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When Maximum Fed Flexibility Is Hawkish

By Marc ChandlerForexJan 27, 2022 06:09AM ET
When Maximum Fed Flexibility Is Hawkish
By Marc Chandler   |  Jan 27, 2022 06:09AM ET
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If equities had appeared to drive the other capital markets recently, the debt market took the bull whip yesterday. The surge in US rates saw equities reverse lower and the dollar rally.

The MSCI Asia Pacific Index was sold to its lowest level since late 2020, led by more than 3% losses in the Nikkei and KOSPI. Foreign investors have been notable sellers of South Korean and Taiwanese shares in recent weeks. Europe’s Stoxx 600 was flat near midday in Europe. The finance, energy, and utility sectors were most resilient. US futures were trading choppily but were at time of writing, little changed.

The US 10-year yield was around three basis points lower around 1.83%, but globally, bond markets sold off in the aftermath of sharp losses seen following the FOMC meeting. Yields in Europe recovered from their worst, and Australia/New Zealand yields surged 6-8 bp. Japan's 10-year yield closed near 0.16%, its highest level since last February when it reached 0.18%.

The US dollar gains were being extended. The Canadian dollar and Norwegian krone were the most resilient, perhaps on anticipated rate moves. Yet, New Zealand, which reported a jump in Q4 CPI earlier today and solidified expectations for its third hike next month, saw the Kiwi sink the most today among the majors, and it was off more than 0.5% to its lowest level since October 2020.

Among the emerging market complex, only a few currencies were higher, led by the Russian ruble's bounce and a small gain in the South African rand ahead of the central bank decision. It was expected to deliver the second hike in the cycle that began last November. Of note, the 0.67% decline in the Chinese yuan was the biggest loss in a little over a year and snapped a six-day advance.

Gold had pushed above $1850 on Tuesday; slipped below $1810 today. The 200-day moving average and trendline off of the mid-December and mid-January lows came in today near $1805. March WTI was little changed, consolidating after reaching a two-year high yesterday just shy of $88. Natural gas was higher for the fifth session in the US, while European gas was recouping most of yesterday's 3.8% decline. Iron ore edged higher, while copper was off 1%. 

Asia Pacific

China's December industrial profits rose by 4.2% year-over-year, half the November pace and the weakest since the contraction in April 2020. There were reports that plans to liquidate Evergrande's (HK:3333) assets to pay its liabilities were being considered. Separately, EC Commissioner Dombrovskis indicated that the EU would take China to the WTO over its coercive actions against Lithuania over its decision about the use of Taiwan as the de facto embassy.

While JGB yields spiked higher, the signal from the BOJ minutes from the meeting earlier this month, showed a determination to push back against speculation about policy normalization. In his press conference Governor Kuroda dismissed such speculation with strong words "absolutely not." Still, the real challenge will come in April, when the sharp decline in mobile phone fees begins dropping out of the 12-month comparison.

New Zealand's Q4 CPI rose to 5.9% year-over-year as the quarterly rate increased by 1.4%, slightly more than expected. It was the fastest pace in more than 30-years. The RBNZ hiked rates twice last year and meets next on Feb. 23. The market had been anticipating another hike then, but the risk of a 50 bp move has grown and now was a little more than a 25% chance. The Reserve Bank of Australia meets next week and was expected to recognize the possibility of a rate hike this year, which so far it has resisted. It will also likely confirm the end of its bond purchases. 

Rising US rates were allowing the dollar to put together its first back-to-back gain against the yen since the first couple sessions of trading this year. Recall that amid the equity market, the dollar had fallen about JPY113.50 at Monday's low. Today, it resurfaced above JPY115.00 for the first time in eight sessions. The JPY115.25 area corresponded to the (61.8%) retracement objective of the decline since the multiyear high was recorded on Jan. 4 near JPY116.35. There was an option for almost $775 mln at JPY115.50 that rolls off today.

The Australian dollar was turned back from $0.7200 earlier Monday and yesterday and briefly dipped below $0.7065 today. A move above $0.7120 was needed to stabilize the technical tone. The $0.7000 area was very important from a technical perspective. 

The jump in US rates finally helped the PBOC stabilize the yuan. The dollar's gains were the first since Jan. 18. The roughly 0.67% gain today was nearly as large as the cumulative gain the greenback recorded in three other times it rose this year. Note that foreign investors were reportedly large sellers of Chinese shares (~$2.3 bln, which would be the most since July 2020). The PBOC set the dollar's reference rate at CNY6.3382 compared with expectations (Bloomberg median) of CNY^.3364.


The light economic calendar in Europe kept the focus on politics. In the UK, Gray's report was expected today or tomorrow, but there had been as steady stream of leaks that would seem to confirm the kind of petty disregard for rules that seemed part of Prime Minister Johnson's persona. The pattern hardly surprised close followers of UK politics. Johnson's enemies smelled blood.

The latest development was the accusation by MPs that the government leaked market sensitive information about the new national minimum wage increase a few days before last October's budget. News that the London police would investigate "partygate" sounded like a blow to Johnson, but while that investigation goes on, it buys Johnson time. The May local elections are looming.

