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U.S. Fed's Hawkishness Roils The Capital Markets

Published 11/03/2022, 06:25 AM
Updated 07/09/2023, 06:31 AM

The Fed’s delivered the expected 75 basis point (bp) rate hike, and although it says it will take into account the cumulative effect of past hikes and their lagged impact, the takeaway has been a hawkish message. Risk appetites have evaporated. The dollar is stronger, while stocks and bonds have been sold. Japan’s markets were spared due to the national holiday, but the other large markets in the area were sold, lead by the 3% decline in the Hang Seng. Europe’s STOXX 600 gapped lower and is off almost 0.9% near midday. US futures are nursing small losses after yesterday’s stunning downside reversal. Benchmark yields are 11-15 bp higher in Europe, while the 10-year US Treasury yield is up nine basis points to 4.19%. The dollar rides high, gaining on all the major and emerging market currencies. Sterling has been hit the hardest ahead of the outcome of the BOE meeting that will be known shortly. Rising rates and a stronger dollar has weighs on gold and it is approaching the low seen in late September near $1615. Falling US inventories helped lift December WTI to a three-week high above $90 yesterday, but it is offered today blow $88.50. US natgas continues to trade choppy and is down almost 4% today after rallying nearly 10% yesterday. Europe’s benchmark is flat after surging more than 50% over the past two sessions. Iron ore rose for the third consecutive session. It is up almost 6% over this run and matches the longest advance since July. December copper is off by 2.3%. If sustained, it would be the fifth decline in the past six sessions. With Russia rejoining the pact to allow Ukraine grain shipments, December wheat is extending yesterday’s 6.25% decline is back at levels seen at the end of last week. 

Asia Pacific

China's Caixin services PMI was weaker than expected at 48.4, down from 49.3 in September. Recall that its measure of manufacturing improved to 49.2 from 48.1. The net results were that the composite slipped to 48.3 from 48.5. It is the fourth consecutive monthly decline and the second below the 50 boom/bust level. US and Chinese rates are trending in opposite direction. China offered around 125 bp than the US on 10-year borrowings at the start of the year. In late October, it offered about 150 bp less than the US. It looks poised to challenge this ahead. China and the US report October CPI figures next week. 

Australia's final services and composite PMI readings were a little better than the flash estimates but still weaker than September. The services PMI stands at 49.3, better than the 49.0 preliminary projection, and down from 50.6 previously. The composite PMI fell to 49.8 from 50.9 in September. The flash estimate had it at 49.6. It is he first sub-50 reading since January. Separately, Australia reported a much larger than expected September trade surplus of A$12.4 bln. Australia had a trade surplus of almost A$8.7 bln in August and the market had looked for only a small improvement. Exports surged 7% in the month, while imports were flat. Through September, Australia has reported a A$102.1 bln trade surplus. In the first nine months of 2021, its trade surplus was about A$92 bln. Still, the key consideration is that the Federal Reserve is considerably more aggressive than the Reserve Bank of Australia. Australia's two-year discount to the US reached 135 bp, the most since 1984 and is hovering near there now (~130 bp).

The dollar recovered from a spike low slightly through JPY145.70 post-Fed yesterday to settled near JPY147.90. Tokyo markets were closed today, and the greenback found support ahead of JPY147 in Asia Pacific turnover. It recorded the session high near JPY148.35 in the European morning. Nearby resistance is seen in the JPY148.50-65 area. The Australian dollar recorded a big outside down day yesterday by trading on both sides on Tuesday's range and settling below Tuesday's low. Follow-through selling today has pushed through the $0.6325, where options for A$520 mln expire today. The Aussie fell to through $0.6300. This area corresponds to the (61.8%) retracement of the rally off the late October low around $0.6170. Yesterday's high was a little shy of $0.6500. The greenback gapped higher against the Chinese yuan. It is knocking on the multi-year high set earlier this week near CNY7.3275. The PBOC set the dollar's reference rate at CNY7.2472 (yesterday's was CNY7.2197). The median projection in Bloomberg's survey was CNY7.2933. The dollar is little changed against the offshore yuan (~CNH7.3435). As expected, the Hong Kong Monetary Authority matched the Fed's 75 bp move (so did Bahrain, Qatar, UAE, and Saudi Arabia, while the Philippines signaled it would also hike 75 bp on when the central bank meets on November 17). 


The market has nearly fully discounted a 75 bp rate hike by the Bank of England. It would lift the base rate to 3.0%. The swaps market sees a peak rate between 4.50%-4.75%. If the BOE were to surprise, it seems it is more likely by delivering a small one (50 bp) rather than a larger one (100 bp). Headline inflation stood at 10.1% in September. The core measure rose to 6.5%, a new cyclical high. The BOE can be more confident that fiscal orthodoxy has returned to 10 Downing Street and that the budget, when announced on November 17, will be austere. Still, the economy is slipping into a recession, which the BOE warned. However, with the labor market still strong, the BOE may see the market giving it free option. Nevertheless, sterling is the weakest of the major currencies. If the BOE does hike 75 bp, it is expected to signal it is a one-off move. Also, the repo rate (overnight rate to borrow cash using Gilts as collateral) is more than 40 bp below the base rate, which is unusually wide. Separately, the UK's final services and composite PMI were poor but not as weak as the flash estimate had it. The service PMI fell to 48.8 from 50.0 in September. The preliminary reading was 47.5. The composite is at 48.2. The early estimate had it at 47.2, down from 49.1 in September. It was the third consecutive sub-50 result.

