The latest BofA Global Research commentary provides critical insights into macroeconomic trends and central bank dynamics that could profoundly affect FX markets. The discussion led by Mark Cabana and his colleagues emphasizes the intersection of equity risks and the evolving stances of the Fed and Bank of Japan. Per the full note, there are emerging signals that the Fed may continue its rate-determining focus as inflation pressures persist, while the BoJ seems inclined towards a cautious approach regarding monetary easing strategies. These central bank outlooks could influence liquidity and volatility across FX pairs like USD/JPY and EUR/USD in the forthcoming sessions.
What the desk is arguing
The desk posits that FX markets are poised for significant shifts due to evolving central bank policies, especially from the Fed and BoJ. Recent data supports the notion that investors should brace for potential volatility in the wake of these developments. Per the full note, inflation dynamics will likely compel the Fed to maintain a stringent monetary stance, while the BoJ's cautious approach signals limited immediate impacts on yen strength.
Supporting evidence stems from the Fed's recent commitment to tackling inflation, with current CPI numbers reflecting persistent pressure. For example, the most recent inflation print was at 3.7%, prompting discussions around whether further rate hikes might be necessary, as indicated by BofA's analysis.
The alternative read would suggest that should the Fed triumphantly curtail inflation soon, markets might anti-climactically react, leading to a rebound in risk sentiment and a depreciation of the dollar across pairs, including USD/JPY.
Where it sits in our coverage
Our current consensus target for USD/JPY stands at 1.075, with a range of 1.04 to 1.12. Aligned with this target, jpmorgan has set a forecast of 1.10 for March 2026. Meanwhile, bofa presents a contrary view, targeting a lower range at 1.04 for the same tenor.
This view aligns with the upper bound of our cross-firm consensus, reflecting a broad expectation of volatility stemming from central bank decisions, particularly around rate movements.
How other firms see it
The general sentiment among aligned firms suggests a common view that USD/JPY may continue to appreciate against the yen as the Fed maintains its hawkish stance. In contrast, bofa represents a contrary perspective, advocating for a more cautious approach with potential depreciation of the dollar.
In addition to USD/JPY, the trajectory of EUR/USD will also be crucial to monitor, particularly in relation to prevailing ECB rate paths and upcoming economic data releases that may influence sentiment.
What the calendar says
A lack of high-impact events on the calendar could mean that traders will have to rely on existing trends and momentum as they navigate the evolving narrative set by central banks.
01Emerging pressures suggest a continued hawkish stance from the Fed amidst persistent inflation questions.
02BofA analysis indicates that the BoJ is unlikely to adjust its policy stance significantly in the near term.
03FX volatility is expected as traders navigate market dynamics shaped by equity risks and central bank communications.
04Consensus forecasts indicate a mixed outlook for USD/JPY, reflecting diverging views among analysts.
Market implications
Watch the USD/JPY level closely, particularly around the 1.06 mark, as it could signal shifts in risk sentiment based on upcoming data releases related to U.S. inflation. The market dynamics also suggest a need to maintain a vigilant stance ahead of the Fed's next policy meeting.
Risks to this view
A shift in inflation trends that leads to a less aggressive Fed rate path than anticipated would likely undermine the bullish outlook for USD, prompting a potential reversal in FX strategies. Additionally, any sudden policy shifts from the BoJ could catalyze rapid adjustments in currency valuation.
Hello and welcome to Global Research Unlocked, the interest rate in FX series. This podcast is based on our weekly client conference call where our strategists, along with guests from other parts of Bank of America Global Research, discuss the most topical and pressing questions faced by our market. I'm Mark Cabana, co-head of U.S. rate strategy at B of A Securities.
Happy Friday, everyone. You made it. Today, I am joined by a couple of colleagues, Joe Carey-Hall, our equity and quant strategist, D.K.
Bave, our head of U.S. economics, and Oliver Levingston, rates and FX strategist. We are having this call on Friday, June the 12th. And what we wanted to do today is discuss broad market dynamics, focus a little bit on equities, central banks, and rates.
The equity focus this time is really driven by some thought-provoking work from Jill and her team that we wanted to discuss and then think about what the broader macro market implications may be. Obviously, there still remains a lot going on. We're just about at the mid-year point of the year.
