MARKET WRAPS
Watch For:
Germany GfK Survey, Italy Industrial Turnover/Orders; UK CBI Distributive Trades Survey; European Investment Bank Annual Press Conference; updates from LVMH, SAP, Deutsche Bank, Salvatore Ferragamo, Banco Sabadell, Metro, SEB, Diageo, STMicroelectronics, St James's Place, Intermediate Capital, 3i Group, Anglo American, easyJet, Anglo American Platinum, SAS, Fuller Smith & Turner
Opening Call:
A post-Powell selloff on Wall Street will likely hammer European shares on Thursday, as concerns mount about the pace of Fed interest rate rises this year. Asian stocks and U.S. futures were deep in the red, while the dollar and Treasury yields pushed higher, adding to Wednesday's hefty gains. Commodities were lower, however, with oil, gold and base metals all suffering modest losses.
Equities:
European shares are likely to slide Thursday as investors digested the possibility of multiple interest-rate hikes by the Federal Reserve this year, starting as soon as March.
The Fed's statement and subsequent news conference kicked off a wild end to the day on Wall Street. Trading was volatile again, with the major U.S. indexes reversing big early gains after Jerome Powell signaled that changes are coming to U.S. monetary policy.
While saying no final decisions have been made yet, Powell said the Fed "was of a mind" to raise the federal-funds rate at its mid-March meeting for the first time since 2018, and didn't rule out the prospect of rate increases larger than 25 basis points given the scope of the inflation challenge. Economists interpreted his comments as opening the possibility of more than four rate hikes this year.
Investors also got new, if vague, details over officials' plans to shrink the Fed's $9 trillion balance sheet, which has doubled since the start of the pandemic and represents nearly 40% of U.S. gross domestic product.
"For now, we maintain our base case for 4 hikes this year, but we now view it as a floor rather than a cap," said Aneta Markowska, chief economist at Jefferies. "The Fed did nothing to contain market expectations to 4 hikes, effectively inviting the market to price in even more."
Forex:
The dollar continued to charge higher against other major currencies, thanks to rallying Treasury yields, after the Fed hinted at an aggressive path of interest-rate hikes.
"Even if the Fed is correct in thinking that intermediate price pressures are abating on many fronts, markets will remain on edge if an inflection point in consumer inflation data is not visible soon," said Corpay Senior Market Strategist Karthik Sankaran.
"Any data that ratifies fears that the Fed's measured approach to hiking is too little--or too late-- could push short-term interest rate markets to price more aggressive rate increases in 2022, hitting equities and commodities and boosting the dollar more broadly."
Westpac said the USD Index has yet to fully price in yield support that has formed in the past several months, let alone what may be in store in the coming months.
---
BNP Paribas said if U.S. inflation picks up faster, the Fed could raise rates about six times this year. Economist Ryutaro Kono said that's up from his previous expectation of an increase every quarter.
Kono said the Fed will likely lift rates a quarter-percentage-point at a time rather than trying a bigger move such as a half-point increase. "If the Fed raises interest rates by 50 basis points or more at once, it suggests that it has fallen into a panic. It would upset global financial markets and also increase the chance of overkill."
Other Currency News:
Sterling could come under pressure as the market may be getting ahead of itself in pricing in four U.K. interest rate rises this year, said Validus Risk Management.
The Bank of England has "limited tools" to tame high inflation mainly caused by external factors including rising energy prices and supply chain bottlenecks, Validus analyst Jesus Cabra Guisasola said.
The BOE also has a history of not wanting to hike rates, having left rates unchanged between 2010 and 2013 when inflation was elevated, and it could do the same this time, he says. Coupled with uncertainty surrounding the U.K. government and risk aversion related to Russia-Ukraine tensions, sterling faces "significant headwinds" throughout 2022.
---
The Russian ruble remained under pressure as tensions between Russia and the West over Ukraine persist. on Wednesday, USD/RUB rose 1.4% to 79.9210, its highest level since November 2020.
Recent developments suggest "some form of hot conflict" is becoming likely, said TD Securities strategists. Against this backdrop, the ruble and other Russian assets have suffered losses but nowhere near close to that experienced in 2014 and 2015 following Russia's annexation of Crimea, they said.
"We think Russian assets would not sell off as much this time around, unless the worst-case scenario materializes."
