If The Market Panicked, Will The Fed?

10 and one 10 us dollar bill

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Overview: The higher-than-expected US CPI coupled with strong comments from the Federal Reserve's leading hawk saw a surge in interest rates, knocking stocks and lifting the dollar. Japanese markets were closed today for a national holiday, but nearly all the other equity markets in the MSCI Asia Pacific Index fell to pare this week's gains. Europe's Stoxx 600's 0.8% loss is shaving this week's gain to about 1.35%. US futures are modestly lower. Australian and New Zealand benchmark yields rose 10 bp and 8 bp respectively to play catch-up. The ECB's Lagarde and Lane argued against "hasty" action, helping to take some pressure off European bonds. However, the widening of the core-periphery spreads warns that it may be temporary. The US 10-year yield is a little softer, hovering around 2%. The two-year soared by 21 bp and is firm today slightly below 1.60%. The US dollar is trading higher against most currencies. The Australian dollar is the weakest of the majors, off about 0.5%, as the central bank governor continues to push against market expectations for the beginning of the tightening cycle. On the week, however, the Aussie, along with the New Zealand and Canadian dollars are holding on to modest gains. The South African rand and Mexican peso are resisting the pressure that is weighing on emerging market currencies. This week five of the eight strongest emerging market currencies are in Latam. JP Morgan's Emerging Market Currency Index is posting a gain of around 0.8% this week, its fifth gain in the past eight weeks. As widely expected, the central bank of Russia delivered a 100 bp hike (bringing the key rate to 9.5%). Gold is recovering from a test on $1820 and is up about 1% on the week. Crude oil is firm for a third session, but not enough to prevent March WTI from posting its first weekly loss in nearly two months. US natural gas prices are flat a little below $4 and are holding on to their biggest weekly losses since mid-December. European natgas is consolidating the week's 10.6% decline after falling nearly 12% the previous week. Iron ore fell 2% today and is up about 5% on the week. Copper is off around 2.5% to leave the red metal up 1.3% for the week after a 4.1% rise last week.

Asia Pacific

Governor Lowe of the Reserve Bank of Australia continues to resist market pressure that sees an early start to the tightening cycle. He argued that it is too early to conclude that inflation is sustainably in the 2%-3% target. Without formally accepting the average inflation target as the Federal Reserve did, Lowe argued that after a sustained undershoot, he is willing to tolerate the near-term overshoot. The risk, he says, of hiking too early would deal a blow to the labor market. On February 17, Australia reports January employment figures and economists look for a flattish report.

Next week, Japan reports Q4 GDP and the January CPI figures. The world's third-largest economy likely bounced back strongly after the Q3 Covid-induced contraction. However, new quasi-emergency measures that went into effect last month risk another contraction in Q1. The GDP deflator is expected to have fallen by about 1.3%, the third consecutive quarter of a more than 1% deflation. Similarly, the CPI report should show fewer price pressures, and more deflation when fresh food and energy prices are excluded. China reports January CPI and PPI. Both are expected to have softened.

Yesterday, the dollar tested last month's multiyear high against the Japanese yen near JPY116.35. It backed off to find support near JPY115.75, where a $750 option expires today. The greenback met resistance in Asia, where Tokyo markets were closed, around JPY116.20. The Australian dollar reversed lower after approaching $0.7250 yesterday and the retreated has continued today. The Aussie tested $0.7100 today, and support below there is seen around $0.7075. The greenback continues to trade quietly against the Chinese yuan. It is a little firmer but below CNY6.36 after reaching CNY6.3660 earlier. It is virtually flat on the week. The PBOC set the dollar's reference rate at CNY6.3681, slightly above the market projection (Bloomberg survey) for CNY6.3674. 


ECB President Lagarde and Chief Economist Lane pushed back against calls for more imminent action to combat price pressures. Some press reports have been playing up the "loss of confidence" in the ECB's forecasts. Leave aside that the EC's updated forecasts also see inflation falling back below 2%. The issue is who takes their case to the press? Those that are coming on top of the internal debate have no need. The hawks that go to the media and some lap it up as if were gospel instead of part of the internecine struggle. That said, Lagarde and Lane have not been particularly persuasive and the swaps market now prices in about 65 bp in tightening over the next 12 months. 

