Bad medicine is what I need

Central banks deliver large rate hikes

Central banks around the world have gone full Bon Jovi handing out some monetary policy bad medicine over the past 24 hours, as the fight against inflation permeates even the most ardent fence-sitters. South Korea and New Zealand hiked by 0.50% yesterday, with Canada weighing in with a crowd-pleaser sized 1.0% hike. You’re getting that bad medicine, whether you need it or not.

This morning, the Monetary Authority of Singapore weighed in with its second unscheduled tightening of the year, recentring the policy band for the currency to “prevailing rates.” The MAS normally only announces monetary policy settings twice a year in April and October. So far it has reacted in January, April and now July, as core inflation surged. We can reasonably assume October will be a live meeting as well. USD/SGD has slumped by 0.67% to 1.3905 in response. For non-Singapore readers, the MAS uses the currency to manage monetary policy because of the nature of trade flows through the city-state. A google of “MAS” and “NEER” will allow you to do your own research on the mechanism. I recommend wrapping a cold towel around your head as you do.

In breaking news, the Philippines Central Bank has just announced an unscheduled rate hike of 0.75% to 3.25%. To say this is an unusual move by the Bangko Sentral ng Pilipinas (BSP) is an understatement, given that they have been amongst the most dovish and reluctant hikers in Asia. The US CPI and the MAS move today, along with the relentless pressure on the Philippines peso (PHP) have swayed BSP’s hand, underling the pressures facing Asian central banks now. USD/PHP has fallen by 0.32% to 56.06, but the PHP remains near record lows. We may see more of this from other monetary authorities in the region now as pain thresholds and the burning through of forex reserves reach their pain points. Bank Indonesia could be the next taxi off the rank, followed by Bank Negara Malaysia.

With even the Bank of England sounding hawkish this week and recent rate hikes in Eastern Europe and Latin America, it is clear that central banks around the world are laser-focused on fighting the entrenched inflation they helped to create, growth-be-damned. Higher rates are coming to a corner shop near you.

That brings us to the Big Kahuna, the US Federal Reserve whose FOMC policymakers meet at the end of the month. Overnight, US inflation surprised markets by surging higher to 9.10% YoY for June, with a 0.10% fall by core inflation to 5.90% cold comfort. Futures markets have raced to price in a more aggressive Fed Funds rate hike at the end of the month, approaching 1.0% overnight. At least one Fed speaker – there were many – mentioned 1.0% overnight as well. I still think it is a bridge too far for the FOMC to go 1.0%, but hey, it’s 2022 and nothing should surprise us anymore.

Unsurprisingly, EUR/USD traded down to parity after the data, but after toughing 0.9998, it rallied back to 1.0040. We saw similar price action in GBP/USD, AUD/USD, NZD/USD, USD/CAD, and USD/CHF as well, although USD/JPY went directly to jail and rose to 138.00. The surprises continued; Wall Street fell overnight, but only modestly so in the context of recent volatility. Gold and bitcoin dropped as well, but actually finished higher on the day. Oil prices didn’t move, shrugging off a huge rise in official crude inventories as well. The biggest head-scratcher for me was the US bond market. The US 2-year yield rose slightly, but yields fell across the rest of the curve. The US yield curve is now well and truly inverted from two years to thirty years.

So, US markets are pricing in faster Fed tightening, and a recession is on the way imminently. Ever optimistic, US markets seem to be pricing in that the Fed will deliver its bad medicine, and send the US into a recession, but it will be short-lived, and the Fed will be cutting rates by H2 2023. That probably plays with the market’s inbuilt psychological need to find reasons to look to be piling back into equities again this year. That’s a lot of faith to place in the Fed, inbuilt market biases aside. Given their track record on inflation in the past two years, that is a looooootttttt of faith to place in the Fed.