Italy's selection process for the next president entered a new phase today. Starting with today's vote, a simple majority was needed. An outcome was possible today or tomorrow. Draghi was still seen as the front-runner. Meanwhile, concern about the political fallout saw the Italian premium over Germany (10-year rates) rise to almost 140 bp, the highest since late October 2020. The premium was easing by around three basis points near midday in Europe.

News that the "Normandy Format" that includes Russia, Germany, France, and Ukraine will meet in two weeks in Berlin was a constructive development. The idea was that as long as Russia was engaged in talks, it will not invade Ukraine. Note the perverse incentive too. NATO membership and German weapon sales to Ukraine were not technically possible if it was in conflict. Doesn't that incentivize Russia to do what it has been doing?  For its part, the Ukraine government has withdrawn a bill that involved governing the separatist areas, which Moscow argued violated previous commitment.

The euro, which approached $1.1485 on Jan. 14, returned to within a few ticks of last year's low set last November near $1.1185. There was an option for almost 700 mln euros at $1.1150 that expires today. A convincing break of that area would bring our $1.10 call into view. The $1.1220 area may cap upticks now.

Sterling was also taking another leg lower. It approached $1.34, which corresponded to the (61.8%) retracement of the rally from the Dec. 20 low near $1.3175 to the mid-January high of almost $1.3750. A break of the $1.3390 area could signal another quick cent decline. Still, the BOE meets next week and a hike has been nearly fully discounted (~97%).


The market drama was not in reaction to the Fed's statement. It was largely as expected. It wasn't until Powell's press conference that risk appetites soured in a big way. The takeaway by the great discounting mechanism was the Chair was sending a hawkish message. He did not rule out rate hikes at all the meetings or a larger move. He did not use code words, such as describing the evolving adjustment as gradual. In effect, Powell rightfully secured the maximum amount of flexibility to adjust policy as the evolving data requires.

Also, the Fed's starting point was that growth was above trend, labor market strong, and inflation well above the target. Powell also played down the impact of the coming rate hikes on the labor market. In the context of noting the effectiveness of the Fed's communication, Powell noted approvingly of the evolution of market expectations toward four hikes even though the median dot for three.

There is to be a flurry of economic reports at the same time in the US today, but the one that will get the attention is the first look at Q4 GDP. The risk is on the upside of most survey results after the jump in December inventories was reported yesterday. Retail inventories surged by 4.4%, the most in at least 20 years, almost three-times higher than expected. Wholesale inventories rose 2.1% against expectation for a 1.2% gain and the November increase rose to 1.7.% from 1.4%.

To our list of headwinds to the US economy, which includes, the tightening of monetary and fiscal policy, the doubling of the price of oil, savings being spent by lower and middle-income earners, we need to add maturation of the inventory cycle in some industries, even if not durable goods. Of course, the record large goods deficit, also reported yesterday, is a drag on GDP. Based on recent data, the Atlanta Fed's GDPNow increased to 6.5% from 5.1%. 

The Bank of Canada held steady yesterday and the main reason seemed to be caution over COVID. Perhaps, because the market was split on it, that more messaging would be helpful. By saying the output gap had closed, the central bank signaled a hike at the Mar. 2 meeting. Although the market was divided and the Canadian dollar initially weakened, when all was said and done, expectations for the rate change in the swaps market over the next year was virtually unchanged between 180-185 bp. The greenback made its highs for the session in the dramatic risk-off move during Powell's press conference.

After the fireworks, and just as the US cash equity market closed, the Chilean central bank surprised with a 150 bp hike in the overnight target rate to 5.50%. Most expected a 125 bp move, partly because that it was the size of the central bank's last two hikes last October and December. Growth last was around 12%. Pass-through from the peso's large depreciation last year plus the higher import prices. Chilean inflation rose 7.2% year-over-year in December. Interestingly, Governor Marcel, who was named by President-elect Boric as the next finance minister, refrained from voting at the meeting, The decision was made by the other four board members. 

The head and shoulders pattern that we had been tracking since before the neckline near CAD1.26 was violated has been negated. The greenback's loss halted last week near CAD1.2450, well short of the CAD1.2250 objective. Earlier today move above CAD1.2710 to its highest level since Jan. 7. It has now retracement a little more than half of its losses from the Dec. 20 high (~CAD1.2965). The next retracement (61.8%) was around CAD1.2770. Initial support was seen by CAD1.2650. A break, and ideally a close below it would likely coincide with a recovery in equities and would help improve the Canadian dollar's technical tone.

Meanwhile, the greenback to new highs for the month against the Mexican peso, poking briefly above MXN20.81. It has been sold back off after approaching the (50%) retracement of the slide since mid-December high (~MXN21.3640). Support was seen in the MXN20.55-MXN20.60 area.

When Maximum Fed Flexibility Is Hawkish

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When Maximum Fed Flexibility Is Hawkish

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Josephine Panta
Josephine Panta Feb 24, 2022 9:42AM ET
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sir have a good day and pm i'm very thankful about the gold bring another bank and the other places , emprove micro finnace
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