Hawkish Central Banks

It was a soft end to the week for global equities, while the US dollar (USD) rallied further as US Treasury yields pushed higher.  Neither the move in Treasuries or the USD shows any sign of slowing, and if anything, US inflation data will keep the upward pressure on yields and USD intact this week.  Clearly, most currencies, expect notably the Russian rouble are suffering at the hands of a strong USD though Asian currencies have been less pressured of late compared to other currencies. 

The surge in US Treasury yields has been particularly stark and fuelled pressure across many other markets.  The USD (DXY) has been a key beneficiary of the rise in US yields, with the currency propelled to its highest level since May 2020.  USDJPY remains one of the most highly correlated currency pairs to yield differentials and with Japan persisting in its defence of Yield Curve Control (YCC) it looks like USDJPY will continue to move higher, with 130 moving into sight. 

There’s plenty of central bank action this week and much of it likely in a hawkish direction, including in New Zealand (Wed), Canada (Wed), Singapore, Korea, Euro area, and Turkey (all Thu).  Tightening is expected from several of these central banks.  The consensus is expecting a 25-basis point (bp) hike in policy rates in New Zealand, but a significant minority is looking for a 50bp hike

In Korea, the consensus is split between no change and a 25bp hike, with the risks skewed towards the latter amid strong inflation pressures and high household debt, even though the new central bank governor may not be installed at this meeting. Similarly, a hawkish outturn from the Monetary Authority of Singapore is likely, with a steepening, re-centering and possible widening of the Singapore dollar nominal effective exchange rate band expected.  Note that Singapore’s monetary policy is carried out via its exchange rate.

In Canada, a 50bp hike in policy rates is likely, while the Bank may announce balance-sheet run off in a likely hawkish statement in the wake of stronger readings both on the growth and inflation front. Last but not least, the European Central Bank (ECB) may announce an early end to its quantitative easing and prepare markets for rate hikes, possibly as early as June.  In contrast, Turkey is likely to continue to maintain its monetary policy on hold amid some stability in its currency. 

On the data front, US March CPI inflation data will be among the key releases this week.  Another high reading is likely, with the consensus expectation at 8.4% year-on-year, from 7.9% previously.  The data will not make for pleasant reading, with headlines likely to highlight that US inflation is back at over 40- year highs.  While the data will likely keep up the pressure on interest rate markets, I would caution that a lot is in the price.       

The Week Ahead

Of course the main focus for markets will continue to be the war in Ukraine. The risk of Nato being dragged into the war has risen after Russian warnings that military conveys to Ukraine will be considered legitimate targets and a military training facility near Poland’s border was attacked.  Russia has reportedly intensified its attacks on key Ukrainian cities while peace talks are reportedly making some progress though nothing concrete has yet been achieved.  The US and China will also gold high-level talks in Rome today while there has been no traction towards a no-fly zone over Ukraine. 

Illiquidity and volatility are likely to continue to characterise market activity in the days ahead while risks of a Russian default grow. Stagflation risks will likely continue to sound louder in the weeks ahead too, leaving central banks in a bind.  As it was, economic growth was slowing and inflation was highly elevated ahead of the crisis in Ukraine.  Now it’s going to look a whole lot worse, implying a still tense environment for risk assets.  The US dollar looks firm going into this week against this background. 

This week’s key central bank events include Bank Indonesia (Tue), Federal Reserve FOMC decision (Wed), Bank of England (Thu), European Central Bank (ECB) Watchers Conference (Thu), CBC in Taiwan, CBRT in Turkey (Thu), BCB in Brazil, Bank of Japan (Fri), and CBR (Fri) in Russia.  Most focus will of course be on the Fed where a 25 basis points hike in interest rates is highly likely.  Any clues to the pace of tightening and details of quantitative tightening will also be in focus.  Similarly, the BoE is likely to hike by 25bp.  The ECB Conference will be watched for discussion on the speed of policy withdrawal. 

