Markets Weekly podcast

Julien Lafargue (JL): Welcome to a new edition of Barclays Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and I will be your host today.

Last week was an interesting week as finally the S&P 500 and the Nasdaq both managed to eke out a modest week-on-week gain, after four straight weeks of decline. Big Tech was mostly lower. And, on the other hand, European equities were little changed, with just the DAX posting a drop in what seemed a sell-the-news type of reaction to the passage of Germany’s fiscal reform, before the old parliament dissolved this week. It was very, very quiet on the trade front as we’re all waiting for ‘Liberation Day’ on 2 April and the announcement from the US administration of reciprocal tariffs. 

It was, though, a lot less quiet on the central bank front with the BoJ, the Swiss National Bank, also known as the SNB, the Fed and the Bank of England meeting last week.

So, we’re going to do things differently today as Michel Vernier, Head of Fixed Income Strategy here at Barclays Private Bank, is going to help me make sense of all those central bank decisions. Michel, welcome back to the podcast. We’re glad to have you here because we have much to discuss.

Michel Vernier (MV): Of course, yeah. Hello.

JL: I’ll pass quickly on the BoJ and the SNB, simply because the BoJ decided unanimously to leave its policy rate unchanged at 0.5%, and that was widely expected. And the Swiss National Bank, the SNB, cut its policy rate by 25 basis points to 0.25%, in a move that was also expected and designed to counter low inflation and prevent excessive economic slowing. The Fed was much more interesting. The decision to hold rates was expected, but markets were eager to see the updated ‘dot plot’ and economic forecast, as well as to hear from the Fed chair. 

As one could have anticipated, the Fed sees lower growth and higher inflation ahead, which looks a lot like stagflation if you ask me. That said, the FOMC still sees only two rate cuts this year, and this could have been seen as a hawkish stance, but markets saw it differently. In fact, the bond market remained fairly stable after that Fed meeting, which seems a good sign. But, Michel, maybe we should ask the expert. What was your takeaway from the Fed? Do you think they were trying to send a dovish or a hawkish message?

MV: Yeah, good point. I think it was a mixed message in some ways, but there were also definitely some dovish nuances. First, as you said, dots were unchanged compared to December, showing two cuts this year and also two in ’26 and one, I think, in ’27. But the rate market had already gone into this meeting with fairly dovish expectations. 

So, the two-year yields, so the short-end of the yield curve, has retreated from recent highs of 4.4% to just 3.9% over the last month, and that also prevented some further downside move in yields, as a reaction to the FOMC. 

Now, in its economic projections, as you already said, the Fed did adjust what seems like stagflationary dynamics, stickier inflation and lower growth. GDP growth projected was revised down significantly to 1.7% for 2024 Q4-to-Q4, so that can be perceived as more dovish. And so that’s already 40 basis points lower than the December projections. And then, for 2026 and ’27, the median projections were lowered to 1.8%, so definitely lower growth.

Now, Jerome Powell acknowledged the higher short-term inflation expectations. I think he mainly looked at the Michigan consumer sentiment index, which you have already mentioned, Julien, and the long-term inflation expectations within that jumped by the most since 1993 recently. But, he mentioned that if multiple measures of long-term inflation expectations become unanchored, then the Fed may adjust to the hawkish side.

So, if we’re looking at market-implied expectations, the picture seems to present itself on a slightly different shade compared to what consumers are pointing to. Now, here we can look at inflation breakeven rates. For example, the two year, so the shorter-end US breakevens, they have indeed surged and are elevated at around 3.1%. 

Over the last two years that measure was averaging more around 2.5%, so it does indeed imply higher inflation, but the Fed really is more concerned about long-term expectations. And if we look at the five-year, five-year breakeven forward, so that’s effectively the expectations of what inflation is going to average over the medium-to-longer term, that has come down and is close to the lower end of its two-year range, at around 2.23%.

So, the market does not seem overly concerned about the inflationary pressures but, nevertheless, we’re talking about long-term progression. What was most interesting to hear from Powell is that he brought back a very delicate expression, in many views. So he said, “so I think transitory is kind of the base case”, referring to inflation. Now, underlying inflation is, you know, what he said is still running in the twos, with probably a little bit of a pickup associated with tariffs. And remember that ‘transitory’ conversation is somewhat of a dangerous word, because, yes, tariffs may be inflationary, it may have growth implications, but we really can’t assess, at this point, how long that transitory period will be. And, at least in the short term, the market may project a little too optimistic an outlook.

JL: I was really surprised that he used the world transitory. I thought that would have been banned from the central bankers’ lexicon for the next few decades after what has happened in recent years.

MV: Absolutely.

JL: But the other thing that I found very interesting was that when asked by journalists as to why the FOMC decided to not change their projection, in terms of interest rates for 2025 despite a higher inflation forecast and a lower growth forecast, he basically said something along the lines of it’s very difficult to know what will happen and what would you put.

