Weekly focus: The Fed preparing to hike

Financial markets saw a shake-out early this week on the back of the more hawkish Fed, now signalling a rate hike already in March when tapering of asset purchases is done. US 10-year bond yields continued to rise to 1.8% and stock markets took a dive. Money markets now price close to 100% probability of four hikes from the Fed this year, which seems fair. However, calm was restored in the middle of the week after Fed governor Jerome Powell argued that the Fed would be able to tame inflation and that it could happen without too much damage to the economy. But yesterday stocks took a dive again in response to hawkish comments from more Fed members.

Another new high in US inflation in December at 7.0% y/y, the highest level since June 1982, was digested fairly well by markets. The increase was in line with consensus but core inflation surprised slightly to the upside rising to 5.5% y/y (consensus 5.4% y/y) from 4.9% y/y. The muted market reaction to the number would suggest that high inflation is to a wide extent already expected by the market. We look for inflation to stay high in the short term as for example the latest increase in used car prices in the US is not yet fully factored into CPI. The same goes for the CPI shelter component. But from Q2 22 we expect price increases to gradually taper off. Inflation is set to be high for all of 2022, though, and with the tightest US labour market in decades the Fed needs to act to rein in inflation.

Despite the hawkish turn of the Fed, EUR/USD moved higher this week. It has been looking technically oversold for a while and with investors still being long USD, there seems to be some profit taking on this trade. However, we see scope for USD turning stronger again as the Fed departs on its hiking journey in a few months.

In China inflation pressures are easing as producer prices (PPI) saw the biggest monthly drop (-1.2% m/m) since April 2020. The decline is due to lower commodity price inflation; we believe this will soon lead to a peak in PPI and headline CPI in US and Europe as well. Falling inflation pressure leaves room for PBOC to ease policy further in coming months.

Omicron continues to drive big waves of Covid around the world. But there are also signs of a peak in some European countries and the Northeastern US states that have been hit the worst. It adds to hope that Omicron will not overwhelm hospitals and could mark the end of the pandemic as we know it. Of course, the risk of new mutations also still looms.

Talks between Russia and US/NATO this week did not change much. Russia stated yesterday that they regarded the talks as unsuccessful but had the will to continue talks. In the paper Research Russia – Expect serious market disruptions if a war breaks out, 14 January, we look at different scenarios for the conflict.

The coming week looks to be fairly uneventful. China kicks off the week with GDP for Q4 on Monday as well as industrial production and retail sales. They will likely confirm that Q4 was weak. We look for a cut in China’s policy rate. In the US we get regional business surveys (Philadelphia and Empire) and in Europe, we expect to see the German ZEW and Euro consumer confidence to decline due to the triple headwinds of Covid outbreaks, supply bottle necks and an erosion of household income from the high inflation, see Euro Macro Monitor – Tripple headwinds, 10 January 2022. On Thursday, the Turkish central bank may cut rates.

Download The Full Weekly Focus