March 8, 2023

Markets Today: Warning Sign

The market was not prepared for Powell’s hawkish remarks, sending short rates and the USD higher and equities lower.

Todays podcast

Overview: RBA less hawkish, Powell more so. Big market response

  • Fed Chair Powell warns stronger than expected data implies higher Fed Fund rate peak
  • If totality of data is strong, prepared to increase pace of rate hikes
  • Market was not prepared for Powell’s remarks, sending short rates and the USD higher and equities lower
  • Big flattening of the UST curve. Now -103bps.  10y @3.94%
  • USD stronger across the board. AUD and GBP the notable underperformers
  • AUD not helped by RBA’s softer tightening bias. GBP weighed down by BoE Mann’s concern on sterling
  • Coming up: RBA Lowe, ECB Lagarde, Fed Powell, BoC Meeting, ADP, JOLTS

Events Round-Up

AU: Trade balance ($b), Jan: 11.7 vs. 12.2 exp.
AU: RBA cash rate target (%), Mar: 3.6 vs. 3.6 exp.
CH: Exports (USD YTD y/y%), Feb: -6.8 vs. -9.0 exp.
CH: Imports (USD YTD y/y%), Feb: -10.2 vs. -5.5 exp.
GE: Factory orders (m/m%), Jan: 1.0 vs. -0.7 exp.

Warning Sign, pay attention I am talking to you -Talking Heads

Following a series of stronger than expected US data releases in recent weeks as well as comments from Fed speakers noting the increasing risk of further policy tightening ahead, speaking overnight Fed Chair Powell delivered a hawkish warning. Given what we already knew, his hawkish remarks shouldn’t have been a surprise, but evidently the market was not prepared. UST front end yields jumped, the USD more than reversed recent losses and equities fell across the board. The AUD and GBP are the notable underperformers, AUD not helped by the RBA’s softer tightening bias. GBP weighed down by BoE Mann’s concern on sterling.

Ahead of Fed Chair Powell’s semi-annual monetary policy testimony before the Senate Banking Committee, recent US data releases were already telling us that the US economy started 2023 on a much stronger footing than most had anticipated with inflationary pressures also proving more persistence.

This economic backdrop had already triggered a repricing in Fed rate hike expectations, but Fed Chair Powell’s acknowledgment of the current economic backdrop as well as warning that the Fed is prepared to do more still triggered a significant market reaction. This of course needs to be seen in the context that early February the Fed had step down the pace of hikes by lifting the Funds rate by “only” 25bps to 4.75%.

Powell said that “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” and then he added that “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.” 
On the data, the Chair noted the moderation in inflation since the middle of last year. The 12 month change in total PCE prices has slowed from a 7% peak to 5.4% as energy prices and supply chain bottlenecks have eased. Core PCE is down to 4.7% and inflation in the core goods sector has fallen. Powell also noted that while housing services inflation remains too high, the flattening out in rents in recently signed leases points to a deceleration in this inflation component. But he warned there is little sign of disinflation in core services excluding housing, which accounts for more than half of core consumer expenditures.

The Fed is clearly data dependent and Powell’s’ remarks about the “totality of the data” means that upcoming data releases are going to be important, they will either vindicate the price action seen overnight and seal the deal for a 50bps hike on March 22 or they will likely trigger a reversal. On Friday we get non-farm payrolls and then next week we get the February CPI report

The Fed Funds futures market now sees an 80% chance of a 50bps hike in March, up from around 20% prior to Powell’s remarks. The front end of the UST curve has a led sharp flattening of the curve with the 2y rate up 13bps to 5.018%, a fresh high at a level not seen since 2007. 10y UST met some resistance (again) at 4% and is currently up 1bps relative to yesterday’s level 3.94%, the flattening of the curve sees the 2s10s scale of inversion breaking minus 100bps (now at 103 bps), a level not seen since the early 1980s .

The USD also enjoyed a decent jump, more than reversing recent losses. The DXY index is up 1.25% and currently trades at 105.624, after trading lower in the previous two days . Looking at G10, the big dollar is stronger across the board with JPY at the top of the leader board, down “just “0.85%”. USD/JPY is back above ¥137, threating the break above recent highs. The euro is down 1.2% and now trades at 1.0554, NOK and SEK are the big underperformers, both down close to 2.6% with the former not helped by a 3.53% drop in Brent oil.

The other two notable underperformers are the AUD and GBP. The AUD now trades at 0.6591, down 2.09% and extending its decline post yesterday’s RBA policy meeting . The RBA lifted the cash rate by 25bps to 3.60%, as widely expected but the Statement was less hawkish with the RBA removing February’s pre-commitment to more hikes over coming months. There was a hint of data dependency with reference to “when and how much further” tightening of monetary policy will be needed. The market saw this as a possible pause in April after the RBA’s ten consecutive rate hikes. Governor Lowe speaks this morning (see more below), so the market will be looking for a little bit more guidance from the chief.

GBP now trades at 1.1834, down 1.6% over the past 24 hours. The pound was not helped by BoE Mann’s remarks overnight, she sits at the hawkish end of the spectrum and while her views on the need for more aggressive BoE rate hikes are well known, overnight she strayed into currency markets, suggesting that the pound could fall further as the Fed and ECB hike rates further – she clearly would prefer the BoE to follow that trend but has been out-voted.

NZD sits somewhere in the middle of the G10 pack down by only 1.37% to 0.6116, the kiwi traded down to a fresh year to date low of 0.6104, but has recovered a little in the past hour.

As noted at the start, US equities were spooked by Powell’s remarks with the S&P 500 down 1.55% as I type and down below the 4000 mark (@3998 ) while the NASDAQ is -1.25%. Earlier in night the Eurostoxx 600 ended the day down by 0.77% while the UK FTSE 100 closed 0.13% lower.

Coming Up

  • Following yesterday’s RBA decision to lift the cash rate by 25bps to 3.60%, the tenth consecutive increase, RBA Governor Lowe speaks this morning on ‘Inflation and Recent Economic Data’ (8:55 AEDT). Yesterday’s Statement was less hawkish and removed February’s pre-commitment to more hikes ahead, the Bank still expects further tightening will be needed but not necessarily over coming months. The main reason for the less hawkish tone this month appears to be less fears of a wage-price spiral (that surfaced following the Q4 CPI) given the recent weaker-than-expected Q4 WPI and strong but not excessive measures of compensation in the National Accounts. The RBA is clearly data dependent, but given inflation pressures, we still think the Bank will hike by 25bps in April and May, taking the cash rate to 4.10%.
  • Also this morning, Japan gets Balance of Payment data for January and later in the day Germany releases retail sales and industrial production figures, also for January.
  • Tonight, Fed Chair speaks again before the House and the US publishes Mortgage Applications, ADP employment (200k exp. vs 106k prev.), Trade balance ($-69bn exp. $-67bn prev.) and JOLTS Openings.
  • BoC meets tonight where a pause is widely expected given it was flagged at the prior meeting. The rationale for pausing is to “assess the impacts of the substantial monetary policy tightening already undertaken”, with scope to do so given the BoC is forecasting inflation to fall to 2.0% by the end of 2024. Markets though are still toying with one more rate hike by September (82% priced).
  • BoE s Swati Dhingra and ECB Lagarde speak.

Market Prices

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