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.       

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.  

US Dollar On Top – All Eyes On Jackson Hole

Although risk assets rallied at the end of last week, weaker than expected US July retail sales data and China’s July data slate including industrial production and retail sales, helped to intensify growth concerns.  As it is, many indicators are showing that we are past peak growth. US economic surprises are becoming increasingly negative as reflected in the Citi US economic surprise index, which has fallen to its lowest level since May 2020.  Combined with intensifying Delta virus concerns, worsening supply chain pressures and sharply rising freight rates as reflected in the spike in the Baltic Dry Index to its highest since June 2008, it has led to a marked worsening in investor risk appetite.  This has been compounded by China’s regulatory crackdown and rising geopolitical risks in Afghanistan

The US dollar has been a key beneficiary while safe haven demand for Treasuries has increased and commodity prices have come under growing pressure.  Equity markets wobbled last week after a prolonged run up though the pull back in the S&P 500 looked like a healthy correction rather than anything more sinister at this stage.  The moves in the USD have been sharp, with the USD index (DXY) rising to its highest since November 2020 and EURUSD on its way to testing the 1.16 low.  Some Asian currency pairs broke key levels on Friday, with USDCNH breaking through 6.50.  Safe haven currencies such as CHF and JPY are holding up much better, highlighting that USD demand against other currencies is largely due to a rise in risk aversion while currencies such as CAD appear to be pressured by weakening commodity prices.  

This week attention will turn to the Jackson Hole Symposium (Fri) where markets will look for clues to the contours of Fed tapering.  Fed chair Powell is likely to repeat the message from the July minutes, with QE tapering likely by year-end if the labour data continue to strengthen.  Markets will be on the lookout for any further clues on the timing and shape of tapering. Separately the US July Core Personal Consumption Expenditures (PCE) report is likely to show a high 3.6% y/y increase though this is unlikely to change the Fed’s perspective on transitory inflation pressures.  Monetary policy decisions in Hungary (Tue) and Korea (Thu) will be in focus, with the former likely to hike by 30bps and the latter on hold, albeit in a close decision.  Ongoing US budget talks and European Central Bank minutes (Thu) will also be in focus. Finally, closer to home New Zealand (Tue) and Australia (Fri) retail sales reports are in focus. 

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. 

Crypto Volatility

It was a calmer end for stock markets in a volatile week but crypto was not so fortunate after China’s State Council repeated its warning about Bitcoin mining and trading as central banks appear to be increasing their scrutiny of crypto at a time when many of them are introducing their own digital currencies.  Concerns over increased regulations, especially in China where the bulk of Crypto mining takes place, taken together with ESG issues as focus turns to the environmental costs of mining crypto, threaten to do more damage.  Volatility continued over the weekend, with Bitcoin and other crypto undergoing sharp moves.  Crypto volatility threatens to find its way into other markets, with for example, US equities positively correlated to moves in crypto while the US dollar (USD) could benefit.

There was at least a little relief for markets in terms of inflation angst, with market inflation measures (breakevens) falling while commodities, another factor fueling inflation fears, continued to come off the boil. It seems that the Federal Reserve’s dovish message may finally be sinking in even as the Fed FOMC minutes noted that they are planning on discussing tapering at some point, rather than previously not even thinking about thinking of tapering. US Treasury yields have been capped amid the cooling in inflation fears while rate sensitive equities, especially Tech are likely to find some solace.  The USD has struggled over recent weeks but the recent rise in real yields will likely offer some support. 

There was yet more evidence that the US economy is powering ahead, with measures of manufacturing and services sentiment as reflected in Markit purchasing managers indices (PMIs), rising to record highs as fiscal support and an improving COVID-19 outlook continue to boost optimism. While US economic data has been strengthening, markets have become accustomed to positive US releases and therefore any reaction is likely to be more muted.  Indeed, the Citi Economic Surprise Index, a measure of US data relative to expectations, is near its lowest since June 2020. 

This week is relatively light on the data front.  The key US data release is the Personal Consumption Expenditures (PCE) report, something that the Federal Reserve looks at closely, on Friday; consensus expectations are for a 2.3% quarter on quarter (q/q) increase in core PCE in Q1.  A number of Fed speakers will also be on the wires and their comments will be scrutinized on any further elaboration on “discussing a plan” on tapering.  There will also be a few central bank decisions including in Hungary (Tue), Indonesia (Tue), New Zealand (Wed), and Korea (Thu).  No changes are likely from any of these central banks.

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