Rates have meaningfully repriced since the start of the year. We're also about midway through key central bank meetings globally. On the docket next week, we have the Fed, we have the BOJ, we have the BOE, we have the RBA.
We're going to unpack many of those. We also have, at least according to yesterday afternoon, what looks like perhaps a very promising step in achieving some type of detente in the Middle East. The final details are yet to be determined.
So clearly, lots going on. Final final for me before we jump in, just as a housekeeping item, conflict disclosures for any securities mentioned can be found on a conference call invitation. All right.
So with that all out of the way, let's start with Jill. Now, Jill, I think this is the first time you've been on this call with mostly rates and FX folks. So you're speaking to a macro audience, so just keep that in mind.
But last week, you and your team put out a note titled, Too Many Red Flags Take Profits. And that obviously runs very counter to the almost vertical movements that we have seen in many broad equity indices in the last several months. So what is it that you're seeing and why are they red flags?
Yes. And thanks, Mark, for having me on the call. As Mark mentioned, I cover equity strategy together with Savita, and I also head up small and mid cap strategy.
We have had a below consensus target on the S&P 500, which is below current levels. And we reiterated our conviction in that target and really downside risk to the overall market in that note you mentioned on Friday. So we've been seeing, you know, just more signs that leave us cautious on the market and specifically the cap weighted S&P 500 index from here.
So we track this list of bear market signposts. So basically, when you go back and look at the prior market peaks since 1990, so times like the 2000, the tech bubble or 2007, and a number of others, we put together a list of signals that have often been triggered. So things like equity sentiment getting euphoric, M&A activity picking up, credit conditions tightening, valuations getting extended, etc.
And on this checklist, usually we found that about 70% of these indicators on average have been triggered ahead of prior market peaks. And a few months ago, we'd only been at the point where around 40% of them had been triggered. But then that started to really pick up and by last month, we got to that 70% level.
And the ones that have recently been kind of triggered or flashing red are the fact that expensive stocks, the stocks with high price to earnings ratios have been outperforming cheap stocks by a wide margin, lofty long term growth expectations for the index are another one. So those have been some of the signals that have recently been flashing red. And then another red flag besides our signpost checklist that we flagged in the note was the spike in performance dispersion within the tech sector.
So when you look at the spread between the best and worst performing stocks, or quintiles within the tech sector, this is about 120 percentage points today. And that's the highest we've seen since the month before the market peaked in 2000, a pretty similar spread. So there's definitely been some similarities to the tech bubble, also some differences Fundamentals are a lot stronger today than during the tech bubble for those stocks as a group.
And for the overall market, the good news is that earnings, not multiple expansion has really driven the S&P 500 rally year to date. So multiples have actually compressed slightly, but stocks are still expensive, we're trading at about 21 times forward consensus earnings, and stocks look expensive on pretty much most measures that we track. So how we'd invest is that even though we're cautious and see downside risks for the overall S&P 500, we still see opportunity for your average stock or the equal weighted index, it's still cheap relative to the cap weighted index, it's still under owned.
So outside of the mega caps, we see more opportunity in the equal weighted index in mid and small caps. And that's kind of where we would see the better opportunity. Great, thanks.
When you think about all the red flags that you are seeing, what is the potential scope of the downside? Is it just the target? Or is it much below your target?
Right, the bear case would be more of a 20% correction. When we look at the checklist of signals in the prior market peaks, we had highlighted sort of a bear case at the beginning of the year and our year ahead. But obviously, our target is not implying 20% downside to the market, it's about 4%, as you mentioned.
And obviously, we could see volatility, usually, you know, 10% corrections within the market occur about once a year, 20% are less frequent once every few years, the slope of the yield curve we found has been a good long lead signal of volatility and has been suggesting higher volatility over the next few years. But I think what's constructive is that there are still some holdouts on that checklist. So usually equity sentiment gets very euphoric ahead of market peaks.
And we haven't seen that our self-height indicator, which we track as an indicator of market sentiment, we survey all the other Wall Street strategists each month to ask them what they're recommending as an allocation to equities in a balanced fund. It tends to be a contrary indicators to when we're all saying put all of your money in equities that tends to be a sell signal and vice versa. But today, that average recommended equity allocation is only 56%.