Norway's Norges Bank opted for a smaller-than-expected 25 bp rate hike. The deposit rate is now 2.50%. It delivered its first hike in September 2021. The deposit rate had been cut to zero when Covid struck. Norges Bank delivered three 50 bp hike in the June-September period. Norway's CPI is slightly below 7%, while the underlying rate (excludes oil and adjusts for tax changes) stands at 5.3%. The swaps market had assumed that Norges Bank would likely be done, officials signaled another hike was likely next month. Given that lower shipping costs and energy prices may temper price pressures and that monetary policy is having the desired tightening effect on the economy, another quarter-point move is probably the base case. After sterling, the Norwegian krone is the second weakest of the G10 currencies, off almost 1%.

Elsewhere, Switzerland's October CPI moderated more than expected. Its national figure rose 0.1% in the month, translating to 3.0% year-over-year, down from 3.3% in September. The core rate eased to 1.8% from 2.0%, while the median forecast in Bloomberg's survey had projected a small rise. Turkey's October CPI rose 3.54% on the month for a year-over-year rate of 85.51%, a touch below the median forecast in Bloomberg's survey. The core rate accelerated to 70.45% from 68.09%. Lastly, we note that while the Czech central bank meets today, it is expected to keep its repo rate steady at 7.0%. It has been at 7.0% since the June hike. Poland's central bank meets next week and is also expected to hold rates steady.

The euro recorded a big outside down day yesterday and follow-through selling pushed it to $0.9745 in the European morning. This meets the (61.8%) retracement of the rally from the multi-year low set in late September near $0.9535. The next area of chart support is seen in the $0.9670-$0.9700 area, though the lower Bollinger Band is not found until closer to $0.9630 today. The intraday momentum indicators are oversold. Sterling is testing a trendline connecting the mid- and late October lows. It comes in near $1.1220 today. A break could spur a move toward $1.1150, where the (38.2%) retracement of the rally from the historic lows set in late September (~$1.0350, according to Bloomberg). Some of the selling pressure today may have come when the $1.1290 area broke, where options for almost GBP470 mln expire later today. Intraday momentum indicators are stretched.


Initially, the market read the FOMC statement dovish. The key element was acknowledging that it will take into account the cumulative effect of the past tightening and the lagged effect it has on the economy. However, as Powell spoke the markets reversed itself. Powell acknowledged as policy become restrictive the discussion of moderating the pace would become more appropriate and explicitly indicated that meant the next meeting or two. The futures market discounts almost a 30% chance of another 75 bp on December 14. Recall that the September dot plot showed the median Fed anticipated 125 bp increase in Q4. It is still early in the cycle, and there will be two more CPI reports before that meeting.

Powell underscored that there was still a way to go on rates. He said that the terminal rate may be higher than expected, and intimated that if the dot plot were to be recast yesterday, it would be higher. However, the market took the comment to mean the market expectations, but in the context, Powell was talking about the Fed's expectations. The median dot was for a peak near 4.6%. The futures market has been hovering near 5.0%. The market now sees the terminal rate between 5.0% and 5.25%, in Q2 23 rather than Q1 23. The implied yield of the December Fed funds futures contract settled 23.5 bp, below the September contract, two ticks lower on the day. It is coming in a bit lower today, but the market continues to price good odds of a cut late next year.

In addition to digesting the Fed's statement and Chair Powell's press conference, the market has a plethora of data to comb through today. We can eliminate a couple reports, like the weekly jobless claims given tomorrow's national figures, and although they are important for economists, productivity and unit labor costs are not unique measures, but are derived from the GDP. The PMI is the final reading, and the preliminary estimate is fairly reliable. September durable goods is a revision, and it suggests that the likely gain in factory orders will be due to transportation equipment. There are two new data points. The first is the September trade balance. The goods part, the bulk of it, has already been reported. It widened for the first time in six months, amid falling exports and rising imports. The risk is for a continued deterioration of the US trade balance. It means that the net export component of Q3 GDP may be revised down. The second is the ISM Services Index. It is expected to have eased but remain well above 50 unlike the services PMI which has spent the last four months under the boom/bust level.

Falling equities and an a still aggressive Federal Reserve weighs on the Canadian dollar. The greenback is approaching the (61.8%) retracement of its decline from the two-and-a-half-year high set in the middle of last month near CAD1.3980. That comes in slightly below CAD1.3800. A move above the CAD1.3850 area would negate the large topping pattern we have been monitoring. Still, the intraday momentum indicators are stretched. Initial support is seen near CAD1.3725. In the initial dollar-bearish reaction to the Fed, the greenback dropped like a rock through MXN19.60 to almost MXN19.50, a five-month low. It recovered to settle a little above MXN19.67. Although Banxico is widely expected to match the Fed's move next week, the price action likely exhausted the move. The market may now test the MXN19.80 area from underneath.

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