Mind the ‘yield’ gap
Last week’s Federal Reserve meeting may not have brought about any immediate policy changes, but Jerome Powell’s hawkish pivot has sent a signal to the global economy that central bank support will soon run out. The Fed will almost certainly hike at least 25bps in March but will also cease adding to its arsenal of bonds—the first step towards ‘quantitative tightening’. Counterparts will certainly follow suit. This week, the Bank of England is expected to lift rates to the level at which it says could lead to it shrinking its own portfolio of debt. Meanwhile, the Bank of Canada already ended quantitative easing in October and has signalled it could tighten policy in the coming weeks.
Markets have already signposted skittishness around the impending cycle of tightening, with the MSCI World Index down nearly 8.00% this year while bond yield curves continue to flatten. Many investors are now on edge over an overshoot in tightening, although this could be necessary to combat potentially stubborn inflation. Indeed, our base case—at least for the BoE—is that the four rate hikes currently priced in for 2022 will not materialise after the likely cost-of-living crisis hits in April.
We’ll be watching closely this week for Monetary Policy Committee guidance on its inflation outlook. If it’s seen at around 2.00% by the end of the BoE’s horizon, this could be a subtle endorsement of a rapid bout of rate hikes. Conversely, any emphasis on the impending consumer squeeze will likely lead to a scaling back of expectations, more in-line with economists’ expectations of rates at 0.75% in December.
Bottom line: This morning, analysts at Goldman Sachs upgraded their Fed rate hike forecasts from four to five 25bps raises this year. Evidently, this will help support the US Dollar, which is currently treading water at around 18-month highs, but could have more profound consequences for FX hedging. If the current trend of GBP/USD and EUR/USD forward points continues to gather pace towards 2018 levels, it could present an opportunity for US Dollar buyers to lock in some cover.
The week ahead
Cable has bounced in early trade following steep declines of 1.20% last week. Sterling has found strength against the Euro, gaining 0.50% over the week as markets price in a 25 basis-point rate hike for the BoE this Thursday. The position is tentative for Sterling, as a failure to raise interest rates could create some downside pressure for the Pound. If US employment data is positive, these effects may compound. In addition to this, Sue Gray’s report into ‘partygate’ has been released, creating further noise in what is a busy week ahead. Omicron continues its retreat as case numbers fall away, and the lifting of restrictions last week paints a more hopeful picture for the economy.
- The Nationwide House Price Index m/m for January is forecast to come in at 0.70% versus a 1.00% reading last month.
- The British Retail Consortium will release the latest Shop Price Index y/y reading this Wednesday after posting a 0.80% gain last month.
- On Thursday, the BoE is due to meet to provide an update on monetary policy, a decision on interest rates, and the asset purchase programme.
- Monetary Policy Committee member Ben Broadbent will be speaking on Friday at 12:15PM.
The Euro has had yet another poor week, falling 1.70% against the US Dollar as monetary policy divergence continues to push the common currency lower. After days of political infighting, Sergio Mattarella was re-elected as Italian President for a second term over the weekend, which will keep him in power until 87 years of age. The European Central Bank will be providing updated monetary policy guidance this week. While no action is expected, many believe the window to act is narrowing as the Federal Reserve and BoE charge ahead with policy normalisation. New Coronavirus rule changes in the EU mean that travel certificates now expire after nine months, pressuring travellers to get the booster vaccine according to some outlets.
- German Retail Sales m/m for December are forecast to come in at -1.30% versus a November gain of 0.60%.
- Eurozone Consumer Price Index and Core CPI flash estimates y/y look set to fall in December to 4.40% and 1.80%, respectively, versus November prints of 5.00% and 2.60%.
- The ECB will meet this week to give its latest monetary policy update, with many expecting the same dovish outlook.
- Spanish Unemployment Change is projected to read -50.7K in January versus -76.8K in December.
The US Dollar Index climbed 1.60% last week after suggestions that the Federal Reserve may raise interest rates at every meeting this year. The Core Personal Consumption Expenditures price index also rose 4.90% in December, the fastest gain since 1983, with markets aggressively pricing tighter US monetary policy. Stock markets reversed losses felt earlier last week to close out higher in most cases; the S&P 500 added 1.70%. It’s another busy week for data, with Non-Farm Payrolls in focus for the US as the Federal Reserve continues to monitor the labour market for confirmation on normalising policy. Elsewhere, large pockets of the US population that are unvaccinated against Coronavirus continue to weigh on hospitalisations.
- ISM Manufacturing and Services Purchasing Managers' Indices are due this week, with forecasts suggesting 57.4 and 59.0 respective readings for January, down from the 58.7 and 62.0 prints previously.
- JOLTS Job Openings are forecast to come in at 10.35M for December, lower than the 10.56M November release.
- ADP Non-Farm Employment Change is projected to come in at around 210K for January versus 807K in December.
- Finally, to close out the week, Non-Farm Payrolls is set to be released. Analysts are expecting a 166K print for January and the Unemployment rate to remain unchanged at 3.90%.
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