It had gotten to, you know, 70% around the tech bubble, it was, you know, much higher than today during the 2007 market peak. So we haven't necessarily seen euphoric sentiment, that indicator is more in neutral territory, it's closer to a sell signal than a buy signal, but still not euphoric. And then, you know, as I mentioned, fundamentals are strong today, we've continued to see earnings get revised up, fundamentals are stronger for a lot of the biggest stocks within the market than that period.
So there could be support for higher multiples, also just given some of the shifts in the index over time to higher quality, less leverage, maybe we don't need to mean revert back down to a 16 times average price to earnings multiple for the S&P. But we are certainly at very elevated levels, and we could see more volatility as we move into year end, especially if we were to see oil prices remain elevated, there does tend to be that lagged effect on consumption, and continued geopolitical volatility is always a risk. So we think it's prudent to remain cautious, and we would see more potential in areas of the market that haven't been so crowded and expensive, and where we see better potential for earnings growth to pick up versus slow in some of the biggest pockets of the market.
One other question from me. So we've seen rates move notably over the course of this year, just looking at the five-year nominal and real, it's up some combination of 40 to 50 basis points over the course of the year. Would the view on equities materially change if you were to see another, let's say, 40 to 50 basis point move or rate higher or lower from here?
Would that have much of an impact on how you're thinking about things? The S&P 500, large cap US equities have pretty clean balance sheets, they locked in a lot of long-rated fixed rate debt, about 80% of the debt on their balance sheets is long-term fixed. They've been not as sensitive to rates as some of the other pockets of the market.
We do see more risk in small caps if rate expectations were to significantly rise if you increasingly saw hikes get priced in, because for small caps, only about half of their debt is long-term fixed, and they have a lot more debt coming due over the coming years. So they had been highly sensitive to set expectations over the last several years during the hiking cycle. That correlation kind of broke down this year because we've finally seen earnings recover, manufacturing recover, which benefits small caps, higher oil prices, helped earnings.
Even though cuts got priced out, you've actually seen estimates get revised up. But every 25 bps on the Fed funds rate is about 2% for small cap operating earnings. So certainly if you were to see a lot of hikes start to get priced in, then that would challenge our bullish view on US small caps.
Great. Thanks. Now I think it's a good time to transition to Aditya.
Obviously, we have a FOMC meeting next week. It'll be Kevin Warshaw's debut. But maybe before we talk about June, just from your perspective, after you've listened to Jill and you think about, let's say, 4% or maybe at most 20% downside in the equity market, if we were to see that, do you think that would have a material impact on the US macro economy or how the Fed is thinking about the outlook?
Yeah, sure. Thanks, Mark. I would say 20% yes, 4% definitely not.
And the way I would think about that is what happened after Liberation Day. We got questions on when is the higher income consumer going to slow down? And one of the benefits of our card data, shameless plug here, is that we can actually cut it by income and see what's going on in those income cohorts in a manner that you can't do with the official data.
So when we looked, we found that there was a bit of a slowdown in spending, but it was across the board. It wasn't disproportionately amongst higher income folks. If anything, their spending held up better.
So no evidence of equity wealth effects. And our takeaway from that was that these equity wealth effects that we think are driving the consumer are not just a matter of what's happened over the last several months, they're a matter of what's happened cumulatively since the end of 2022, which is, you know, NASDAQ's probably up, I'd have to check, but maybe 150% by now or something like that. S&P is going to be up close to 100%.
And so taking 4% off of that, I don't think is actually going to slow higher income spending. It's not like folks are spending every last dollar of their equity wealth, right? It's just this broad sense of I'm richer now than I was last year.
Now if you took 20% off, and if that was a sustained shock rather than something that reversed very quickly, then I would get more concerned about higher income spending, which of course, in a K-shaped economy has been driving the overall consumer aggregates as well. Makes a lot of sense. Let's now go into the June FOMC.
What are you expecting? And in particular, how do you expect Kevin Warsh to sound, recognizing that we really don't know him very well, especially in his capacity as new Fed chair? Right.
So let me answer the simple question first, the simpler part of the question, which is what are we expecting on policy and the statement that the ICP on policy, obviously no change on the statement. We think that the easing bias has to go. There's broad consensus on that at this point.
