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MARKETS

Wall Street extended the sell-off on Tuesday as the benchmark U.S. Treasury yield surged to its highest level in over a month. This trend emerged as robust economic data diminished the urgency for the Federal Reserve to initiate a policy rate cut as early as March.

It's a sea of red as all three major U.S. indexes recorded declines, with mega tech growth stocks susceptible to shifts in rates markets exerting the most significant pressure on the tech-heavy Nasdaq. Furthermore, U.S. Treasury yields continued to advance, building on the recent uptick.

With doves getting their wings clipped, this week has seen a shake-up in sentiment, as a combination of factors, including a tight job market, inflation surpassing targets, resilient consumer spending, and a more hawkish-leaning commentary from the Fed indicates that central banks may not be so eager to loosen policy. Consequently, rate cut expectations are being pushed out further, dashing hopes for a New Year rally party as central banks adopt a more inflation-wary stance.

The impact of Fed Waller's comments, stating that there is "no reason to move as quickly or cut as rapidly as in the past," continues to resonate across financial markets. Additionally, a stronger-than-expected U.K. Consumer Price Index (CPI) print has left the market less convinced that a rate cut by the Fed in March is a sure-fire bet. And the recent above consensus retail sales release in the U.S. only emphasizes the shifting tide.

When the entire market goes off script, you end up with these volatile sell-all inflection points. Suddenly, the ambiguity from Fed speakers moves to the forefront, creating more drama and leaving sentiment swaying at the mercy of the next random gust of information. But what a difference a few days makes.

Overenthusiastic markets appear to have fallen hook, line, and sinker to their own impending rate cut narrative so much that they swiftly brushed aside an upward surprise in the headline U.S. inflation. Instead, traders redirected their rate-cut enthusiasm to a downward surprise on producer price reports, intensifying dovish bets on the Federal Reserve's actions.

The reaction wasn't entirely unfounded—core U.S. inflation is seemingly in check, which holds significance for the Fed; hence, the positive outcome of the release of the Producer Price Index (PPI) was considered good news. However, whether it was good enough to warrant a 25 basis point cut in March, accompanied by an escalation in rate-cut bets, is now a contention, and it may continue to be right up to the next inflation print as rate-cut cards get selected and discarded in the ultimate high-stakes game of gin rummy.

In conclusion, the Federal Reserve appears to be setting a higher bar for rate cuts than the market initially anticipated. However, prevailing sentiment suggests that the path of least resistance for the Fed is leaning toward rate cuts mid year. The key uncertainties revolve around the pace of cuts and, perhaps significantly, the timing of such monetary policy adjustments.

OIL MARKETS

The recent market sell-off, triggered by investors adjusting their expectations for near-term rate cuts from the Federal Reserve, has been further compounded by structural challenges facing China, the  world's second-largest economy. These challenges include inadequate domestic consumption, a lack of stimulus, and a persistent property crisis. Despite these headwinds, the oil market remains bid as cross-asset traders feel compelled to hedge amid a turbulent wave of attacks and reprisals in the Middle East this week, raising concerns about the potential for a broader regional conflict.

FOREX MARKETS

U.S. 10-year yields extended their rise overnight, with the Japanese Yen (JPY) experiencing the impact of widened interest rate differentials, as it traditionally does. This condition may keep USD/JPY supported for a period, but the situation is entering a possible volatile window with an upcoming crucial Bank of Japan (BoJ) meeting. The potential for a weaker JPY could lead to speculation and stories about possible changes in BoJ Yield Curve Control (YCC) policy. It perhaps could act as a deterrent for speculators from aggressively pushing USD/JPY higher at its current elevated levels.

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