It was risk-off mood in markets this week as a cocktail of Russia-Ukraine tensions and the outlook for a hawkish Fed drove the VIX volatility gauge to one-year highs. The USD has strengthened significantly; a move that was further amplified when Fed chair Powell in fact took a hawkish stance at the Fed meeting on Wednesday. It implies a hint that the Fed will hike for the first time in March. The Fed needs to tighten financial conditions further to put an end to high inflation and we now expect five rate hikes this year with risks tilted towards even more rate hikes. The market reacted by driving EUR/USD to the lowest level since spring 2020, short-dated US yields higher and flattening the curve. The outlook for higher rates implied a tough week for equities, particularly Wall Street, with indices plummeting on a global scale. A hawkish Fed and strong USD was not enough to stop the trend higher in commodities in general and oil markets in particular as Brent oil traded above USD90/bbl.

The euro area economy has shrug off Omicron in the beginning of the new year as composite PMI remained in expansionary territory at 52.4. The service sector shows resilience to the pandemic although growth slowed, while the manufacturing sector accelerated again amid easing supply chain delays. Inflation remains a concern as prices charged for goods and services rose at a record rate in January. Also German Ifo figures were quite uplifting as headlines improved amid a significant improvement in expectations for the coming six months. The assessment of the current business only declined slightly.

Also the US economy proved in good shape with Q4 GDP growth of 1.7% QoQ, beating expectations. Some was driven by inventory rebuilding, but private consumption remained strong. That said, GDP remains below the pre-COVID growth path and thus the figures are another testimony to the fact that potential GDP has declined permanently in the US.

Next week will be busy in the euro area. The economic recovery has slowed significantly and we expect Q4 GDP growth at 0.4%. January inflation likely dipped as German VAT effect falls out but energy will continue to keep inflation elevated for some time. We expect headline inflation at 4.3%. We expect no changes from the ECB on Thursday, but the meeting has certainly become more interesting in the light of the hawkish Fed and we will look out for changes in the inflation assessment.

In the US, Fed speeches will be particularly interesting, as we might get more details about the likely policy path. We expect the jobs report will show jobs growth around the current level of 200,000. Employment growth is unlikely to pick up pace until more people return back to the labour force.

We expect a small decline in Chinese PMIs, but there will be some noise from the Chinese New Year so the number should be interpreted with caution. The Reserve Bank of Australia (RBA) is widely expected to end QE purchases on Tuesday. We do, however, think RBA is unlikely to take as hawkish stance as markets are currently pricing. We will also keep a close eye on a potential new meeting between Russia and the US. If such a meeting will indeed be set up, it will be hard to imagine a Russian move into Ukraine near-term.

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