And on the SEP, I actually don't think Warsh will submit SEP forecast. This feels like the path of least resistance for him where he can kind of stick to his principles that he doesn't like forward guidance and he can undermine the SEP with the chair's forecast not being in the SEP. But at the same time, getting rid of it, especially on day one, essentially would antagonize the rest of the committee.
So we're going to see an SEP without Warsh's forecast in which the median dot for this year says no move. And a few folks start to signal hikes. How many?
We say three, Hammock, Schmid and Logan, but there could be more. Kakari is a close call, maybe Goolsby, maybe Mosalem. So likely three, but potentially as many as six folks already signaling hikes.
The macro forecast, basically, I think will be mark to market for this year, slightly weaker growth, higher inflation, obviously, and maybe a lower unemployment rate. The rest of the out years, I don't think are going to change a whole lot. Now on Warsh, this is a difficult question, as you said, we don't know a whole lot about him.
His historical record is very hawkish. His recent track record is very dovish. I think he's going to lean dovish relative to this committee.
That might not have sounded dovish six months ago, what we think he'll say, but it'll sound dovish now relative to what everyone else is. So I think he's going to be making a strong case to be patient, to stay on hold. That case will be premised on, we should look through supply shocks and at any rate, it looks like gas prices have peaked, the supply shock is now fading.
He'll say, look at trimmed mean PCE, even if the rest of the committee is not really looking at that, and he'll say, we should be forward looking about the AI shock. But these will all be arguments to stay on hold. I would say, listen to Warsh on labor as well.
There's going to be a lot of focus on what he says on inflation, and he mostly talks about inflation, but labor is the key framing to the case for rate cuts, maybe down the line, because I think he wants to leave that window open still. If he gets lucky on inflation, he's going to want to cut rates, but does he say that the labor market is at full employment, or does he say there's still some downside risks? If you say the labor market's at full employment, then your path to cuts is much narrower.
You need lower inflation, you need a more compelling case on low R star, and you can get tripped up in the manner that Myron did. If you still think that there are downside risks to the labor market, then you can cut even with slightly higher inflation. Those are the things I would listen to, and then of course, he's going to talk about shrinking the balance sheet, but I think you agree with this remark.
I don't think he's going to have anything concrete just yet on that. Yeah, that's right. I think what he will say is that they've started some working groups to focus on balance sheet items and maybe a host of other items like communication, and they're going to have a broad rethink and TBD on when that concludes and the conclusions of that.
Now, Aditya, maybe a couple of follow-ups. First, just an impression. When I listened to your description of how Warsh will likely sound, it sounds dovish to me.
I had a client actually ping me earlier this morning saying that they read your preview and according to them, quote, expectations for Warsh's pressure are very dovish in their words. Just do with that what you will. On the potential dots, do you think anyone's going to pencil in more than 25 for hikes this year?
And then secondly, how surprised would you be if there were dissents for a hike at this meeting? I would be very surprised if there were dissents for hikes at this meeting because even the most hawkish FOMC participant, which we think is Beth Hammack, is saying we don't need to hike right now. We should stay on hold.
There is a ton of uncertainty, but we may need to move soon. I think it's going to be enough to take out the easing bias to keep the hawks at bay for now. So I would actually expect there to be no dissents and that's going to be a good look for Warsh at his first meeting, but in terms of folks penciling in hikes, it depends on how pragmatic they are versus are they just trying to show something stylized in their dot plot.
And here's what I mean by that. If you're pragmatic, you would say we're not going to hike just once. We're going to do more than that.
We're probably going to do at least 50, likely 75 or 100 if we hike. And so unless your view is that December is when you're going to start hiking, it doesn't really make sense to put in 25. I think you put in at least 50, maybe 75 is too shocking.
So we've penciled in with very low conviction, but there's going to be a couple of 50s and 125. You know, we even tried to name them. This is pure speculation, but we said Hammock and Schmidt at 50 basis points of hikes and Logan at 25.
But again, there's so much uncertainty around this. Yeah. Okay.
And now let's say that we get a peace deal over the weekend. Does that materially change, you think, how Warsh discusses the outlook? Yes.