The UK economy grew by 1.0% quarter-over-quarter in Q4, the same as Q3 after the revision (from 1.1%). Consumption slowed from 2.9% in Q3 to 1.2% in Q4. Government spending, which was flat in Q3, increased by 1.9% in Q4. Fixed capital formation rose by 2.2%, well above expectations after falling by a revised 0.2% (from -0.9%) in Q3. The UK also reported that the expected contraction in December was less than feared, hobbled by the Omicron variant. Output fell by 0.2% not the 0.5% of the median forecast in the Bloomberg survey, helped by stronger than expected industrial production, construction, and a smaller than expected decline in services. A week ago, the market had about a 45% chance of a 50 bp hike in March and now it is about 80%.

The euro stopped 5/100 of a cent below the $1.15 level yesterday, where about 3.25 bln euros in options expire today. The single currency made a new low for the week near $1.1370. Nearby support is seen closer to $1.1350, and a break could spur a test on the $1.13 area early next week. The US 2-year premium is widening for the sixth consecutive session, and at 190 bp, it is the most since February 2020. At the end of 2019, it was near 225 bp. Sterling made a new high for the month yesterday near $1.3645 before surrendering the gains in the face of the broader greenback recovery. It found support today near the lower end of its recent range around $1.35. Nearby resistance is seen in front of $1.3580. Sterling settled at $1.3530 last week.


The higher-than-expected US CPI panicked market participants and drove the 2-year yield up a whopping 21 bp and the implied yield of the December up 26.5 bp. One inflation report that was 0.2% above the median in the Bloomberg poll is worth another 25 bp rate hike this year? The Fed's leading hawk, St. Louis Fed's Bullard talked about a 100 bp increase in rates here in H1, which implies a 50 bp move. However, it seemed like professional courtesy more than conviction deterred him from calling for a 50 bp at next month's meeting. Two other Fed officials that spoke, Barkin and Daly, seemed more measured in their remarks. That said, there is a perception that if the market has a 50 bp priced in (~86%), it makes it more likely in and of itself for the Fed to deliver it. It offers the Fed a free option, as it were. Yet, it makes it more difficult for the Fed to get ahead of expectations. At the same time, it may reinforce perceptions that the Fed is often a slave to the markets. 

The vaccine-mandate protest continues to roil Canada. The disruption is estimated to be costing Canada around CAD350 mln a day. There is some fear that a similar protest may be coming to Washington DC in time for President Biden's State of the Union speech on March 1, even though the judiciary has circumscribed the vaccine mandate on the federal level. However, the vaccine mandate may spur demonstrations in France as early as this weekend.

The new governor of Banxico led the central bank in delivering the second 50 bp hike in a row. It was widely expected, especially after the firm CPI reading above 7%. The swaps market has another 100 bp discounted over the next three months and 260 bp over the next 12 months. The next meeting is on March 24. Peru also delivered a 50 bp hike yesterday. It has raised its target rate by 50 bp for six consecutive meetings now and it stands at 3.5%. Lima's CPI rose by almost 5.7% last month after 6.4% in December

The US dollar recorded an outside up day against the Canadian dollar by trading on both sides of Wednesday's range and closing above Wednesday’s high. The greenback briefly took out the shelf in the CAD1.2650-CAD1.2660 area where about $4.9 bln in options expire today, before rallying to about CAD1.2730. Follow-through buying lifted the US dollar to almost CAD1.2755 earlier today. The CAD1.28 area has held back the greenback a couple of times in the past few weeks. The risk-off move yesterday saw the US dollar bounce from the 200-day moving average against the Mexican peso (~MXN20.35) to almost MXN20.59. Some follow-through buying lifted it to around MXN20.64 today before backing off and it looks set to fall back below MXN20.50 today. Initial support is seen around MXN20.44.

Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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