking the death of fiscal conservatism in what was the last bastion of balanced budgets.

Markets were, truthfully, pretty unreactive to the deal passing, as this had been priced in long ago, though some modest downside was observed in Bunds regardless. That said, this is clearly a game-changer not only for Germany, but for the eurozone as a whole, which at long last finally seems to be getting its fiscal act together. The common currency rallied to fresh YTD highs at 1.0955 yesterday, just 45 pips away from me getting a free lunch, before paring gains, though a test and break of that 1.10 handle does increasingly feel like an inevitability.

Elsewhere, the dollar traded in somewhat mixed fashion across the G10 board, retracing early declines as the day went on. That, subsequently, saw cable back away from the 1.30 figure, having briefly traded above that level for the first time since last November. I wonder whether the quid might take a bit of a pause here, particularly after last Friday’s January GDP figures gave us all a useful, if grim, reminder of the stagflationary backdrop facing the UK economy. In any case, I still see the rallies in the greenback as selling opportunities, amid ongoing incoherence in policymaking from the Oval Office.

Outside of the FX space, it was a choppy day across the Treasury curve, though benchmarks ultimately ended with modest gains. I still like bonds higher/yields lower here, particularly as growth expectations continue to re-rate lower, and policy uncertainty persists. That should also spark some haven demand, demand which continues to provide a fillip to the yellow metal, which ran to fresh ATHs around $3,040/oz, in a move that one would have to be brave, or foolish, to fade right here.

Lastly, overnight, the Bank of Japan stood pat on policy, holding rates steady at 0.50%, as expected, in a unanimous vote. Policy guidance, though, reiterated the “virtuous” wage-price cycle which continues to take place, leaving further tightening on the cards. Focus now shifts to Gov Ueda’s presser at the bottom of the hour.

LOOK AHEAD – Happy Fed Day!

Powell & Co announce policy later on, though no changes are expected; the target range for the fed funds rate should remain at 4.25% - 4.50%, in a unanimous vote, with quantitative tightening also set to continue at its current rate. Policymakers will, by and large, be seeking not to ‘rock the boat’ today, issuing a broadly similar statement to that released last time around, and with Powell repeating that the Committee are in “no hurry” to deliver further rate cuts, as the economy remains in a “good place”.

That said, participants will be forced to pencil in their latest views as part of the updated Summary of Economic Projections. Given the huge degree of economic uncertainty, uncertainty around the SEP will be even greater than usual, though the recent softening in momentum, and Trump’s tariff policies, should see short-term inflation expectations nudged higher, and growth projections revised lower. The dots, though, should be largely unchanged, with the median again pointing to 50bp of cuts this year and next, though there’s a chance the ‘longer-run’ dot might be nudged a handful of bp higher.

All of this shouldn’t move the needle too much from a market perspective, though there is perhaps a degree of upside USD risk in the short-term here, with the USD OIS curve discounting around 58bp of cuts by year-end.

Away from the Fed, final eurozone inflation figures, as well as a plethora of ECB speakers, and the initial read on Q4 GDP from New Zealand are due, though all of that will be overshadowed by J-Pow.