Market Strategist
Summary: Powell’s testimony to the Congress started with a hawkish message. Market is now tilting in favor of a 50bps Fed rate hike this month and a terminal rate expectation of over 5.6%. Friday’s jobs data and next Tuesday’s CPI print will be key tests for whether a 50bps March rate hike gets cemented, but what is clear is that Powell’s shift to disinflation narrative in February was premature. Risk assets may remain under pressure if data stays hot, while the path of least resistance for the dollar is higher.
The semi-annual testimony from Fed Chair Powell was indeed hawkish, despite a political stage being set up. Instead of being relieved by incoming growth indicators, Powell still seemed worried about inflation despite his relaxed stance at the February FOMC meeting where he started the chatter on disinflation. Powell increased the prospect of a return to larger rate hikes, saying, “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”.
The resulting increase in the probability of a 50bps rate hike at the March 22 FOMC meeting is shown in the chart below. He also added that with the latest economic data having “come in stronger than expected”, it “suggests that the ultimate level of interest rates is likely to be higher than previously anticipated”. This change in stance, after just one month of strong data, is proof that Powell took comfort in disinflation prematurely.
The reaction to Powell’s testimony remains at risk of reversal, unless upcoming data supports it. Friday’s jobs report or next Tuesday inflation print will be key to watch to make or break the expectations of a 50bps rate hike in March. Hotter-than-expected prints can also bring the terminal rate pricing closer to the 6% mark, making the Fed’s lag to the market ugly. Moreover, shifting to a 50bps rate hike after just one go at the 25bps rate hike pace will be an embarrassment for Fed and its models.
Bloomberg consensus expectations point to another strong jobs report after the blowout report of January. Headline jobs are expected to come in again at 200k+, but risk of disappointment remains given the scope of correction from +517k in January. The unemployment rate is expected to remain unchanged at 3.4%, while wage growth is projected to accelerate. Most early indicators such as the business surveys from S&P pointed to an acceleration in hiring, while applications for unemployment benefits remained historically low. Overall message, despite a potentially softer headline print, is likely to be that US labor market is still tight and there are millions of open positions even as layoffs continue to ramp up in some of the sectors.
Along with a higher probability of a 50bps rate hike in March, the shift in tone from Powell has also seen the terminal rate pricing for the Fed Funds target rate to rise to 5.65% from 4.9% at the end of 2022 and the 5-5.25% hinted in the December dot plot. A brutal sell off in Treasuries followed the remarks, with the yield on 2-year Treasuries rising over 12bps to over 5% for the first time since July 2007 and rising further to 5.05% in Asian session. The longer end of the curve, however, recovered from their intraday lows with the 10-year yield closing only 1bp cheaper at 3.96% and the 30-year yield 2bps richer at 3.87%. This made the 2-10-year yield curve flatten to -105bps, the deepest inversion since September 1981.
But something seems amiss with the higher-for-longer message not moving the 10-year yields. Either the 10-year yield will need to move higher or the 2-year will need to revert back lower to give a consistent message. This means higher interest rate volatility will remain in the cards, also suggesting higher risk premium for equities. This keeps diversification beyond US equities in favor. We expect European and Asian equities to outperform this year. China also appears poised for an upswing in growth as economic momentum picks up, but the recovery can remain bumpy in light of regulatory and geopolitical risks.
The US dollar is now back at its YTD high with potential for another leg higher after a minor correction. For the DXY index, key levels to watch are the 200DMA and 76.4% retracement at 106.45. The dollar is benefitting from a host of tailwinds including:
Even if the Fed was to go for a 25bps rate hike again at the March meeting, there is enough reason to believe that that the dot plot will shift higher. That will also be sufficient for the USD to stick to its current range.
A new fragmented world order can render some of today's infrastructure obselete, but it also calls for massive new investments across the globe, which requires a new set of strategic and tactical investment strategies.
Steen Jakobsen,
Chief Investment Officer
As globalisation turns to fragmentation, China seems set on playing a role in the global economy, while simultaneously working towards proofing its own economic situation from external shocks and crises.
Redmond Wong,
Market Strategist
The recent bank runs and ensuing challenges are reminicent of something we've seen before. Will it end like the S&L crises of 1986 and 1995?
Chris Dembik,
Head of Macroeconomic Research
Equity markets need to recalibrate to another - fragmented - global world. What's your view on equities in this market - are they going up or down?
Peter Garnry,
Head of Equity Strategy
With every development comes new opportunites, some of which could be in India. Have you considered the country as a part of your diversification strategy?
Charu Chanana,
Market Strategist
A collar is an option strategy that allows some protection while maintaining some upside potential. What investment would you like to use a collar strategy for?
Hans Oudshoorn,
Trainer Academy
There are arguments to be made for many commodities to have upside. Which are you paying the most attention to this quarter?
Ole S. Hansen,
Head of Commodity Strategy
In a very challenging macro environment, which currencies do you think will come out on top?
John J. Hardy,
Head of FX Strategy
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)
