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.  

Singapore revalues, Asian currencies jump

The positive tone to risk appetite is keeping the USD on the back foot and for once FX attention has turned away from events in Greece. Before elaborating further and staying with Greece, it’s worth highlighting that the outcome of Greece’s note auction was reasonably solid, with more debt than anticipated being sold. However, the cost of borrowing for Greece rose compared to the previous auction in January, which means that the Greece will still suffer higher funding costs to roll over debt.

The positive reception to the debt offering was not particularly surprising given that it followed so closely after the EU/IMF loan package announcement but it is difficult to see sentiment for Greece and the EUR for that matter, getting much of a lift. The main positive for the EUR is the fact that market positioning remains very short but EUR/USD is likely to struggle to make much headway above technical resistance around 1.3653.

More interestingly Asian central banks are continuing on the track towards fighting rising inflation pressure and Asian currencies, in particular the SGD, were boosted by the Monetary Authority of Singapore (MAS) decision to revalue its currency. Singapore has moved back to a policy of a “modest and gradual appreciation” of the SGD from a policy of zero appreciation, which obviously implies openness to further FX appreciation in the weeks and months ahead.

The rationale for the decision was clear and as revealed in the strong first quarter Singapore GDP data which revealed a 13.1% annual rise. Stronger growth is fuelling growing inflationary concern and to combat this Singapore’s MAS will allow greater SGD appreciation. The reaction in other Asian currencies was also positive, with markets (quite rightly in my view) that other Asian central banks will be more tolerant of currency strength in their respective currencies.

Moreover, Singapore’s move was pre-emptive, perhaps with one eye on an imminent revaluation in China. The recent easing in tensions between the US and China has if anything increased the likelihood that China revalues its currency, the CNY, sooner rather than later, and most likely before the end of Q2 2010. Whatever the rationale, strengthening inflation pressure across the region, will mean a less FX interventionist stance in Asia, and likely stronger currencies over coming months.

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