And I find that the admission from the Fed chair that he doesn’t really know, and nobody really knows what the tariff and trade war is ongoing to mean for the US economy, is very refreshing, and I think we should admit that we don’t really know. But anyway, do you think that Powell’s approach of staying calm and carrying on, or still staying calm and waiting for inflation to come down, is the right one?

MV: Yeah, look, I quite liked your expression. You put it very nicely, calling it refreshing. I think it’s more that you should be concerned in some way. Look, I think the Fed is definitely in a position where it can define, as the current policy stands, as restrictive. And I think it’s more about how restrictive they really are at this point of time, and we see two paths and two forces coming against each other at this point of time. 

We need to look at inflation first. So, consumer prices rose at the slowest pace in four months in February. That was definitely offering some relief. You know, headline inflation is now 2.8% year on year, still above where we want to be. Now, the main inflation measure of the Fed, the core PCE, that is at 2.6%. That could come towards 2.7%, with the inputs being already received. And we do see reciprocal tariffs that could lead to further inflationary pressures, but it remains a moving target. 

So, core PCE, this core inflation measure, has remained now at around its current levels for 11 months, so that should, to some extent, let people think about what’s going on here. Remember, everyone was talking about the last mile being the hardest. Now, what we see from this data is that there wasn’t any progress. From that perspective, remaining at a restrictive policy stance seems definitely the right choice, but you may need to adjust. 

Now, we think the low point for the annual rate of this core inflation measure, will be around 2.6% by April, or middle of this year, but not more. Then, potentially, we see a moderation towards 2.2% for next year. Now, we also need to look at the other side of the equation, which is growth. If we believe the Fed’s Atlanta Now cast GDP indicator, in combination with soft indicators, US growth is indeed heading to negative growth. 

Now, this weakness is not only partly reflected on the hard data front. So, remember most of the soft data were driven actually by increased concerns and uncertainty over tariffs. So, if Trump, as you mentioned, indeed is introducing more targeted tariffs, we may see some relief there from the soft data over the next few weeks and that could lead to less growth weakness. 

So, the Fed, for its part, will be watching the job market data like the payrolls and they still remain stable to robust. So, kind of 51,000 was the last number. The three-month average is still at a decent 200,000. The unemployment rate is still low, but underemployment, so just maybe to point that out, that includes those working part-time for economic reasons and discouraged workers. That has actually risen notably lately. So, definitely something to watch out. 

So, low growth weakness on the hard front, yes, that’s something which the Fed will look at. And, as long as that’s not the case, the Fed won’t move on the lower end. And to come back to your question: to wait and see makes sense, but suggesting we are out of the woods is far from appropriate, I think at this stage.

JL: So, if they do indeed wait and see, how long do you expect them to wait? Do we still expect some interest rate cuts, interest rates to come down later this year?

MV: Yeah, we believe that there will be two further cuts this year, so that’s pretty much in line now with the markets. I mean, the market hadn’t expected any cuts initially, and there’s probably some adjustments here. But then again, there may be some delays if we actually see a bit of a relief on the tariff front. You know, if growth is not coming down as significantly as some soft indicators suggested, and the GDPNow cast, for example, which is very often quoted, is not coming down as quickly, then the Fed needs to look at inflation, and if inflation doesn’t come down as quickly, then they need to just remain restrictive.

So, at the same time there’s a higher risk that the economy is indeed rolling over. So, if there’s a higher risk then we may actually be speaking about more cuts than is priced in for the longer term. 

So, we need to have more clarity over trade flows and inflation and also for consumer resilience, that’s going to be very important over the next coming quarters.

JL: OK. So, before we talk about the Bank of England, I also wanted to ask you quickly about the Fed’s balance sheet, because I think this is an important element that hasn’t necessarily been discussed as much. So, maybe two things. One, can you remind us of what the Fed said and, second, do you see any implication for the bond market?

MV: Yeah, it’s a bit technical. I mean the Fed said that starting April the cap of what the Fed is allowing to mature, in terms of Treasuries, will be lowered from $25 billion to $5 billion. The Fed will leave the cap on mortgage-backed securities unchanged. So, just as a reminder, the central bank has been winding down its holdings since June 2022. That’s a process known as ‘quantitative tightening’, or QT. It seems that this quantitative tightening may end in June, maybe September 2026. Now, this is an element of the balance sheet which the Fed can control, so that’s the asset side. And that means actually they’re buying at this point, or letting more supply come into the market, but less and less so, and at some stage will fully reinvest again any maturities, which should bring some relief again to the supply-demand situation.

Now, there’s another element of the balance sheet which I’d like to bring up, which the Fed cannot control, and that’s not on the asset side, like the T-bills or mortgage-backed securities, but that’s on the liability side, and we’re talking here mainly about the Treasury general account. 

Just for a quick explanation, this is basically the chequing account for the US Government or US Treasury. Currently, the US has reached their debt ceiling and is not allowed to increase the debt, which means that they are withdrawing from this chequing account. And this leaves significant room to grow another part of the liability side, which is bank reserves, and we have plenty of cash reserves here and the money market hasn’t really felt the effects of the last quantitative tightening dynamics. 

