Equity markets are in a state of shock. After a stellar year last year equities have started the year in terrible shape. The rout extended further at the end of last week, capping off the worst week in over a year for US stocks. Tech continued to lead losses, with the Nasdaq down 7.6% over the week. Notably global equities were impacted less than the US, reflecting the fact that most equity markets outside of the US are less tech orientated. Anything with leverage and consisting of highly speculative investment such as Crypto are bearing the brunt of the pressure. Volumes of equity put options on the S&P 500 have also risen sharply as investors try to hedge further losses on US stocks.
The main cause of market pressure remains the build-up of expectations of Fed tightening, with Fed officials sounding increasingly hawkish and speculation growing of a 50 basis point Fed rate hike in March as well as several more hikes over the course of this year, with four hikes already priced in for this year. It’s hard to see such pressure abating soon. Indeed, technical indicators on the S&P 500 look poor, with the index having closed below its 200 day moving average level. However, with market pricing for US rate hikes already so aggressive, a lot of the pain may already have been inflicted unless the Fed really does hike at every meeting this year.
Wednesday’s Federal Reserve FOMC meeting will give further clues US interest rate policy, with the Fed likely to give signals that a March rate hike is in the offing. However, this should not be surprising given that Fed officials have over recent weeks already strongly hinted at a March rate hike. What will be scrutinised is any clues on Fed balance sheet reduction (quantitative tightening) as well as the path of the funds rate after March. It’s unlikely that the Fed provides any firm indications, but nonetheless the press conference could prove more interesting.
Other policy meetings this week include the Bank of Canada meeting (Wednesday). It’s a close call but strong domestic data points to a 25-basis points policy rate hike, kicking off a likely cycle of hikes in the months ahead. Separately, rate hikes in Hungary (tomorrow) and South Africa (Thursday) are also likely. Following unchanged outcomes from Malaysia and Indonesia and a policy cut in China last week, there is little on the data and events front in Asia this week.
Political and geopolitical developments will garner plenty of attention this week. In the UK the Sue Gray report on “Partygate” will be released. In Italy, the path for Draghi to be elected President appears to have become easier, with Berlusconi pulling out of the running though it is by no means a clear cut process. Meanwhile, the situation with regard to Ukraine is on tenterhooks, with Russia reportedly continuing to build up troops on the border, and risks of “significant military action” rising.
Currency markets have been largely spared the carnage seen in equity markets. Speculative positioning data suggests the market remains heavily long the dollar index (DXY). Higher US real rates and continued tightening of Fed rate expectations suggests any pull back in the USD will be limited and the currency remains a buy on dips. Notably, GBP positioning has remained firm, ignoring the potential for a no-confidence motion on Prime Minister Boris Johnson. Asian currencies also remain relatively resilient, with the Chinese currency likely to continue outperforming.
ECONOMETER 