Markets
European stock markets rebounded in today’s countdown session to the FOMC meeting. Main indices gain around 2%. US benchmarks open up to 1.5% stronger (Nasdaq), but doesn’t seem to build on opening momentum. Core bonds lack direction. US yields add around 1 bp across the curve. The German yield curve bear steepens slightly with yields adding 0.6 bps (2-yr) to 1.8 bps (30-yr). 10-yr yield spread changes vs Germany widen by up to 2 bps (Italy). The third round of the Italian presidential election ballot failed to produce a winner. Tomorrow could be D-day as the necessary majority drops from 2/3rd to 50+1. EUR/USD treads water in the high 1.12-zone.
The first FOMC meeting of 2022 is today’s main event. We expect the Fed to lay the groundwork for a 25 bps March rate hike/lift-off. Abruptly ending net asset purchases (normally tapered down to zero in March) is a wildcard. The Fed in December accelerated the monthly taper pace from $15bn/month to $30bn/month. Based on that decision, net asset purchases come to a halt in March. We currently take into account a scenario of four consecutive 25 bps rate hikes in the US central bank’s inflation battle (March-May-June-July), before allowing for a pause once the central bank puts in motion pillar two of its normalization process: shrinking the balance sheet at stealth pace. US money markets currently discount a path of quarterly 25 bps rate hikes, but we think that the current environment doesn’t warrant the gradual quarterly tightening pace. Rapidly deteriorating inflation dynamics probably imply that risks surrounding this scenario are tilted to the hawkish side. This means potentially more and/or bigger rate hikes and a sooner start to winding down the balance sheet. Investors will also be looking for clues on how the balance sheet run-off will proceed. Atlanta Fed Bostic is the only one so far to give any guidance, saying he’d favor a monthly reduction of around $100bn, totaling at least $1.5tn. The current balance sheet total of the Fed amounts nearly $9tn. From a market point of view, we hold our downward bias for US Treasuries via higher US real rates. (Lack of) specific guidance on the balance sheet will be decisive in determining the curve’s move: flatter (no guidance) or steeper. We expect more turbulence on risk markets. The combination of both could benefit the dollar short term. First support in EUR/USD stands at the 2021 low of 1.1186.
News Headlines
The Central Bank of Ireland sharply raised its inflation forecast for this year to 4.5%. In a previous update three months ago, it only estimated 2022 HICP inflation at 2.9%. HICP reached 5.7% in December. It is expected to peak in Q1 but the central bank expects it to stay north of 5.0% in the second quarter. Higher energy prices are expected to persist for longer while supply chain issues and labour shortages might raise costs of businesses. Forecasts for 2023 and 2024 are also higher than previously expected at 2.4% and 2.1% respectively, especially due to higher services prices. The central bank anticipates wage growth to rise to 5.0% in 2024 from 3.3.% this year. The Irish central bank also substantially revised this year’s unemployment rate forecast from 7.2% to 5.8% and expects it to return to 4.9% in 2024.
The Swiss government today announced it will reactivate a countercyclical capital buffer to address risks related to the property market. From September 30 banks will have to put aside 2.5% of the risk-weighted exposures secured by residential property in Switzerland. A 2% capital buffer was suspended in March 2020. The volume of mortgage lending and prices for residential property have risen more strongly than can be explained by fundamental factors such as rents and income.
