Action Shifting To Currencies as Rates Volatility Eases

May 23, 2022 — Mitul Kotecha

US stocks barely closed higher at the end of last week and flirted with bear market territory. US consumer and retail stocks remain under pressure alongside industrials as recession fears intensify.  Indeed while inflation concern remain elevated, recession fears are increasing. US Treasury yields are finally coming off the boil amid such fears, with May seeing a significant pull back in yields; the biggest decline has been in the 3-10 year part of the yield curve over recent weeks.  This has been met with a decline in interest rate volatility unlike equity and implied currency volatility measures, which have pushed higher.   For instance, major currency implied volatility measures have reached their highest since around March 2020. Emerging markets volatility breached its March 2020 high in March 2022 and after a brief fall is moving back higher.  

Action is shifting to currencies and the drop in the US dollar from its highs, with the currency increasingly undermined by lower US yields.  In Asia, the 3 most sensitive currencies to yield differentials (US 10 year yield minus 10 year local currency bond yields) are the Thai baht, Indonesian rupiah and Korean won.  As such, Korean won is likely to rally the most in Asia should US yields fall further.   The Chinese yuan has strengthened amid US dollar weakness though underperformance of the Chinese currency is likely versus its peers as the authorities likely aim to weaken it on a trade weighted (CFETS) basis. 

In China, the surprisingly large 15 basis point cut in 5-year loan prime rate last week will be seen as a boon for China’s property market.  However, while support for the property market has increased there does not seem to be much more stimulus ready to be unleashed despite various pledges.  China’s April data slate was weak highlighting the risks of a contraction in GDP this quarter and providing evidence that the “around 5.5%” official growth target looks increasingly out of reach.  COVID restrictions across the country are easing gradually pointing to some pick up in activity though consumption and the service sector are likely to remain under pressure for months to come as mass testing, quarantines and border controls continue to restrict mobility.  

There was relief for China’s markets today as President Biden highlighted the potential for a reduction/removal of tariffs implemented by President Trump, stating that he will discuss tariffs with Treasury Secretary Yellen when he returns from his Asia trip.  Removing tariffs is by no means a done deal given there will be plenty of pressure to maintain some level of US tariffs on China. A reduction in tariffs would be beneficial for the US in that it would help reduce imported inflation pressures while it would also help to support Chinese exports at a time when they are slowing down and adding pressure on China’s current account position.  However, some of this impact would likely be mitigated by a relatively stronger yuan, which would undoubtedly benefit as tariffs were cut.  

Key data and events highlight this week include monetary policy decisions in Indonesia (Tue), New Zealand (Wed), South Korea and Turkey (both Thu).  Federal Reserve FOMC meeting minutes will also be released (Wed). Although not expected by the consensus there is a good chance that Indonesia hikes policy rates by 25 basis points. In New Zealand a 50bp hike is likely while a 25bp hike in South Korea is expected.  In contrast despite pressure on the Turkish lira and very elevated inflation no change in monetary policy is expected in Turkey this week.  Meanwhile the Federal Reserve FOMC minutes will provide further detail on how quickly the Fed wants to get to neutral rates and beyond and on its quantitative tightening policy. 

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Hawkish Central Banks

April 11, 2022 — Mitul Kotecha

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.       

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The Week Ahead

March 14, 2022 — Mitul Kotecha

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.   

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

February 11, 2022 — Mitul Kotecha

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.  

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Debate Over Fed Tightening Rages On

February 2, 2022 — Mitul Kotecha

After receiving a major beating over recent weeks this week has seen a ‘risk on’ tone permeate through markets as dip buyers emerge.  COVID is increasingly taking a back seat though risks from simmering geopolitical tensions over Russia/Ukraine continue to act as a threat to markets.  Nonetheless, equity volatility has fallen, with the VIX ‘fear gauge’ dropping sharply over recent sessions.  In contrast, interest rate volatility remains elevated as debate over a potential 50 basis point hike from the Federal Reserve and/or policy hikes at successive FOMC meetings continues.  Fed speakers this week including St. Louis Fed President Bullard and Philadelphia Fed President Harker in comments yesterday appear to have dampened expectations of a 50 basis point hike, but this has unlikely put an end to such speculation.

Overall market uncertainty is likely to persist in the weeks ahead setting the scene for renewed bouts of volatility.  The debate over Fed rate hikes both in terms of magnitude and timing is far from over, with analysts ramping up expectations of multiple hikes this year.  There is a strong chance that the Fed will announce tightening at each of the next three meetings including beginning quantitative tightening (QT).  Markets are pricing in five quarter point hikes in the next year and there may be scope for even more aggressive tightening.  Given likely persistently high inflation readings in the months ahead it is not likely the time to push back against markets tightening expectations. 

Much of Asia has been closed for part or all of this week though China’s purchasing managers index (PMI) data for January released last weekend highlighted a loss of economic momentum.  Although official stimulus measures will likely help to avoid a sharp slowing in economic growth, sentiment is unlikely to get back to pre-COVID levels anytime soon. China’s zero-tolerance approach to COVID means that even small outbreaks will lead to lockdowns, likely dampening services sentiment and travel. Meanwhile, manufacturing pressure may find some support from fiscal policy measures as policy is front loaded, and likely further monetary easing ahead, with at least another 10 basis point easing in the Loan Prime Rate and 50bp cut in the RRR likely in the weeks ahead. However, the overall trajectory of activity remains downwards.

Monetary policy decisions in the Euro area (Thu) and UK (Thu) will be among the highlights this week in addition to US Jan jobs (Fri).  The Reserve Bank of Australia (RBA) left policy unchanged as expected but revealed a relatively dovish statement even as it formally announced an end to quantitative easing (QE). There is likely to be a contrasting stance between the Bank of England (BoE) and European Central Bank (ECB), with the former likely to hike by 25 basis point on concerns about rising inflation expectations while we the latter is likely in cruise control for H1 2022. In the US there are risks of a worse than consensus outcome for US non-farm payrolls due to a surge in Omicron cases (consensus 175k).  Separately, in emerging markets, focus will be on Brazil, where the central bank, BCB is expected to hike rates by 150bp (Thu).

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