That said, given the mess the Fed has made with the transitory/entrenched inflation narrative, it’s just as easy to assume they will make a dog’s breakfast of tightening as well. The US inflation numbers overnight should have seen bond yields and the US dollar shoot higher, equities should have been stretchered off with a season-ending injury, and gold and cryptos should have headed so far south, that they found themselves in Mexico. Not that has happened, the opposite in fact. One must respect the price action and right now seems to be yelling that a bear market correction is on the way for equities and that the US dollar rally is about to take a pause for breath. That is in line with a number of overbought/oversold technical indicators I am seeing across asset classes and helped along by the rest of the central bank world ex-Europe and China, seemingly rushing to play monetary catchup.

Yesterday, China’s June Trade Balance printed a monster USD 98.0 billion surplus, well above forecasts. Whether it is due to a clearing of export backlogs or that things in China and the rest of the world aren’t as bad as they seem, I know not. It does suggest there is upside potential for the China data dump tomorrow in my opinion. If we are talking about bear market rallies, a healthy set of very important data releases tomorrow from China could be the catalyst to give that some momentum.

The Monetary Authority of Singapore and the Reserve Bank of Australia will be sharpening their tightening pencils today, despite the MAS action this morning. Singapore’s Advanced GDP for Q2 YoY surprised to the upside, rising by 4.80%. That comes after healthy retail sales data earlier in July and upgraded inflation assessments by the MAS this morning.

Over in the lucky country, the economic temperature needle rose to overheated territory today. Australian Employment for June rose by 88,400 jobs, well above the 30,000 forecasts, and follows excellent numbers in May. Healthy gains were made in both full-time and part-time jobs. An elevated CPI release on the 27th of July will lock and load another 0.50% hike in early August by the RBA, perhaps 0.75% if the FOMC goes 1.0% a few days before. The fact that AUD/USD remains near one-year lows is even more surprising in this context, although the AUD is driven by international investor sentiment these days, and the slump in energy, industrial and agricultural commodity prices over the past six weeks means that Australia’s terms of trade are probably going to soften in Q3.

On the subject of agricultural commodities, Turkey and the United Nations appear to have pulled off a miracle and are on the verge of brokering a deal between Russia and Ukraine allowing Ukrainian agricultural exports to partially resume from the Black Sea. That may put downward pressure on soft commodity futures in the short-term, although any impact from Ukrainian exports will have a substantial time lag, and quite frankly, to say it would have implementation challenges is an understatement.

That will be of limited solace to Europe, with emerging markets being the most likely immediate beneficiaries, and rightly so. Europe watchers should circle the 21st/22nd of July in their calendars. Russian annual maintenance on the Nord Stream 1 gas pipeline to Germany finishes that day, and the Canadians have given the Russians back their pipeline pump. The question is whether the gas starts flowing again. If it doesn’t EUR/USD at 1.0000 will be but a memory and there will be no bear market rally for European asset markets.

Looking through the rest of the day, the Japan 20-year JGB auction and Industrial Production data is unlikely to move the needle. India releases WPI Inflation for June this afternoon, and if it stays around 15.80% or higher, the pressure on the rupee, local equities, and the Reserve Bank of India is set to continue. Europe’s releases are second-tier this afternoon, and US PPI this evening will have been drowned in the noise of the overnight inflation data.

All roads lead to China’s data dump tomorrow, featuring GDP, retail sales and industrial production amongst others. That is followed by heavyweight retail sales and consumer sentiment data from the US.

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Jeffrey Halley

Jeffrey Halley

Senior Market Analyst, Asia Pacific, from 2016 to August 2022
With more than 30 years of FX experience – from spot/margin trading and NDFs through to currency options and futures – Jeffrey Halley was OANDA’s Senior Market Analyst for Asia Pacific, responsible for providing timely and relevant macro analysis covering a wide range of asset classes. He has previously worked with leading institutions such as Saxo Capital Markets, DynexCorp Currency Portfolio Management, IG, IFX, Fimat Internationale Banque, HSBC and Barclays. A highly sought-after analyst, Jeffrey has appeared on a wide range of global news channels including Bloomberg, BBC, Reuters, CNBC, MSN, Sky TV and Channel News Asia as well as in leading print publications such as The New York Times and The Wall Street Journal, among others. He was born in New Zealand and holds an MBA from the Cass Business School.
Jeffrey Halley
Jeffrey Halley

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