But this will change again at some stage, and it’s expected that the debt ceiling will be suspended or increased, and that will mean that the chequing account will increase again and squeeze out the liquidity out of the money-market system, and in turn this could lead to some volatility on the money-market front.

Now, we don’t expect large disruptions, like seen in 2019, because the Fed still considers that cash reserves are ample, but money-market managers are watching the current dynamics.

Now, coming back to medium and longer rates, now once QT is finished and the Fed starts to reinvest all maturities, that could provide some relief. But, remember, the flood of Treasury issues has yet to come and this is where volatility could come back again on the long end. Now, this is why we are reasonably constructive when it comes to duration or Treasury yields, but we also still feel more comfortable with medium or short duration at this stage.

JL: Excellent. All right. Let’s move on to the Bank of England. So, the BoE kept its bank rate at 4.5%, with a somewhat hawkish eight-to-one vote split, as only Dhingra backed a 25-basis point cut, while Mann rejoined the majority after previously supporting a 50-basis point move. 

The MPC expressed heightened concern about inflation risk, noting uncertainty over the supply-demand balance and persistent domestic price pressure. I think the only new statement language in the commentary provided by the BoE was this emphasis on no presumption of a preset path for future meetings, which suggests that the BoE could remain on hold until summer, if underlying inflation surprises to the upside.

So, Michel, looking at the bond market, what do you feel was the takeaway from the MPC meeting?

MV: Look, I think you summarised it pretty well. I mean, overall it was maybe a bit more hawkish, the meeting, in a way. You know, the market sees two cuts roughly this year, and seems to perceive the MPC meeting as being a bit more hawkish. The MPC said it continues to remain restrictive, and that’s something which obviously the market is looking at. And as you said, I mean Catherine Mann was perceived to be a more hawkish member, and she was actually then leaning towards the other side at the last meeting, and now suddenly is again not calling for any cut this time. So, that’s something which the market was looking at as well.

And then the Bank of England is looking more at the inflationary side was something which the market perceived to be a more hawkish message, in some ways.

JL: Yeah, and I think the market pricing for rate cuts moderated after that decision, right, with a cut probability in May falling quite substantially to the lowest in six months. And I guess, in this context, it will be interesting to see what the OBR has to say about the UK economy when we receive the updated projections that should be released as part of the Spring Statement this week. 

You know, growth has undershot expectations, inflation has climbed to its highest level in maybe 10 months, around 3%, and we’ve seen a sharp rise in government bond yields, which has all but wiped out the Chancellor’s around £10 billion headroom against her own fiscal rules. So, very interesting to see what the OBR and what the Chancellor says. But how do you think the Bank of England thinks about all that? Do you think that comes into consideration?

MV: Yeah, I mean, look, Andrew Bailey said that we need to be quite careful how we calibrate our response, because we’re still seeing a very gradual fall in inflation. He mentioned the supply-and-demand effects and the second-round effects of inflation, which could lead to increased inflation, in the near term at least, and made some references to wages. That’s also something which they are really looking at. When it comes to inflation, the labour market is easing. That’s what they’re saying. And then, underlying pay growth is slowing, but then again, just hours after the BoE decision we saw the release of the private sector pay growth figures, and they rose to 6.1% in the three months through January. That’s hardly at a pace which is compatible with the 2% inflation target of the BoE.

JL: Right. So, do you think we’re going to see lower rates in the UK? I believe Barclays Investment Bank has quite a punchy forecast which is, I guess, four cuts by September. How do you feel about that?

MV: Yeah, I think obviously 3.5%, I think it could be probably more delayed, 3.5% is definitely possible. We do need to look at growth. You know, that has been definitely overestimated by the OBR, by the MPC and by the markets to some extent. You know, growth is probably going to be more at 0.7% this year, 1.3% in 2026. So, it has hardly kind of a very solid basis and could potentially also be a drag for inflation at some stage. So, whilst we may not see immediate cuts, there’s definitely a fairly good chance that, at a later stage, 3.5% will be reached. 

So, yes, our colleagues from the investment bank seem to be fairly excited about it. It very much depends on wage growth in the first place, which has been so far fairly sticky. They do expect a bit of a rollover, which could be a bit stickier. But again, 3.5% is definitely not out of reach, but maybe with a bit of a delay.

JL: Great. Excellent. Well, look, Michel, I think we’re almost out of time, but, as always, it was a real pleasure to have you shed some light on central banks’ thinking as well as the bond market and we’ll have you back very soon.

Now, let me just quickly flag a few important data releases this week. We have talked about UK inflation and the OBR projections already. We will also have UK retail sales on Friday as well as US PCE inflation. But clearly, all eyes will be on Washington, to see if we get any more details of what Liberation Day could look like.

So, we will be back next week to discuss all that and preview that Liberation Day, but in the meantime, as always, we wish you the very best in the trading week ahead.