Meanwhile, the BoJ is likely to downgrade its growth outlook while no change in policy is expected in Indonesia, Turkey and Russia.  In contrast, Brazil is expected to hike rates by 100bp.  There will also be attention on China’s 1 year medium term lending facility where a cut amid slowing activity, would presage a potential easing in the policy Loan Prime Rate (LPR) next week.  Data in focus will be China activity data (Tue) where a further slowing in both industrial production and retail sales is likely while US February retail sales (Wed) are likely to gain momentum.  Last but not least, Australian jobs data (Thu) are likely to reveal a strong print for February.   

Will The Fed Hike By 50bp? Asia Singing To Its Own Tune

The outsized gain in the US January CPI inflation rate has firmly put a 50 basis points (bp) Federal Reserve rate hike on the table as well as reinforcing expectations of a series of consecutive rate hikes while St Louis Fed President Bullard even raised the prospect of an inter-meeting hike in the wake of the CPI data.  Markets are now pricing close to 7 hikes in 2022 and 80% odds of a 50bp hike in March. 

US CPI inflation jumped to 7.5% y/y, a 40-year high, with prices rising by 0.6% m/m and core CPI rising to 6% y/y, all above consensus.  In the wake of the data Bullard strengthened his hawkish rhetoric by saying that he would like to see 100bp of hikes by July 1 2022.  Markets have quickly ramped up their expectations for Fed tightening, with a growing chorus expecting a series of consecutive hikes.

Markets are reacting badly, with equities under renewed pressure, bond yields moving higher and the US dollar firming.  It’s hard to see such pressure easing anytime soon.  Historically the bulk of market pressure takes place as the market prices in / discounts rate hikes rather than after the Fed actually hikes.  This suggests that markets will remain highly nervous at least until the March Federal Reserve FOMC meeting. 

It is clear that the data is killing off any chance of a more tepid pace of US monetary tightening. The Fed alongside other major central banks are frantically trying to regain credibility in the wake of much stronger inflation readings than they had anticipated by espousing increasingly hawkish rhetoric, which will likely soon be followed with action as policy rates increase and central bank balance sheets start to shrink. 

There is now a growing probability that the Fed will kick off its monetary tightening with a 50bp rate hike followed by consecutive hikes in the months ahead as well as quantitative tightening in the second quarter.  It’s not quite a done deal but another strong US inflation print for February will seal the case for a 50bp hike in March.

In contrast, Asia monetary policy is singing to its own tune.  Unlike in past tightening cycles when Asian central banks were forced to tighten to avoid pressure on their markets, especially to avoid currency weakness, there is limited signs of such pressures at present.  Some in Asia such as the Bank of Korea and Monetary Authority of Singapore have tightened already, but this is largely due to domestic factors rather than the Fed.

The stark difference in stance between Asian central banks and what is being priced in for the Fed has been particularly apparent by the recent dovish policy decisions in India, Indonesia, and Thailand, with all three central banks showing no urgency to tighten.  Similarly, the Bank of Japan acting to defend its yield curve policy by conducting unlimited fixed-rate JGB purchases, was clearly a dovish move.  Last but not least, the PBoC, China’s central bank has already cut its policy Loan Prime Rate and is likely to do so again in the next few months.  

Busy Week Ahead For Central Banks

US equities came under more pressure at the end of last week, with the S&P 500 falling to its lowest in four weeks, down around 2% month to data.  The drop will test the buy on dips mentality as the S&P is once again resting just above its pivotal 55-day moving average, a level that has seen strong buying interest in the past. 

Economic data gave little help to market sentiment, with the University of Michigan confidence index improving a little to 71.0 in early September but falling slightly below consensus expectations at 72.0.  Separately, the inflation expectations measures were broadly unchanged, with the most relevant series for Fed officials (the 5-10y) remaining steady at 2.9%, which is still consistent with the Fed’s 2% goal.

This week is all about central bank meetings, with an array of policy meetings including in Indonesia (Tue), Sweden (Tue), Hungary (Tue), China (Wed), Japan (Wed), US (Wed), Brazil (Thu), Philippines (Thu), UK (Thu), Norway (Thu), Switzerland (Thu), South Africa (Thu), and Taiwan (Fri), all on tap. 

Most focus will obviously be on the Federal Reserve FOMC meeting, during which officials will likely signal that they are almost ready to taper. A formal announcement is likely in December or possibly November.  Most other central banks are likely to stay on hold except a likely 25bp hike in Norway, 25bp in Hungary, and 100bp in Brazil.

