Equities: New extremes and a challenging opportunity set
Discover insights on the future of equity markets in Q1 2024 and navigate the potential recession with strategic investment choices.
Head of FX Strategy
Summary: The market is clearly having a hard time absorbing the Fed shift to inflation fighting from its assumed post-2018 and especially post-covid outbreak stance of forever moving to support financial markets. On a relative basis, now that the Fed has made no secret of what it is setting out to do, can the market get much more out of it actually carrying through with its intentions? In short, the risk of the US dollar rolling over may rise soon.
FX Trading focus: Fed shift risks breaking markets, USD may be nearing a top.
The drama at the weekend in cryptocurrencies looks like the latest expression of the significant adjustment we are seeing across markets to the Fed’s recent clear shift into inflation fighting mode, a move that is already seeing the withdrawal of Fed liquidity that supports the riskiest of assets. The Fed, especially in last week’s testimony to Congressional panels, has made it very clear that a political signal was delivered during the course of US President Biden’s renomination of Powell to a second term: that inflation fighting should be the paramount concern within the Fed’s dual mandate. The Fed had, of course, already begun tapering asset purchases and is now expanding its balance sheet some 25% below the rate it was doing so before the early November FOMC meeting and could be set to announce at the December 15 FOMC meeting that it will double the pace of the reduction, such that tapering is set to be complete by the end of March. The “dot plot” forecasts of the Fed funds rate for the near future will also likely receive a significant adjustment that looks far more like the market’s actual pricing of the Fed policy than it has in some time.
But looking out the Fed expectations curve, the market is struggling to see how the Fed ever gets much above 1.50% for a policy rate, as is evident in the futures pricing for short-term interest rate futures and the pricing of five-year Treasury yields at below 1.18% this morning, up from below 1.15% on Friday’s close. And while the Fed’s shift to a more hawkish stance could continue to impact risk sentiment and even trigger a further deleveraging of risky assets, I suspect the Fed shift has reached maximum momentum for now and between now and either the December 15 FOMC meeting and the turn of the calendar year or shortly thereafter we could see peak US dollar, at least versus the more liquid currencies in the G10 (EUR, JPY, maybe GBP and the traditional safe-haven CHF), if not necessarily against the smaller currencies and possibly EM, as the USD safe-haven status could continue to see these underperform if we are set for significant further deleveraging across assets.
Meanwhile, the market’s reaction to the Friday US data set was rather interesting. There, we got a November ISM Services that broke a new hole in the roof, with a record high reading of 69.1, significantly beating the former record from OCtober, no mean feat for a diffusion index in which things must improve at a faster rate for the reading to continue higher from the prior month. The Nonfarm payrolls change was far below expectations (210k versus more than 500k expected), but will likely be revised up like nearly every other month of late. Meanwhile, the Household Survey registered a massive increase, taking the unemployment rate down 0.4% to 4.2%. The pace of the falling unemployment rate is breathtaking compared to previous cycles. The Average hourly Earnings data was in lower than expected (0.3% MoM and 4.8% YoY), but was held back by a small increase of the Average Weekly Hours denominator.
AUDUSD has reached a major inflection point in this 0.7000 area, an important level back prior to the pandemic out break and since. Not sure at all that we will get anything interesting from the RBA tonight, with the bank having declared it would like to wait until the February meeting before taking any next steps on asset purchases or other guidance. Rather, risk sentiment and commodity prices are likely the key drivers here for whether this pivotal level can offer any support after the remarkable slide of late.
China has finally started to ease, cutting the reserve ratio requirement for banks by 0.5%, which will release CNY 1.2 trillion (a bit less than $200 billion) of liquidity int the domestic economy. The move was flagged last week and the PBOC is taking pains to tamp down on any anticipation that this represents the start of a major stimulus move and said that it will guide banks to increase support for small businesses. Chinese growth has stumbled on power shortages that have now been largely eliminated and more importantly on an aggressive policy move against the over-leveraged property sector. The Chinese economy is increasingly held back on all levels by the strict “zero tolerance” policy toward covid, which has become a mounting challenge due to the very contagious delta variant, with the omicron variant potentially adding a new twist.
Riksbank minutes show hawks getting restless – after receiving a drubbing on recent weak risk sentiment, the krona is attempting a recovery this morning on spots of more hawkish than anticipated language in the Riksbank minutes out this morning, as three of the six members are clearly getting a bit restless on the asset purchases signals for next year and want to reduce purchases more quickly. But it’s all rather incremental stuff. Yes, SEK looks cheap, but seems forever susceptible to a weak euro and weak risk sentiment – both probably need to improve before we can reverse the relative krona weakness.
Table: FX Board of G10 and CNH trend evolution and strength
The AUD and NOK are the bottom dwellers for now, with AUD particularly weak over the last five trading days ahead of the RBA meeting tonight. On the strong side, interesting to see if the CNH can maintain its outperformance now that crude oil prices have dropped and the PBOC has made its first easing move of the cycle.
Table: FX Board Trend Scoreboard for individual pairs.
Overall, the volatility as displayed in the bright volatility readings is notable, with the distinct exceptions of EURUSD and USDCNH. New developments are few and far between, save for the EUR picking up versus traditionally riskier currencies over the last week and more.
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