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.       

Inflation Debate Rages On

Good morning, last week ended on a solid note for global equity markets, capped by strong gains in US stocks and in particular a surge towards the end of the session on Friday.  The S&P 500 is on track for its best month since November though in the next few days, month and quarter end rebalancing will continue to hold risks, which could result in increased volatility.  Another imponderable is potential follow through from huge equity sale block trades at the end of last week reportedly from Archegos Capital, which hit US media companies and Chinese tech stocks. All of this suggests risks of higher volatility in the days ahead.  

US interest rate markets came under renewed pressure, with yields backing up over the week, while the US dollar (USD) had a firmer week, with the USD index (DXY) ending above its 200-day moving average and technical indicators pointing to further gains this week.  CFTC IMM speculative positioning data (in the week to 23 March) shows that net aggregate USD short positions have been pared back further as USD sentiment continues to improve.  Positioning in most currencies vs. USD fell while Japanese yen (JPY) short positions increased further.  The oil market and container costs could be pressured higher by the continued delay in dislodging the stricken Ever from the Suez Canal, which seems to have made little progress over the weekend.

Attention this week will turn to a few key data and events.  Important among these will be President Biden’s speech in Pittsburgh (Wed) where he will likely give further details on his infrastructure plan and how it will be funded.  Key US data include the March ISM manufacturing survey (Thu) and March non-farm payrolls (Fri).  Solid outcomes for both are expected.  In Asia, focus will be on March purchasing managers indices (PMIs) across the region (Thu) including in China (Wed) where broadly positive readings are likely.  There will also be attention on the going malaise in Turkey’s markets since the sacking of the central bank (CBRT) governor while Europe continues to struggle with fresh virus waves, lockdowns, and vaccine reluctance as well as tensions over vaccine exports to the UK.

As President Biden gives his speech this week the debate about a potentially sharp rise in inflation rages on.  The Fed has tried to calm fears by highlighting that any rise in inflation over the coming months will likely be transitory.  However, with massive stimulus in the pipeline, economic recovery taking shape and the Fed set to keep policy very accommodative for years to come, market fears have risen as well as warnings from the likes of former Treasury Secretary Larry Summers.  Consumer inflation expectations remain largely subdued but the debate will not end quickly, and bond markets will be on tender hooks.  In the next few months inflation will turn up but this will largely be due to base effects as the collapse in activity in prices in Q1 last year falls out of the equation.  However, the jury is out on whether this will turn to more persistent inflation, something that could have a much more severe impact on markets and force central banks to belatedly tighten policy. 

Reflation Trade Is Back

A much softer than expected US January jobs report didn’t prevent US equities from closing higher at the end of last week as the reflation trade kicked back in.  One of the biggest driving forces for markets was the growing prospects that much of President Biden’s $1.9 trillion fiscal stimulus plan will be passed, albeit via a process of reconciliation, which allows Democrats to circumvent the need to gain the support of at least 10 republicans. This contrasts with prior expectations that the final stimulus was going to be less than $1 trillion. 

Pushing stimulus through this way highlights Biden’s urgency to inject more spending into the economy but could come at the cost of hurting bipartisan policy efforts. The impact of expectations of increased fiscal stimulus is particularly apparent in the US rates market, with US Treasuries selling off and bear steepening of the curve.  Although higher US Treasury yields failed to give support to the US dollar (USD) there is still scope for a short covering rally, which could still help give the USD relief.     

At the beginning of the year the US jobs market took a hit from renewed lockdowns and surge in COVID cases; US January non-farm payrolls increased 49k, and December was revised to -227k from -140k while more positively the unemployment rate fell to 6.3% from 6.7% though this was flattered by a drop in the participation rate as less people were looking for work.  According to the payrolls report there are still 9.9 million more unemployed compared to pre-COVID levels.  As such, the weak jobs data added more support to Biden’s fiscal stimulus proposals.   

This week focus will likely turn more to President Trump’s impeachment trial in the Senate than economic data.  Key data/events this week include China’s credit and monetary aggregates (9-15 Feb), central bank decisions in Sweden (Wed), Philippines, Mexico (Thu) and Russia (Fri).  Among these the consensus is for only Mexico to cut its policy rate. Also in focus are inflation readings in China (Wed), US (Wed) and India (Fri).  UK GDP (Fri) and US Michigan sentiment (Fri) will also garner attention. 

