Powell says Fed could become more aggressive
Fed Chairman Jerome Powell set the cat amongst the pigeons overnight stating that the Federal Reserve could raise interest rates more aggressively to tame inflation if needed, not ruling out 0.50% increases if necessary. That is quite the volte-face from three months ago and really isn’t helping the feeling that the Fed is well behind the curve vis-à-vis inflation. US yields across the curve rose sharply, equities eased, and currency markets saw the US dollar rise sharply, notably against the Japanese yen which is a window into the fate of Asian FX in general in H1 of 2022.
Lost in the noise is another reality, the Fed is looking to start tapering its balance sheet by mid-year, a one-two combination on the tightening front. We are not at taper tantrum yet, but I, like others, do wonder about the Fed’s growth projections in this environment. The abrupt change by the Fed from dove to hawk even as the Ukraine conflict sends another cost-push inflation wave across the world isn’t inspiring confidence. The flattening move higher by the yield curve suggests others share my concerns.
We haven’t even got into the full effects yet on the price of staples such as wheat that the Ukraine conflict will inspire. Even if the conflict stopped tomorrow, those full effects and rises by other key commodities have yet to be fully felt. Oil also spiked higher in an emotional session overnight after stories circulated that the EU was considering a full oil embargo on Russia. Unsurprisingly, there was no agreement on that which is completely logical, as large parts of the EU cannot just flick a switch and substitute Russian energy. The acute vulnerability of Europe’s energy security looks increasingly likely to be Angela Merkel’s legacy.
In Ukraine, fighting continues to rage with no signs forthcoming since Turkish comments over the weekend that either side is any closer to reaching a peace agreement. Markets have been putting much store in this outcome, somewhat naively in my opinion, and the chickens appear to be coming home to roost. That reality, I believe, is the main reason oil prices moved sharply higher overnight, even as the EU declined a Russian oil embargo. That said, I fully agree that any headlines suggesting negotiation progress will see a sharp reversal by oil and a rise by equities in the short term. We are all slaves to the hews headline ticker now.
Asia’s data calendar is dead today, but two notable headlines caught my eye. Firstly, Bank of Japan Governor Kuroda said it was premature for the BOJ to speak about exiting its easy monetary policy, and that it would continue buying ETFs as needed. Secondly, RBA Governor Lowe said something along the lines of the RBA wouldn’t respond with monetary tightening unless there was widespread evidence of price pressures. Both governors’ comments sent their currencies lower and their stock markets higher.
Both could be considered a microcosm of the Asia-Pacific as a whole, where, thankfully, most of the region is starting from a much lower inflation base than the northern hemisphere. That has spared regional currencies the worst of the ravages of a hawkish Fed, for now. But it looks like the dam is cracking on the Japanese yen. China is also in an easing mood, but significantly in my mind, has refused thus far to show the colour of its money. If the Fed throws in a couple of 0.50% rate hikes over the next few months, it is hard to see there being no fallout in Asian FX, with the region clearly more interested in supporting growth, inflation be damned. As for the RBA, it is in danger of the same complacency that the RBNZ is guilty of and may find itself in a monetary box canyon like its South Pacific neighbour. With all of this in mind, I am struggling to make a bullish case for equities in the region in 2022.
Fitch has downgraded world GDP growth by 0.70% to 3.50% overnight, and it won’t be the last. In my opinion, the upcoming US quarterly earnings session now has significant downside risks. Not so much from performance in Q1, but in negatively revised forward outlooks by companies. Thanks to the QE addiction as a normal monetary policy tool by the world’s central banks since 2008, markets are programmed to buy the dip. With interest rates rising, rampant inflation and war-time economics, dusting off some old trading and economics textbooks, written on paper, may be required. Or follow Warren Buffet.
Tuesday is the quietest day of the data calendar globally this week, which only has global PMIs to get excited about anyway. China’s Caligula of leverage, Evergrande, suspended trading in its stock yesterday pending a meeting with international creditors. There could be some headline risk associated with this today. Otherwise watching the price of oil and wheat has become a market favourite to go alongside the usual Ukraine watching. Watching from the sidelines in this sort of market isn’t such a silly strategy.
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