Bonds:
Treasury yields extended gains in Asia after 10- and 30-year rates hit their highest in over a week on Wednesday following Jerome Powell's press conference. In addition, the 2-year yield climbed to another 52-week high.
Yields turned higher during Powell's speech even though he said policy makers haven't made any decisions on the path of future rate hikes, and that they will make final choices on shrinking the central bank's almost $9 trillion balance sheet at "upcoming meetings."
Strategists said the lack of specificity around the pace of balance-sheet runoff implies that policy makers are still working out the details
The FOMC "continued to alert markets that it would begin Quantitative Tightening," said Northeast Investors Trust Chairman Bruce Monrad. "If Quantitative Tightening will serve as an active tool to tighten financial conditions, that is a notable change compared to the passive approach to balance sheet runoff taken several years ago."
Reaction to Fed, Powell:
Powell worked hard to keep his options open for both rate rises and balance sheet reduction. But with the Fed chief pretty much locking in an increase at the next Fed meeting, he hinted that balance sheet reduction could start at the June meeting.
How? He flagged the need to debate balance sheet actions at the meeting right after a rate rise, and if that's March, then June appears to be in play for cutting back on the now $9 trillion balance sheet.
---
The Fed's new guidelines for the upcoming monetary tightening, called "Principles for Reducing the Size of the Federal Reserve's Balance Sheet, " suggest to Wells Fargo that "the Committee will not rush headlong into shrinking its balance sheet, but that it is moving closer."
Wells Fargo economist Jay Bryson expects that "the FOMC will announce at the September policy meeting that it will begin balance sheet reduction in the fourth quarter, and that the amount of run-off will accelerate over the subsequent few months."
---
Capital Economics' Michael Pearce noted that Fed officials agreed to "a short set of principles for reducing the size of the balance sheet, reaffirming that interest rates remain the main policy tool and that the FOMC wants to hold primarily Treasury securities in the longer run."
Pearce said the FOMC statement failed to give details such as caps and how quickly it will allow assets to run off. He said "the Fed is still on track to deliver four rate hikes, beginning in March, and to start normalising the size of the balance sheet by mid-year."
Energy:
Oil prices were lower in Asia after fears of a potential Russian attack on Ukraine helped lift futures Wednesday back to their highest levels in over seven years.
Goldman Sachs said it expected a limited disruption to energy flows despite the tensions, adding that historical precedent suggests sanctions to limit Russian energy exports would be unlikely. Furthermore, an impact from a possible oil or gas pipeline outage in Ukraine should be modest.
It said prices may rise just $2/bbl as a fallout of the ongoing tensions, given that only a limited quantity of undivertible pipeline volume will be affected, because Russia can reroute flows away from Ukraine and use other pipelines instead.
However, Goldman Sachs cautioned that tight inventories remained a concern, so price risks are skewed to the upside.
Metals:
Gold futures fell deeper into the red in Asia after they settled at their lowest in over a week Wednesday, following "Powell's hawkish press conference," said OANDA.
However, rising geopolitical risks remained, so "the path higher for gold is there, but it will likely be a tough grind higher," OANDA added.
Goldman Sachs said gold is likely a good hedge against geopolitical risk, as long as the event is severe enough to impact the U.S. economy, such as the 9/11 attacks or the 2003 Iraq War. The precious metal moves less when events don't have a direct link to the U.S., it said, citing examples including the annexation of Crimea and the 2005 London bombings.
"This may be due to the fact that dollar itself often acts as the safe haven when tensions arise in other parts of the world, rather than gold. But when the U.S. itself is affected investors go for gold as a hedge of last resort."
---
Base metals were broadly lower too, as traders weighed supply risks caused by the Russian tensions, said ANZ. Nickel and aluminum could be affected if tensions escalate given Russia's significant market share in these metals.
TODAY'S TOP HEADLINES
Fed Interest-Rate Decision Tees Up March Increase
The Federal Reserve signaled it would begin steadily raising interest rates in mid-March, its latest step toward removing stimulus to bring down inflation.
Fed Chairman Jerome Powell said Wednesday that the central bank was ready to raise rates at its March 15-16 meeting and could continue to lift them faster than it did during the past decade.
China Industrial Profits Rose 34.3% in 2021
(MORE TO FOLLOW) Dow Jones Newswires
01-27-22 0045ET