The return of the reflation trade, rally in risk assets and decline in cross-asset volatility bodes well for emerging markets (EM) assets.  However, there are definitely various cross currents impacting asset markets at present especially with US Treasury yields rising, which could potentially support the USD and pressure EM local bond rates markets.  EM assets were clearly favoured towards the end of last year, and while the positive story has not dissipated, EM assets may take a pause for breath before pushing higher again.  

In Asia, the Chinese-new-year holidays this week may dampen activity while China’s PBoC also appears to be limiting liquidity injections around the holidays, which could limit some of the gains in Chinese and impact China linked assets.  Chinese authorities have re-focussed attention on preventing an excessive build-up of leverage and credit metrics have peaked as a result.  As such, they may be less keen to inject a lot of liquidity into markets at present. 

The Devil is in the details

The “partial solution” delivered by European Union (EU) leaders last week has failed to match the high hopes ahead of the EU Summit. Nonetheless, the deliverance of a “fiscal compact”, acceleration of the European Stability Mechanism (ESM) to July 2012 , no forced private sector participation in debt restructuring (outside Greece), and possible boost to the International Monetary Fund (IMF) of up to EUR 200 billion, are steps in the right direction. The fact that UK Prime Minister Cameron threw a spanner in the works to veto a joint proposal to revise the EU Treaty should not detract from the progress made.

Nonetheless, the measures may not be sufficient to allay market concerns, with disappointment at the lack of European Central Bank (ECB) action in terms of stepping up to the plate as lender of the last resort still weighing on sentiment. Data will add to the disappointment this week as “flash” Eurozone purchasing managers indices (PMI) drop further in December.

This week events in the US will garner more attention, including the Federal Reserve FOMC meeting, November inflation and retail sales data plus manufacturing confidence gauges as well as November industrial production on tap. The Fed will not shift its policy stance at this meeting but may sound a little more upbeat on the economy following recent firmer data. Inflation will likely remain subdued while the other data will continue to show gradual recovery.

Overall, the market is likely to thin further as the week progresses and holidays approach, with ranges likely to dominate against the background of little directional impetus. Our call to sell risk assets on rallies remains in place, however. The EUR will likely struggle to make much headway in the current environment, especially given that many details of the EU agreement still need to be ironed out and once again the risk to market confidence lies in implementation or lack of it. A range of EUR/USD 1.3260-1.3550 is likely to hold over the short term.

Euphoria fades, risk currencies weaker

The euphoria emanating from last week’s eurozone agreement will likely fade into this week as renewed doubts creep in. Details of how the EFSF bailout fund will be leveraged or how the special purpose vehicle will be utilised have yet to emerge while the firewall to protect countries such as Italy and Spain may still be insufficient given that the use of the European Central Bank (ECB) to provide unlimited support has been ruled out.

With more questions than answers markets will be hungry for further details over coming weeks and until then it is difficult to see risk appetite stretching too far. One indication of such concern was the fact that Italy’s borrowing costs climbed to euro-era highs the day after the European Union (EU) plan was agreed. The G20 meeting on 3-4 November will be eyed for further developments as well as further reaction to the EU agreement.

There are plenty of events to digest this week that could add to any market nervousness. In terms of central banks we do not expect to see any change in policy stance from the ECB, Federal Reserve or Reserve Bank of Australia (RBA) this week but the decisions may be close calls. The ECB under the helm of new President Draghi will be under pressure to ease policy as growth momentum has clearly weakened but the Bank will likely hold off for the December meeting when new growth and inflation forecasts will be released.

The RBA may also take some solace from a better global economic and market climate but the market disagrees having priced in a cut this week. The Fed will look to see how ‘Operation Twist” is faring before moving again but recent indications from some Fed officials suggest growing support for purchases of mortgage backed securities.

On the data front eurozone inflation today will be the key number in Europe while the US jobs report at the end of the week will be the main release in the US. Ahead of the payrolls data, clues will be garnered from the ISM manufacturing data and ADP jobs report. The consensus is for a 95k increase in non-farm payrolls and the unemployment to remain at 9.1% maintaining the trend of only gradual improvement in the US jobs market.

Recent data releases have turned less negative, however, and at the least have helped to alleviate renewed recessionary concerns. Overall, I suspect that markets will come back down to the reality of slow growth and unanswered questions this week, with risk assets likely to lose steam over coming days.

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