Market Briefing: Hiking until it hurts
Fed speak. Chair Powell reiterated that inflation should fall, but the Fed still has more work to do, and that the interest rate 'peak' could be even higher.
RBA hikes again. Another 25bp rate rise, with the RBA flagging that more is expected over coming months. We see the cash rate reaching 3.85%.
AUD volatility. The 'hawkish' RBA guidance has given the AUD some support. But FX is a relative price. Rate differentials remain in the US' favour.
Markets were whipsawed a bit overnight by Fed Chair Powell. Initial comments from Powell that the “disinflation process” had started supported risk sentiment and weighed on the USD, however this largely unwound as the Fed Chair stressed that this process could take some time and that the Fed still has more work to do on the policy-front. According to Powell, it could take “well into 2024 to get inflation down close to the 2% target”, and to get there the Fed “probably needs to do further rate increases” as policy still isn’t “sufficiently restrictive”. Chair Powell reiterated that these high levels need to be in place for an extended period, and he also warned that if the strong labour market data persists, the interest rate ‘peak’ may be even higher than the Fed now predicts.
On net the US S&P500 equity market ended the day higher (+0.7%), while US bond yields and the USD were little changed. The USD index remains up near its 1-month high and is being underpinned by the lift in US interest rates. The US 10-year bond yield is now 3.67%, up ~30bps from its mid-January low. In the wake of the strong US labour market report, money markets are now factoring in the Fed funds rate to peak at ~5.15% in May. This is an extra 25bp hike compared to this time a week ago.
The Fed’s determination to win the war against inflation continues to sink in, but we think there could still be more to go. While markets are now pricing in US interest rates to peak around the Fed’s forecasts, in our view, the assumption about the interest rate cutting cycle, which is penciled in to kick off by year-end, looks too optimistic. For the US Fed to be confident inflation is on a sustainable path back down to target sticky services inflation needs to turn around. And for that to happen, the labour market needs to weaken. This could take some time to unfold, and we doubt the Fed is looking to repeat the policy mistakes of the 1970s, when it let up too soon and inflation came roaring back. As these macro tensions play out, market volatility can continue, and we think the USD can remain supported.
Global event radar: China CPI/PPI (10th Feb), US CPI (15th Feb), US retail sales (16th Feb), Eurozone PMIs (21st Feb), FOMC meeting minutes (23rd Feb).
AUD corner
AUD has experienced some RBA and Fed-induced volatility over the past 24hrs, but on net, at 0.6947 the AUD is only ~0.3% higher compared to where it started the week.
In terms of the RBA, another 25bp rate hike was delivered. This was expected and is the 9th straight meeting the RBA has raised rates. This is now the fastest tightening cycle since at least the mid-90s, and there is still more to go. A surprise for markets were the “hawkish” tinges in the post meeting statement, with the RBA stressing that its “priority is to return inflation to target”, and to ensure that happens “further increases” in rates “will be needed over the months ahead”. We expect the RBA to deliver another 25bp hike in March, with another set to follow in April or May. Our 3.85% projected peak in the cash rate is broadly in line with where the market now sits. While the tweaks in RBA rate expectations can provide the AUD with some near-term support, we think it could come through more durably on some of the crosses like AUD/NZD where we believe a range of relative fundamentals such as commodity prices and labour market trends are also in the AUD’s favour.
For AUD/USD, the RBA has more to do, but that view now looks discounted in interest rate markets. At the same time, even though expectations about how high US interest rates could go have been added to recently, we believe the market still hasn’t moved far enough when it comes to how long the very high interest rates may need to stay in place. Our judgement is that relative interest rate differentials should remain firmly in the US’ favour, limiting the extent of the rebound in AUD/USD. Additionally, over the next few months, we think the risks are tilted to the Australian economic data underwhelming as the RBA’s increasingly restrictive policy settings constrain activity across the indebted household sector. This points to further AUD volatility over the period ahead.
AUD event radar: RBA SoMP (10th Feb), China CPI/PPI (10th Feb), US CPI data (15th Feb), AU jobs data (16th Feb), US retail sales (16th Feb), RBA Gov. Lowe speaks (17th Feb), AU wages (22nd Feb), RBNZ meeting (22nd Feb), AU retail sales (28th Feb).
AUD levels to watch (support / resistance): 0.6810, 0.6856 / 0.7050, 0.7172
SGD corner
USD/SGD has held its ground, and at ~1.3245 remains ~1.6% above its recent low. The adjustment in US interest rate expectations has been the main driver underpinning the rebound in the USD (and USD/SGD).
Chair Powell’s overnight comments reiterating the Fed’s higher for longer interest rate view, and that the potential ‘peak’ in interest rates could be even higher than they now think if the US data continues to positively surprise, should reinforce the upswing that has come through in US bond yields, in our view. In turn, we think this should continue to provide support for the USD (and USD/SGD), with near-term pullbacks likely to be limited. USD volatility should pick up next week with the release of the crucial CPI inflation and retail sales data.
SGD event radar: China CPI/PPI (10th Feb), US CPI (15th Feb), US retail sales (16th Feb), Eurozone PMIs (21st Feb), FOMC meeting minutes (23rd Feb).
SGD levels to watch (support / resistance): 1.3050, 1.3110 / 1.3290, 1.3371
FX Moves
Peter Dragicevich
Currency Strategist - APAC
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