Fed hawkish, but cease-fire trades are the rage

US equities were stronger Wednesday, S&P up 2.2%, Europe’s Stoxx600 up 3.1%. US curve flattened: US10yr yields up 3bps, 2yrs up 8bps as Fed dots lean hawkish. Oil down 2.1%. So clearly, cease-fire trades are the rage.

The FOMC was interpreted as hawkish, but expectations ran high for that scenario. Perhaps getting the event out of the way without a significant shock was enough to keep risk supported and, potentially, USD on the back foot.

Risk assets could be interpreting this arguably “too aggressive.” I think it’s too early to panic on that front, 25bp is not a dramatic initial tightening, and per the statement, the Fed maintains its flexibility.

The last thing the FED wanted to do was to err on the side of caution, which would have crushed their credibility. 

Markets seem satisfied with Chair Powell’s performance today as Nasdaq has fully recovered the drawdown after the FOMC statement and is now eyeing intraday highs. 5y yield is back to 2.17% pre-FOMC level. EURUSD has rallied into the close. My initial interpretation of the FX price action is a possible mechanical reaction to “risk-on”  and short-covering before Europe and Asia hit the ground running. 

But, I think the Fed’s hawkish tone is pushing away worries of the Fed behind the curve and inflation out of control. And stock markets like that.

Still, the objective side of my trading screen is flashing warning signs with the Fed swinging from one extreme to the other with Powell’s whole communication pointed to overheating. So while the Fed’s aim is a soft landing, this is the policy for a hard slowdown.

And don’t think you are out of the ADR frying pan just yet. Amid a 39% rebound of KWEB, Sens. Marco Rubio and Chris Van Hollen reiterate that Chinese companies must fully comply with American rules to keep trading on New York exchanges.

OIL 

Oil prices are lower due to the rise in US inventories. 

Brent slipped below $100/bbl for the first time in 2 weeks as talks between Russia and Ukraine continued. Reuters also reported signs of progress around the Iran nuclear deal after Russian Foreign Minister Sergey Lavrov said that Russia had received guarantees from the US regarding trade with Iran. Trading remains particularly volatile amid the uncertainty, and prices are bouncing to and fro overnight after  >$13/bbl since the start of the week.

Last week I  suggested everything happens at warp speed these days and extrapolated that demand destruction would set in quickly. A one-off build in US inventories should not be interpreted as demand destruction, but at minimum, it will assuage concerns about tight US supply for a bit.

Oil trading remains somewhat sticky. Despite the evident relief on the back of the latest headlines suggesting Ukraine and Russia are inching towards a peace plan, with gains in stocks and the losses in fixed income, oil is broadly unchanged ( sure prices are a bit lower, but what’s a $3 drop- among oil trading friends these days). It might be a belief that even if the war does end, sanctions on Russia will likely persist, making oil supplies tougher to source for longer.

GOLD

Gold survived a hawkish FOMC on recession fears.

I think gold is taking its cue from the inverted yield curve.

A historical look back at the 5s10s, which are now inverted, shows the last two times this happened (or was close to happening) was Y2K & right before the Global Financial Crisis. This happened post FOMC   in the face of equities over 100bp higher and the USD getting hit through Powell’s presser.

I think the inversion results from investors buying longer-term TIPS to offset that inflation risk; hence, the 10y Treasury yields fall mechanically. I don’t consider it a sign of recession but a reflection of inflation haven assets not performing as expected, so TIPS are perceived as a more reliable bet.

Still, the primary tool for tightening financial conditions is the real curve, and I  continue to see real rates moving significantly higher through 2022; hence higher reals should limit gold top side ambitions as the hawkish Fed should open the door to every central bank to keep the pedal to the metal and fight inflation.

FOREX

EUR/USD

Today’s currency markets have a mechanical propensity to chase risk, so I’m not putting a lot of faith in the post FOMC bounce on the EURUSD.

That said,  the hawkish Fed does open the door to a more hawkish ECB iteration and as we have seen in past episodes where the markets price out  NIRP, the EURO flies.  
 

And since cease-fire trades have become increasingly popular, particularly in the energy market, I think the EURUSD could hold a bid. Lower energy prices are good for the EU economy hence the EURO.