Market Briefing: Waiting for the Fed
More positive tone to markets. A slowdown in US wages has raised hopes inflation has turned and central banks could 'pivot' soon.
US Fed meeting in focus. A smaller 25bp rate hike by the Fed is expected. But will the Fed pushback on the markets thinking rate cuts are coming in H2?
AUD volatility. AUD has swung around on the back of weak AU retail sales and softer US wages. A 'relatively' hawkish Fed could exert more pressure on the AUD.
A more positive tone to markets overnight, with US equities ticking up (S&P500 +0.9%), oil prices higher (brent crude +1.3%) and bond yields a few basis points lower. In FX, there was some intra-day volatility, with the USD’s early gains unwinding. On net, the AUD completed a round trip to be hovering near 0.7050.
In terms of the drivers, the slightly weaker than expected US Q4 Employment Cost Index was a catalyst. The ECI is a broad measure of wages and is one of the indicators monitored by the US Fed. The ECI rose 1% in Q4, pushing the annual run rate down slightly to 5.1%pa. Markets having taken this as another sign wage/inflation pressures have peaked, and that this could open the door to a ‘pivot’ by central banks, like the US Fed, in coming months.
In our view, this is a bit short-sighted. Growth in the ECI has slowed, and this is welcomed, but at its current pace wages growth is still too high and inconsistent with US inflation being at the Fed’s target. Fed Chair Powell has previously highlighted that wage growth of 3-3.5%pa is what can deliver 2%pa inflation. For wage growth to slow to these desired rates, more slack is needed in the labour market, and for that to occur an extended period of weak economic growth is typically required.
In terms of tomorrow's Fed meeting, a downshift in the pace of hikes to a 25bp move looks probable. This would take the Fed Funds target up to 4.5-4.75%, moving policy further into ‘restrictive’ territory, and cementing this as the fastest hiking cycle since the mid-80s (see chart below). Where we think markets could be surprised is around the policy outlook. This meeting isn’t a forecasting round for the FOMC, hence Chair Powell should stick to the script and reiterate the view that rates are projected to go a bit higher, and more importantly, that these higher levels are expected to stay in place for an extended period in order for the Fed to be confident inflation will slow and stay down. We think a pushback by the Fed against the idea US interest rates could be lowered later this year may ruffle a few feathers, generating some volatility and providing short-term USD support.
Global event radar: US FOMC policy meeting/Fed Chair Powell speaks (2nd Feb), ECB policy meeting (3rd Feb), US employment report (4th Feb), US CPI (15th Feb).
AUD remains on the backfoot. After briefly dipping below 0.70 for the first time in a week, some USD weakness and rebound in risk sentiment helped the AUD recover to now be little changed from this time yesterday. AUD volatility has picked up over the past 24hrs, and the upcoming US Fed and ECB meetings suggest this could continue.
Recent swings support our thinking that after its rapid rise since mid-October, near current levels the AUD has discounted a lot of good news and there are more near-term downside than upside risks. Indeed, on the local macro front, the weak December retail sales report (turnover fell 3.9%, the biggest fall since August 2020) suggests the run of rate hikes may be starting to gain traction, backing our view that the pragmatic RBA who is looking to keep things on an “even keel” is close to the end of its hiking cycle. We see further 25bp moves in February and March before the RBA pauses and shifts to assessment mode.
Attention now turns to the US Fed meeting (announcement tomorrow 6am AEDT) and Chair Powell’s press conference (tomorrow from 6:30am AEDT). As discussed, we see risks that the USD continues to recoup some of its losses if, as we expect, the Fed delivers on expectations looking for a 25bp rate hike but also pushes back on the loosening in financial conditions and the markets forecast assuming rate cuts could occur from mid-2023. A pick up in financial market volatility typically generates headwinds for the AUD (see chart below).
On the crosses, AUD/NZD (now ~1.09) has been trending higher over the past ~6-weeks. NZ labour market data is released this morning. Conditions in NZ remain tight and another positive report/low unemployment rate is forecast. That said, some of the timelier growth indicators have turned, indicating that the RBNZ's rapid rate hiking cycle is having an impact, and NZ recession risks are rising. In our view, the relative growth trajectories and commodity price outlooks point to AUD/NZD continuing to edge higher over coming months.
AUD event radar: US FOMC meeting/Fed Chair Powell speaks (2nd Feb), ECB policy meeting (3rd Feb), US employment report (4th Feb), RBA policy meeting (7th Feb), US CPI data (15th Feb), AU jobs data (16th Feb), RBA Gov. Lowe speaks (17th Feb), AU wages (22nd Feb), RBNZ policy meeting (22nd Feb).
AUD levels to watch (support / resistance): 0.6962, 0.7010 / 0.7172, 0.7220
USD/SGD remains in a holding pattern, trading in a ~0.5% range centred on 1.3140 so far this week. Markets remain focused on the upcoming US Fed and ECB meetings. The Fed announcement is tomorrow morning, and this will be followed by Chair Powell’s press conference. Another, albeit smaller and more typical 25bp rate hike by the Fed is priced in by markets.
In our view, rather than being overly fixated on the pace of rate moves, the attention should be on what is said about the outlook. And this is where we think the market’s optimism that the Fed could soon declare victory in its fight against inflation and begin to cut interest rates later this year may come unstuck. While overall US inflation looks to have topped out, we believe the tight labour market and still elevated ‘sticky’ services inflation support the case for the Fed to maintain its message that there is a bit more work to do and that interest rates may need to stay higher for longer than markets now predict. In our opinion, a relatively ‘hawkish’ message that leans against the market’s updated interest rate view may generate market volatility and/or see the USD bounce back, pushing USD/SGD higher.
SGD event radar: US FOMC policy meeting/Fed Chair Powell speaks (2nd Feb), ECB policy meeting (3rd Feb), US employment report (4th Feb), RBA policy meeting (7th Feb), US CPI (15th Feb).
SGD levels to watch (support / resistance): 1.3009, 1.3054 / 1.3220, 1.3290
Currency Strategist - APAC
WEDNESDAY (1st February)
USD Employment Cost Index (Q4) (12:30am)
AUD House Prices (Jan)
NZD Labour Market (Q4) (8:45am)
EUR CPI Inflation (Jan) (9pm)
THURSDAY (2nd February)
USD ADP Employment (Jan) (12:15am)
USD ISM Manufacturing (Jan) (2am)
USD JOLTS Job Openings (Dec) (2am)
USD FOMC Policy Meeting (6am)
USD Fed Chair Powell Speaks (from 6:30am)
AUD Building Approvals (Dec) (11:30am)
GBP Bank of England Policy Meeting (11pm)
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)
*Note, all times/dates provided are AEDT