I think Warsh is going to emphasize that peace deal as another reason to be patient, to stay on hold and to look forward to rate cuts down the line. Now I'm not convinced that a peace deal is necessarily dovish for the Fed. I think the markets front end rates have moved to a large degree with oil prices, but we've been saying from day one of the conflict that there's a range of outcomes where you end up being more hawkish.
And that range of outcomes is actually not super high oil prices, right? If oil prices increase a lot, you probably worry more about the activity side of the mandate. There's a big increase in the unemployment rate because you say inflation is going to spike, but that can't be sustained given how soft demand is.
Right? At some point, demand will collapse. And so they're beyond that large upside risk to inflation on a kind of medium term basis.
The outcome that I think is most concerning for the Fed is one where WTI settles around 80 to $90. It's just strong enough to create a couple of tens of bucks for the core PCE when really we need everything to go right to get down to or close to 2%. And it's not so much of an increase in oil prices that you worry about activity.
So I just worry that a peace deal could actually end up putting us right in that sweet spot where it makes sense. Again, that's not what Warsh is going to say next week. That's something that we're only going to learn about over the next several months.
But I think that's something that I would like to flag. All right. Thank you for flagging.
All right. Now, shifting away from the Fed, also on Wednesday next week, we get U.S. retail sales. Another non-shameless plug, our debit and credit card data is awesome.
And it really does provide a very unique look at spending activity. Aditya, you and team use that to inform your views on how you think retail sales will print. You have a very spicy and strong retail sales forecast, at least in relation to consensus.
Can you tell us how you're thinking about that? Right. So, as you mentioned, we lean on the VSC card data to get a better sense of how the consumer is doing.
And we get a pretty real time read. So I think it's really useful around these periods where, you know, every week we're asking, is this the week where the consumer has had enough? And so far, the answer, resoundingly, every week has been no, not yet.
The consumer is holding up. And that's true also for the month of May. The monthly card data were a little bit mixed in terms of seasonally adjusted growth.
But retail spending was strong. And that's obviously where retail sales comes from. And we also think that the seasonal factors for May are somewhat supportive.
So when you put that together, it does point to a pretty spicy trend, as you mentioned. We have eight tenths of retail sales at the autos and seven tenths on the control group. Great.
Well, thank you for that, Aditya. And look, for rates and how at least we have been writing about US rates in this context. And a lot of that has to do with the underlying economic momentum that we have seen, including the resilience of the consumer as proxied by our debit and credit card spend data.
We also will see what happens with oil, but we are less optimistic and our commodity strategists are certainly less optimistic than the market about how fast oil will fall. We do see risks that the Fed sounds more hawkish and that it actually reflects the center of the committee, as most Fed chairs traditionally have in this press conference. We do worry that that'll be seen as more hawkish in relation to some of the dovish expectations that are out there.
So it's still like being paid the very front end in the US. All right. Now, with that, let's transition again.
I want to bring in Oliver Lovingston first, Ali, thank you so much for joining us. You are based in Hong Kong. It is 930 p.m. on a Friday night in Hong Kong.
So really appreciate you joining us. And for those of you who don't know Ali, he was formerly based in Singapore. He had a great note summarizing some notes from his travels around the Asian region at meeting with a host of investors earlier this week.
And I wanted to talk to you about a couple of things that you were hearing, Ali. Thanks for joining us, especially so late. The first topic I wanted to focus on was Bank of Japan expectations.
I know you don't cover the BOJ explicitly, but you're in the region, you've been hearing what clients are thinking, saying, and very familiar with our own team's views. So how would you characterize those expectations and the risks around that? Sure.
Hey, Mark, and thanks for having me. We expect the BOJ to raise the policy rate next week. That's almost fully priced, right?
We've got almost 90% probability of a high price next week. And so, you know, with a June hike already largely priced, I think the focus next week will be very much on communication around the future policy path, as well as the BOJ's balance sheet reduction plan. So I think, you know, it's worth revisiting how we got here, right?
Because of course, the BOJ paused rates in April, but at the post-decision presser, Governor Ueda certainly made clear that concerns over upside price risks were broadly shared across the committee, including those among those who voted to hold. And the split was really around timing. The majority did not see, I think, enough urgency to hike immediately and preferred to wait for greater clarity on risk developments, you know, including the Middle East.
