Investors got a double shot of hawkishness from Federal Reserve (Fed) Chair Jerome Powell’s semi-annual testimony before the US Senate yesterday.
This time, Powell left no place for doubt. He clearly said that nothing about the data suggests to him that they have tightened too much, and that ‘if the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes’.
I repeat, ‘increase the PACE of rate hikes’.
That means that if the US jobs data remains strong, and inflation won’t cool down, the Fed will throw the slower-but-higher-rate-hikes strategy out of the window, and they will just hike by decent chunks.
And the level of rates will ‘likely be higher than previously anticipated’; it will be higher than 5.1%.
The message went through
Activity on Fed funds futures now assesses 73% chance for a 50bp hike for the March FOMC meeting, up from around 30% before the speech. Pricing also suggests 100bp hike in the next four meetings. And swap markets price in a peak Fed rate of 5.6%. That was around 4.90% at the start of the year.
Chaos
Powell’s comments wreaked havoc across the US treasury and equity markets and the US dollar. The US 2-year yield spiked past the 5% mark. The 10-year yield spiked to 4%. The gap between the 2 and 10-year yield hit a full percentage point for the first time since 1981.
The widening yield gap means that the pricing of further rate hikes is well in play, yet the rate hike expectations increase the odds that the US economy could come down sharply. That’s why the 4% mark on the 10-year is less enthusiastic about further upside.
In equities, the S&P500 had to give to the bears and fell 1.53% to below the 4000 mark and the 50-DMA.
To be true, the reaction could’ve been worse, but the selloff may not stop here.
Data, data, data
The next few data points will be very important in cementing the expectation of a 50bp hike at the March 21-22 FOMC meeting.
Today, the ADP report and job openings data. JOLTS data would better soften this month, after last month’s booming figure of 11 mio.
On Friday, February jobs report will be released. We’d better see an easing here as well after last month’s blowout half-a-million NFP read.
Finally, the latest CPI update is due next Tuesday. And again, it’d better head sufficiently lower after last month’s disinflation disillusion.
If the fresh data doesn’t go where the Fed wants to see them, bigger rate hikes will be on the menu, and hope of soft-landing and easy disinflation could fade away.
And with all the hawks in the air, the US dollar went straight up yesterday and there is no reason to bet on a softer US dollar for the next couple of days. The dollar will likely consolidate and extend gains against most majors.
The EURUSD tanked to the 100-DMA, which stands a few pips above the 1.05 mark, and the major 38.2% Fibonacci retracement on September to February rally, around the 1.0473 level, is just about to get tested, and could be broken depending on the strength of the USD bullishness. It’s true that we were expecting the rate hikes in the US to gently end in Q1 and the rate hikes in the Eurozone to continue. But the new turn of things suggests that the Fed is not done hiking yet, so the euro can barely strengthen its back if the USD bulls remain in charge of the market.
The Reserve Bank of Australia (RBA) head Philip Lowe said, just a day after the 25bp hike, that they are approaching a point where a pause in tightening is needed. The combination of a hawkish shift in Fed’s language and the dovish hike from the RBA cost dearly to the Aussie. The AUDUSD dropped two figures yesterday and is now around the 65 cents mark. At this point, even the Chinese reopening will hardly make up for the negative pressure.
In Canada, the Bank of Canada is preparing to do nothing at today’s monetary policy meeting. But Canadian policymakers could make some careful tweaks to the statement to leave the door open for further action, if needed. The cup and handle formation on the dollar-CAD hints that the move could extend to 1.40 mark, if the BoC fails to show a bit of teeth.
