Markets
This time really is different. Fed Chair Powell couldn’t make it more clear to all remaining doubters. The economy is stronger than at the start of the previous tightening cycle, inflation is running way hotter and the labour market is much more tighter. Even in the sense that most FOMC participants agree that labour market conditions are consistent with maximum employment. These differences will have important implications for the appropriate pace of policy adjustment. Say goodbye to quarterly guided 25 bps rate hikes and welcome a more volatile rate path. Forward guidance is officially buried. It strengthens our call that the Fed will raise rates on consecutive policy meetings, starting in March. It simultaneously makes our call of 4 consecutive 25 bps rate hikes look conservative. Powell refused to rule out more and stronger (>25 bps) rate moves. Embedded in our outdated scenario of a rate pause after Summer was the start of the Fed’s balance sheet roll-off. The Fed already published some high profile guidelines, but didn’t commit to a specific timing our pace yet. We now expect those principles and the effective start of the run-off to start in June while it won’t derail the tightening cycle. Especially in the early months, It’s a process running in the background which has little to do with the Fed’s inflation crusade via higher policy rates.
Markets didn’t take Powell’s message well. They struggle to make peace with the idea of the Fed taking the punchbowl away. US stocks and bonds sold off in lockstep when Powell indicated that there’s quite a bit of room to raise interest rates without threatening the labour market. Main US equity indices closed flat compared to Tuesday’s closing levels, but this hides a 5% drop from intraday high to intraday low. The Fed’s focus on the interest rate path instead of the balance sheet run-off, caused the US yield curve to bear flatten. US yields added 13.4 bps (2-yr) to 5.3 bps (30-yr) with new cycle highs for tenors of up to 5 years. The US 10-yr yield (1.84%) closes in on that reference (1.9%). Real yields were obviously responsible with the US 10-yr real yield moving to its highest level since June 2020 (-0.55%). Heavy risk-off and higher real yields benefited the dollar, though gains could have been stronger. The trade-weighted greenback (DXY) closed at 96.48 from a 95.96 open. A test of the recovery high at 96.94 is imminent. Risks of a short term break clearly increased. EUR/USD drifted from 1.1301 to 1.124 and is currently lured by the November low at 1.1186. Again, we think a break could follow especially should the ECB continue its ostrich policy at next week’s policy meeting, which is our base case. Post-FOMC dynamics will remain dominant near-term.
News Headline
Q4 CPI inflation in New Zealand rose 1.4%Q/Q bringing the Y/Y measure to 5.9% (from 4.9% in Q3). The latter was the fastest yearly rise since 1990 and beat both market and RBNZ (5.7%) forecasts. Price rises were widespread apart from telecommunications. Prices for construction of new dwellings rose 16% Y/Y. Petrol prices went up 30% Y/Y. Housing rents rose 3.8% Y/Y. The rise in domestic non-tradeable inflation was slightly more modest at 5.3% . The RBNZ is expected to extend its tightening cycle at the Feb 23 meeting following rate hikes in October and November. The Kiwi dollar didn’t profit even as short term rates rose further. The post-Fed rise of the dollar even triggered further kiwi losses with NZD/USD declining to 0.6605, the lowest level since early November 2020.
The Bank of Canada yesterday left its policy rate unchanged at 0.25%. BoC Governor Macklem indicated that the lift-off might come soon as the economy doesn’t need the support that was put in place to cope with the Covid crisis. According to the BoC statement, the overall economic slack has been absorbed. The economy entered 2022 with a considerable momentum and the labour market has tightened significantly. Inflation is expected close to 5.0% in H1 2022. As the slack is absorbed, the BoC removed its extraordinary guidance to keep interest rates at the effective lower bound. Interest rates will need to be increased, but the BoC wasn’t specific on the pace of rate hikes. Markets are discounting about six 25 bps rate hikes for this year. The loonie lost modest ground immediately after the decision and USD/CAD rose further post-Fed currently trading north of 1.27.