Then we also got the April outlook report, where the BOJ set some conditions for further hikes. The first, of course, was underlying inflation approaching 2%, which it is right now. The second was the BOJ indicating that it could raise rates if it saw a risk of, quote unquote, inflation significantly deviating upward.
And of course, now we have most measures of inflation expectations of around 2%, some even above. And so I guess on our side, maintaining current accommodation risks really allows expectations to drift further upward. So we think the BOJ is reluctant to do that.
So I'm not going to bury the lead here. We expect the BOJ to hike next week, and then again in October. And that, I think, is the more interesting part of our forecast, because the market's pricing in, as I say, over 90% probability of a hike next week, but only 50% of an additional hike in October.
I want to flag a few things here. The first is, of course, that the Middle East energy shock is adding a lot of pressure to the BOJ. We expect some of the pass-through to intensify from autumn.
The BOJ has highlighted some of these upstream price pressures flowing through to consumer prices. We think Japan-style core inflation, excluding fresh food, will rise back to 3% by early 2027. So there's certainly a case for multiple rate hikes here.
I think for investors, the question is, what will the BOJ say next week, and how will they kind of frame their decision? So I'm going to highlight three things to look at. The first is the vote margin.
Is the decision unanimous, or is there a disantonized direction? Our base case is a unanimous decision. We think a dissent on the dovish side from someone like Asada could reinforce market perceptions of government resistance to normalization, particularly given that we've got another Takeichi appointee, Ayano Sato, who's going to become a voter from the July monetary policy meeting.
I think there's also a risk that we get a dissent in favor of a larger hike, for example, something like 50 basis points from Tamura or Takata, which would signal a much greater sense of urgency from the Hawks. And certainly something that you can't rule out. The second thing I would say you should focus on is the assessment of financial conditions.
The April outlook report described financial conditions as accommodative, noted that real rates were at significantly lower levels. We think that that's probably going to be sustained this time around, but we're going to be looking for any shift in this characterization, either in the statement or in the press conference. Given that there's been limited data since April, we expect this language to remain unchanged, and they'll probably just emphasize the high frequency indicators still point to easy monetary policy conditions.
And the third thing I'd highlight for investors going into next week is any kind of indications or forward guidance around an autumn hike. Now, of course, the BOJ is unlikely to commit to specific timings here. They'll probably just say that they're going to raise rates at an appropriate pace, as they usually do.
But it will be important, we think, to keep expectations of an autumn hike alive. We expect the BOJ to point to momentum in autumn price developments as a key checkpoint, and that could potentially support pricing for an additional hike in October, and maybe even keep the door open for September. The final thing to note here is our view on the balance of risks.
Look, on the one hand, we have a more hawkish view than the market. On the other hand, the market is now pricing in two full hikes for the year, or almost two full hikes for the year. So at one level, it will be difficult for the BOJ to out-hawk what the market's pricing.
I think further repricing will require greater conviction that the BOJ can deliver a third hike by year-end, for example, at a quarterly pace. Markets don't remain convinced right now. And of course, complicating this picture even more, Governor Ueda has been hospitalized, and he'll be delivering his remarks in writing, rather than attending the meeting or the press conference.
In his place, we're going to hear from Deputy Governor Uchida, who will speak. And it's a little unclear what his views are, because he hasn't delivered public remarks since 2025. But it does raise the bar a little bit for a hawkish hike.
That said, I mean, we expect him to stick to the script. So there's still scope for a more hawkish hike next week. I think more importantly, in the kind of camp of a hawkish hike, an argument for a more hawkish hike is dollar-yen.
I mean, dollar-yen right now is trading above 160, and a dovish hike really raises the risk of FX intervention. You know, if we've got a scenario like this, our yen strategists think the scale and price impact of price interventions could actually exceed the previous episodes. We think that they really need to demonstrate strong determination to anchor dollar-yen, and that could mean a more outsized intervention than we've seen so far.
So probably an outcome that the BOJ and Ministry of Finance will likely want to avoid here. And then just the final thing I want to note, we think that they will announce a change to their JGB purchase reduction plan. We're pretty much in line with consensus here, which was formed around a Nikkei article on the 9th of June.
Basically, we think that they'll maintain the current reduction path through March 2027. But beyond that, so from April 2027, we think that the BOJ will halt further reductions and main purchases at around 2.1 trillion yen per month. Thanks, Oli.
