Markets
US equities rose Friday, S&P up 1.2% Friday to be 6.2% higher over the week: best outcome since November 2020. US10yr yields down 2bps Friday, but up 16 bps for the week, closing at 2.15%. Oil up 1.3% Friday, but down 4.2% for the week.
Stabilizing stock markets point to less cautious investors. Not because views on geopolitical or policy/rates risk have improved, but because price action shows a market more tolerant of those challenges.
Monetary policy is always relevant for markets, but has taken a backseat to the cross-asset impact of the Russia-Ukraine war. However, it is worth noting that front-end rates markets are close to pricing in eight 25bp Fed rate hikes, i.e., seven in addition to last week's 25bp increase.
US 5y5y inflation breakevens are settling into a higher range (2.30%-2.45%), partly reflecting higher oil prices (up 3% this morning) and the Fed's explicit recognition of the extremely tight labor market conditions.
Meanwhile, the yield curve continues to flatten (2s10s: 20bp). That matters not because flatter yield curves mechanically cause recessions, but somewhat because a tightening in financial conditions that the Fed wants is circumvented by curve flatness; hence they may start to ratchet up 50 bp language. With the Fed sitting on their hands too long before hiking, policy rates must do more of the heavy lifting than the long end.
Reflecting this dynamic, 37bp is priced in for the May meeting, a move accentuated by recent comments from the Fed's Waller and Bullard that signaled a preference for a 50bp rate hike at the next meeting.
Oil
WTI and Brent haven't had much respite amid fresh tensions in the Middle East, with both up over 3% today. Media reports that Yemen's Houthis targeted at least six Saudi Arabian sites with drones and missiles over Saturday night/Sunday morning, including some run by Saudi Aramco (SE:2222).
Provided the damage reports remain tame, the market will focus on China's COVID policy ( price negative ) vs the possibility of more Russian sanctions already being practiced by Western Buyers, which is a colossal risk (price positive). But until there is better visibility on how the war will play out, markets will still be sentiment-driven.
Gold
Gold is a bit higher with oil up as Commodities remain the ultimate macro hedge if inflation expectations get de-anchored. While risky assets and fixed income are likely to suffer in this environment, commodities are likely to benefit.
Forex
The big four central banks have approached the same inflation problem but with four different strokes. The Fed is all in against inflation, apparently willing to take the risk it causes a hard economic landing. The ECB presented a glide path on APP withdrawal that will allow it to unwind negative rates—the communication was likely much more hawkish than the intended policy intentionally designed to support the euro.
The BoE was far more dovish than the market was pricing, but they were entirely consistent with recent guidance—it just wants to keep inflation expectations in check. The BoJ was more concerned by the economic damage from high energy prices and will push for economic growth rather than pushing back against inflation angst.
Curiously, international investors ultimately view the four equity markets the other way around. A positive attitude towards the US, the beginnings of another negative look at Europe, back to worrying about Brexit damage to the UK, and ignoring Japan completely.
The S&P is the market that is most likely to pick up the investment flows, but FX traders are looking at the curve, signaling later in the year that the US markets will be most at risk from a hard economic landing. Hence I think the dollar will struggle to regain its former glory this week, although a hawkish run of Fed speak could tilt the momentum back in the greenback's favor.