Market Briefing: The end of the beginning?
ECB & BoE hike by 50bps. But their guidance suggests they could be nearing the end of the hiking phase of this cycle.
USD rebounds. The shift in rate pricing saw European bond yields fall. EUR & GBP weakness helped the USD bounce.
AUD round trip. AUD has unwound a lot of yesterday's spike. The near-term focus is tonight's US labour market report.
Mixed fortunes across asset markets. European and US equities rose with the major indices up 1-3%. In addition to some better-than-expected US earnings results, markets have continued to digest yesterday’s US Fed meeting. The European Central Bank and Bank of England announcements and guidance overnight further reinforced the current market theme that the rate hiking stage of this cycle is in its final stages. US bond yields declined another 2-3bps across the curve (the benchmark US 10yr yield is now down at 3.39%, almost 1% below its October peak). European bond yields plunged. German and UK 10yr yields declined by 21bps and 30bps respectively. In FX, the USD index bounced back, unwinding the post-Fed weakness. EUR fell by ~1.1% from its highs to be back near 1.09, GBP underperformed, while the AUD is nearly ~1c below yesterday’s peak.
In terms of the ECB and BoE, both met expectations and delivered another 50bp rate hike. The ECB policy rate is now 3% and the BoE bank rate is at 4% (both are at their highest levels since late-2008). But for markets the focus has been on where things could go from here. The ECB provided explicit guidance that it “intends to raise interest rates by another 50bps” in March, but notably after that it will “evaluate” the path for policy. This looks to have opened the door to a pause in a few months. In the UK, the BoE also adjusted its guidance. It no longer says it will respond “forcefully”, and when coupled with the focus on the lagged effects of the hikes already in the system, much more work may not need to be done.
In our view, the end of the rate hiking cycle may only be the “end of the beginning”. Important messages from the central banks over the past 24hrs have been that while rates may soon peak it is too early to declare victory, that these high levels of rates may need to stay in place for some time to be sure inflation washes out of the system, and that given policy works with a lag the economic impacts of all the tightening hasn't fully shown up. By contrast, markets continue to assume inflation will slow quickly, economies could have a “soft landing”, and that central banks like the US Fed may begin cutting rates later this year. We think markets may be too complacent, and could be caught out over coming months by the central banks resolve given sticky inflation and/or the weakness in the activity data. In our opinion this could help the USD regain some lost ground.
Global event radar: US employment report (tonight), US Fed Chair Powell speaks (8th Feb), US CPI (15th Feb)..
A round trip for the AUD, with the post US Fed gains unwinding overnight. On net the AUD is now slightly lower so far this week (-0.4%). The AUD’s retracement, largely due to the bounce in the USD, supports our view that up near its recent highs (~0.7150) the AUD is discounting a lot of good news, and it may take something new to generate the next leg higher. Tuesday’s RBA meeting is the major upcoming AUD-centric event. We think the RBA will raise rates another 25bps, but beyond that we only foresee one more move. In our view, there is a risk that the pragmatic RBA follows the path set out by other central banks and starts to soften its forward interest rate guidance, given how much work it has already done, opening the door to a conditional pause in its hiking cycle over the next few months. As seen over the past few days, in reaction to their respective central banks dialing back their hiking rhetoric, other currencies have weakened. Something similar could occur in the AUD, if the RBA follows suit.
Ahead of the RBA, markets and the AUD also must contend with tonight’s US labour market data (12:30am). The US labour market remains very tight and wage growth is too strong to be consistent with the Fed’s 2%pa inflation target. Until the US labour market cracks, we don't think the Fed will be looking to cut interest rates. Given the way markets have been trading, we believe there are asymmetric risks to the US data. Another solid US labour report, particularly if it shows a surprise re-acceleration in wages, could shake the markets view that the Fed may lower rates later this year, generating a relatively larger positive reaction in the USD, weighing on the AUD.
AUD event radar: US employment report (tonight), RBA policy meeting (7th Feb), US Fed Chair Powell speaks (8th Feb), US CPI data (15th Feb), AU jobs data (16th Feb), RBA Gov. Lowe speaks (17th Feb), AU wages (22nd Feb), RBNZ meeting (22nd Feb).
AUD levels to watch (support / resistance): 0.6962, 0.7010 / 0.7172, 0.7220
USD/SGD has retraced ~2/3’s of yesterday’s drop to be tracking near 1.3095. The reversal in the USD, as markets factored in hiking pauses by the ECB and BoE down the track, has been the catalyst. Short-term the focus is now on tonight’s US labour market report. We see unbalanced risks in terms of potential market reaction to the data. A weaker result could exert some renewed downward pressure on the USD, however we think there could be a relatively bigger positive USD reaction if the labour market report shows conditions are still tight and wages are too high for inflation to come back down to the Fed’s target.
Beyond the short-term swings, as mentioned above, we think markets may be wrong to test the central banks resolve in terms of how long very high interest rates could be needed to definitively lower inflation, and may be complacent about the economic consequences that have yet to unfold. Over coming months we think this could see volatility re-ignite, helping the USD (and USD/SGD) rebound.
SGD event radar: US employment report (tonight), US Fed Chair Powell speaks (8th Feb), US CPI (15th Feb).
SGD levels to watch (support / resistance): 1.3009, 1.3050 / 1.3220, 1.3290
Currency Strategist - APAC
FRIDAY (3rd February)
EUR ECB Policy Meeting (12:15am)
EUR ECB President Lagarde Speaks (from 12:45am)
AUD New Housing Finance (Dec) (11:30am)
SATURDAY (4th February)
USD Non-Farm Payrolls, Unemployment (Jan) (12:30am)
USD ISM Services (Jan) (2am)
MONDAY (6th February)
AUD Retail Sales Volumes (Q4) (11:30am)
EUR German Factory Orders (Dec) (6pm)
GBP BoE Governor Bailey Speaks (7:40pm)
EUR Eurozone Retail Sales (Dec) (9pm)
TUESDAY (7th February)
AUD Trade Balance (Dec) (11:30am)
AUD RBA Policy Meeting (Feb) (2:30pm)
EUR German Industrial Production (Dec) (6pm)
WEDNESDAY (8th February)
USD Fed Chair Powell Speaks (4am)
EUR ECB’s Schnabel Speaks (4am)
*Note, all times/dates provided are AEDT