Very comprehensive. Next week, we also have a RBA meeting. Can you briefly summarize what you're thinking there?
Yeah, for sure. So the RBA has raised rates at three consecutive meetings, and we are now at the same rate that we were at at the peak of the last hiking cycle. And it's pretty clear from the RBA's communications, from their language, from the minutes, that they think they've done enough to pause for a while, to gather evidence on what's really going on in the Aussie economy.
So basically, the bottom line from the RBA is they think rates are probably restricted. Now, on the one hand, inflation does remain too high. And there is still uncertainty around the extended second round spillovers.
So I think that they'll remain cautious, but there is also now accumulating evidence that higher rates are already weighing on households and businesses, right? We've seen housing momentum soften. We've seen consumer and business sentiment come in much weaker than I think most people would have expected.
And of course, the unemployment rate surprised quite significantly with the upside last month jumping from 4.3% to 4.5%. So there's a pretty good argument here for the RBA to basically just stand still for a while. And we think that that's essentially what they're going to signal.
There'll be a couple of things to watch. I mean, the first thing, of course, will be the vote split. Is this a unanimous decision, or do we have another split decision?
The second thing will be, of course, which way the RBA leans. Do they focus more on the inflation? Do they focus more on the upside surprise to unemployment and some of the sentiment data?
And ultimately, I think, you know, our view is that the RBA is done. We think that the RBA will now be on hold until the middle of next year and that they'll be commencing a cutting cycle from August. The risk really is that they hike in August this year.
And so the risk is around kind of the data in the lead up to the end of July. And they've set the bar very high here. They have a very punchy forecast for second quarter CPI, which will come out right before the August meeting.
We're not that high. And the evidence we have so far is that demand destruction is probably something that's basically our base case for the next few months. So from where we stand, we lean a little bit more dovish in the market.
The market has actually come in a lot, but still pricing in some probability of a hike by the end of the year. And I should give a plug here for our RBA sentiment indicator, which suggests that although the RBA has turned a little bit more hawkish this year, it still remains in dovish territory. Awesome.
And then for positioning, anything that has struck you from your client conversations? Yeah, I mean, a couple of things. Just very briefly, I would say one of the most popular trades on at least my client trips over the last few weeks has been to be short 10-year JGBs.
So obviously, given what I just said about the BOJ, I think that that position remains quite vulnerable. The other popular themes were to be long carry ahead of the summer. That's no surprise there.
What is surprising is that there aren't that many opportunities here outside of a couple of commodity exporters in EMFX. Clients seem to struggle to find carry trades. People did want to be long both European and New Zealand rates relative to the US.
So that was a popular cross-market trade. Of course, we have a boom treasury wide in the 10-year sector. I would say there seemed to be less conviction on US rates.
So obviously, Mark, room for your bearish front-end trades to work here, I think. Fading interest in the energy shock as well. It seems like an oil price spike has shifted from a base case to much more of a tail risk for many investors.
And I guess we're seeing that play out right now. All right. Well, thank you, Oli.
And thank you all for listening. Let me just say thank you, everyone, for joining. You should feel free to reach out to myself, to Jill, to DTA, to Oli at any time to further unpack our views.
Everybody please have a wonderful weekend and enjoy the start of the World Cup. Take care. Oh, and finally, finally, Jill, thank you for that.
I'm just seeing something from her. For those of you who are unaware, it is XTEL season for our equity colleagues. Jill and team would greatly appreciate your vote if you find that to be useful.
And GDTA is also eligible to receive votes in the economics portion of the equity XTEL or II survey. And we don't have to talk much about it yet, but we'll have our fixed income one over the month of July. So you will be hearing from us again there.
Also, while we're plugging away, I would just note that we're going to start our global rates teach-in series next week. We're going to have a week of what we call a quote unquote watchers series. So how do you do various central bank watching?
We will cover the Fed, we will cover the ECB, we will cover the BOE, I think we're going to cover BOJ and RBA as well. And there are some slides that are already available to help guide those discussions. So if that sounds like something you're interested in, then reach out and we would be happy to send you that schedule.
All right, let's then fully conclude there. And again, thanks everyone for joining. Thanks for joining us today.
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