The Fed will start its interest rate tightening cycle tonight

Markets

US stock markets had a better run yesterday with main indices closing up to 3% higher. Support in the Nasdaq at 12552 (38% retracement on 2020-2021 post-Covid-rally) held for a second time, but the technical picture obviously doesn’t improve yet. We hold our view that 2022 will be tough year for riskier assets as they’ll have to stomach a hawkish Fed in reaction to/on top of surging costs. Core bonds stabilized/recovered somewhat after this month’s heavy beating with some investors locking in profits ahead of tonight’s verdict. Daily changes on the US yield curve range between -1.1 bp (2-yr) and +1.1 bp (10-yr). The German yield curve bull flattened with yields sliding 7.2 bps (2- yr) to 1.9 bps (30-yr). The euro didn’t really mind the relative loss of interest rate support with EUR/USD and EUR/GBP closing broadly flat at respectively 1.0956 and 0.8399.

The Fed will start its interest rate tightening cycle tonight by delivering a 25 bps rate hike. Some Fed governors suggested a 50 bps inaugural move, but Fed Chair Powell earlier this month told lawmakers that uncertainty and market volatility related to the Russian invasion in Ukraine meant that the US central bank shouldn’t become a source of additional market stress. He nevertheless suggested that >25 bps steps could be a possibility later in the cycle if warranted by inflation (expectations) and/or the tight US labour market. The new Summary of Economic Projections is expected to show yet another upgrade to inflation forecasts but focus will turn to governors thoughts on the future interest rate path (dot plot). Markets currently discount the equivalent of 25 bps rate hikes at every remaining Fed meeting this year (7 including today). We think that the Fed will show readiness to more or less walk that line. Apart from this year’s projections, the key question will be on where Fed governors see the terminal rate. The market currently discount a neutral top just under 2.5% at the end of 2023. Will the Fed be more hawkish in this respect by signaling readiness to apply a restrictive monetary policy stance (exceeding the 2.5% neutral rate)? Apart from the guidance on interest rates, there’s the second important pillar of the Fed’s normalization plans: running down the balance sheet. The US central bank indicated that this process would start shortly after raising interest rates, but provided little intel on the pace and target of the current $9tn balance sheet. We think the Fed could delay any such detailed plans for its May or June meeting, in line with Powell’s guidance not to become a source of additional market stress. From a market point of view, we don’t expect any significant correction yet in core bond sell-off. If the focus turns to interest rates rather than the BS run-off, this implies a further bear flattening of the curve. While the European central bank last week finally gave some backing for the euro medium term, we think the dollar can take the upper hand short term. Because of a hawkish Fed, fragile risk sentiment and ongoing tensions in Ukraine. The YTD low at EUR/USD 1.0806 is the final reference ahead of the March 2020 low (1.0636).

News headlines

Sarah Bloom Raskin withdrew as President Biden’s nominee to be the Fed’s vice chair of supervision yesterday. She faced stiff Republican opposition ever since her nomination in January. But Raskin’s chances for what is seen as the most powerful banking regulator post really diminished significantly after Senator Manchin from the Democratic Party announced he wouldn’t support her in the 50-50 split Senate. Biden hasn’t come up with an alternative candidate yet. The post may even remain open heading into the US midterm elections in November.

Australian house prices rose 4.7% q/q in the last quarter of 2021. That’s slightly down from the 5% the quarter before but more than the 3.5% expected. The year-on-year rise hit a new record with 23.70% (up from 21.70% in Q3) since recording began in 2003. From the eight capital cities, Brisbane (9.6% q/q) and Adelaide (6.8%) registered the biggest increases. “Days on market fell and sales transaction volumes increased”, the statistics bureau said, referring to record low interest rates and ongoing strong demand to have supported growth in property prices.

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