Market Briefing: Markets keep fighting the Fed
Fed hikes again. The Fed lifted its policy rate another 25bps, and repeated that there is a bit more to go and that higher rate for longer are expected.
Markets don’t believe it. Interest rate markets, on the other hand, think US rate cuts could start in Q3.
Lower USD, higher AUD. The slump in US bond yields has weighed on the USD, and given the AUD a leg up.
All eyes were on this mornings US Fed announcement and Chair Powell’s press conference. As widely expected, the Fed raised rates by a smaller, more typical 25bps, lifting the target range to 4.50-4.75%. This is only the second 25bp move this cycle (the other was the very first hike in March 2022), with rates now at their highest level since H2 2007, and well into ‘restrictive territory’. The Fed estimates the ‘neutral’ rate (where policy is neither stimulatory nor contractionary) to be ~2.5%.
Over recent months a disconnect has opened between markets and the Fed around how high rates could end up and how long they may need to stay there. These tensions remain. The Fed repeated that it thinks “ongoing increases” will be appropriate near-term to get settings to a level that it thinks could bring inflation back down to 2%pa. Indeed, the Fed looks far from declaring victory on inflation, stating that while it has “eased somewhat” it remains “elevated”, and according to Chair Powell there needs to be “substantially move evidence” inflation is on the right path. And for that to occur restrictive policy will be needed “for some time”, which will flow through to “below-trend growth” and a “softer labour market”.
That said, rather than being attuned to the unfolding negative growth/labour market consequences of the Fed’s actions and its resolve to get sticky core inflation lower, markets continue to overly focus on a future “pause” in the hiking cycle as this could open the door to eventual rate cuts. In contrast to Chair Powell’s point-blank statement that he doesn’t see cuts this year if things pan out as projected, markets continue to factor in an interest rate reversal from Q3 2023.
The markets thoughts that the Fed is nearing the end and could turn course later this year has seen US bond yields fall 8-12bps across the curve, this helped lift equity markets (S&P500 +1%, NASDAQ +2%). The USD index also weakened, with EUR pushing up towards 1.10, USD/JPY below 129, and AUD up near 0.7140. This post Fed market reaction may continue a bit further, in our view, particularly if the ECB and Bank of England deliver their own 50bp rate hikes tonight. But over the next few months, as the economic effects of the Fed’s actions continue to manifest in the data and/or inflation holds up longer we think complacent markets could be caught out, potentially re-igniting volatility, helping the USD regain some lost ground.
Global event radar: Bank of England policy meeting (tonight), ECB policy meeting (tonight), US employment report (4th Feb), US CPI (15th Feb).
The post-US Fed weakness in the USD and rebound in equity markets has seen the AUD spike back up towards last week’s highs (~0.7140). Today’s local data calendar is fairly empty, with monthly building approvals unlikely to move the dial. Further reaction to the Fed meeting can provide a bit more support for the AUD near-term, in our view, via positive risk sentiment across Asia and a softer USD, particularly if the ECB and BoE deliver on expectations of 50bps rate hikes at their respective meetings tonight.
However, we continue to think that up around current levels the AUD is discounting a lot of good news. AUD appreciation has outpaced China’s activity pulse, indicating that a re-acceleration in momentum as it emerges from COVID lockdown may already be factored in. Similarly, while the slump in US bond yields after the US Fed meeting, and widening in AU-US rate differentials has provided some AUD support, as the chart below shows, the AUD looks stretched compared to relative interest rates. As discussed, we think the Fed is unlikely to crystallise the market’s pricing looking for rate cuts later this year. Similarly, we believe the RBA is unlikely to deliver more than what the market is now looking for. We think the RBA will raise rates another 25bps next week, but beyond that we only foresee one more move. This suggests that over coming months relative rate spreads could narrow, creating some headwinds for the AUD.
On the crosses, yesterday’s slightly weaker than expected NZ labour force data has helped push AUD/NZD up towards 1.10. In our view the relative domestic growth and commodity price trends point to more upside in AUD/NZD. The RBNZ moved earlier than the RBA and has delivered more tightening. This is starting to show up across the NZ data with growth indicators rolling over, and the housing downturn looking more pronounced.
AUD event radar: Bank of England policy meeting (tonight), ECB policy meeting (tonight), US employment report (4th Feb), RBA policy meeting (7th Feb), US CPI data (15th Feb), AU jobs data (16th Feb), RBA Gov. Lowe speaks (17th Feb), AU wages (22nd Feb), RBNZ policy meeting (22nd Feb).
AUD levels to watch (support / resistance): 0.6962, 0.7010 / 0.7172, 0.7220
The fall in US bond yields and weaker USD in response to the US Fed has seen USD/SGD decline by ~0.5% to be around its lowest level since Q1 2018. A near-term test of 1.30 could be on the cards, in our view, as the market reaction to the Fed washes out, and if the ECB and BoE deliver on rate hike pricing tonight (this should be EUR and GBP supportive).
However, looking beyond the short-term, as mentioned above, we think the markets may be wrong to test the Fed’s resolve in terms of how long very high interest rates could be needed to definitively lower US inflation, and may be complacent about the negative economic consequences all of the policy tightening could generate. Monetary policy changes work with long and variable lags, and based on the signals from leading indicators like the US ISMs, the effects could show up in the top-tier activity data over the next few months. This is typically a recipe for higher market volatility, which if realised could see the USD (and USD/SGD) bounce back.
SGD event radar: Bank of England policy meeting (tonight), ECB policy meeting (tonight), US employment report (4th Feb), RBA policy meeting (7th Feb), US CPI (15th Feb).
SGD levels to watch (support / resistance): .3009, 1.3054 / 1.3220, 1.3290
Currency Strategist - APAC
THURSDAY (2nd February)
USD ADP Employment (Jan) (12:15am)
USD ISM Manufacturing (Jan) (2am)
USD JOLTS Job Openings (Dec) (2am)
USD FOMC Policy Meeting (6am)
USD Fed Chair Powell Speaks (from 6:30am)
AUD Building Approvals (Dec) (11:30am)
GBP Bank of England Policy Meeting (11pm)
FRIDAY (3rd February)
EUR ECB Policy Meeting (12:15am)
EUR ECB President Lagarde Speaks (from 12:45am)
AUD New Housing Finance (Dec) (11:30am)
SATURDAY (4th February)
USD Non-Farm Payrolls, Unemployment (Jan) (12:30am)
USD ISM Services (Jan) (2am)
*Note, all times/dates provided are AEDT