Politics will also be in focus, with Canada’s Federal election and the results of Russia’s parliamentary elections today.  Polls suggest the incumbent Liberals ahead though the most likely outcome is a minority government in Canada while in Russia the ruling pro Kremlin United Russia party is likely to renew its supermajority. 

Other issues in focus this week are frictions over the US debt ceiling, with the House voting soon on raising the ceiling.  US Treasury Secretary Yellen renewed her calls for Congress to raise of suspend the debt ceiling stating in a Wall Street Journal op-ed that failing to do so “would produce widespread economic catastrophe”. 

In China, Evergrande’s travails will be in the spotlight on Thursday when interest payments on two of its notes come due amid growing default risks.  Indeed, China related stocks slid on Monday morning as Evergrande concerns spread through the market.  Property developer stocks are under most pressure and whether there is wider contagion will depend on events on Thursday.

The US dollar has continued to strengthen, edging towards its 20 Aug high around 92.729 (DXY) and looks likely to remain firm heading into the Fed FOMC meeting especially as it will hard for Fed Chair Powell to sound too dovish and given risks of a hawkish shift in the dot plot.  Positioning data is showing increasingly positive sentiment towards the dollar, with speculative positioning (CFTC IMM net non-commercial futures) data showing the highest net long DXY position since May 2020. 

Conversely, speculative positioning in Australian dollar has hit a record low likely undermined by weaker iron ore prices.  Similarly, positioning in Canadian dollar is at its lowest since Dec 2020 while Swiss franc positioning is at its lowest since Dec 2019. Asian currencies have been hit, with the ADXY sliding over recent days.  The Chinese currency, CNY has been undermined by weaker data and concerns over Evergrande while high virus cases in some countries are hurting the likes of Thai baht. 

Lots Of Buyers On Dips

Last week’s bout of risk-aversion proved short-lived though more volatility likes lies ahead. The reflation trade looked like it was falling apart last week as reflected in the sharp decline in US Treasury bond yields and the shift out of value into big tech/growth stocks.  The markets appeared to have increasingly absorbed the Fed’s message that inflation increases will be transitory while a reversal of crowded market positioning in reflation trades exacerbated the moves.  The malaise in markets coincided with several indicators revealing peak growth has passed and the rapid spread of the Delta variant globally.

However, clearly that didn’t appear to be the case by the end of last week as equities rallied strongly and the US Treasury curve shifted higher.  The US dollar gave up some of its gains while oil and gold rallied.  While there are still concerns about peak growth passing and the rapid spread of the Delta variant, there are obviously still plenty of buyers willing to jump in on dips. 

China’s central bank, PBoC went ahead with a much anticipated reserve requirement ratio cut sooner than expected on Friday though this targeted liquidity easing is unlikely to change the fact that growth is losing momentum amid a weakening credit impulse.  This week, key events include China’s June trade data (Tue) for which outsized gains in exports and imports is likely.  China’s monetary and credit aggregates will also be out sometime over the week as well as Q2 GDP and the June data dump, with some further moderation likely to be revealed. 

Top US data includes June CPI inflation (Tue) and retail sales (Fri).  CPI is likely to record another sizeable 4.9% y/y increase though the Fed’s repeated message of transitory inflation, will limit any market concerns over inflation pressures.  Also given the gyrations in markets last week, there will be even more focus on Federal Reserve Chair Powell’s semi-annual testimony to Congress (Wed & Thu).  The start of the Q2 earnings season will also come under scrutiny, with expectations of a 63% surge forecast according to FactSet data.   

Monetary policy rate decisions in New Zealand, Canada, Turkey (all on Wed), Korea (Thu) and Japan (Fri) are on tap, with the former two likely to reveal upbeat views while the CBRT in Turkey will have limited room to ease given the recent spike in inflation.  BoK in Korea may dial back a little of its hawkish rhetoric giving increasing virus cases in the country, while BoJ in Japan is likely to revise higher its inflation forecasts but leave its economic outlook unchanged.  Australian and UK jobs data (Thu) will also garner attention. 

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