Post date: 09/05/2022 14:34
Interest rates are going up everywhere, hard and fast, and markets are finding it increasingly difficult to ignore the consequences. Stocks staged a relief rally in the wake of the Federal Reserve’s 50 basis point hike, but it was short-lived, and by the following day they resumed their downward trend, closing the week at the lowest levels since late-2020. The great beneficiaries of the flight to safety were the dollar and, less predictably, the euro, which benefited from the sense that the ECB’s quest to ignore the reality of inflation is finally coming to an end.
The focus in markets this week will be on April inflation data out of the US. Any sign that inflationary pressures are peaking could prompt a sharp countertrend sell-off in the dollar and rates, both of which have been rising in tandem for a while now. The euro could receive further support from hawkish commentary from ECB officials, which are starting to sense how far behind the inflation curve they have fallen.
The Bank of England managed to deliver yet another negative surprise for sterling. Last week, they hiked rates as expected, but combined the move with a uniquely downbeat message that the UK faces stagflation, and that inflation will continue to rise while the economy goes into recession later in the year. The Pound dropped sharply to end the week dead last among major currencies, in sharp contrast with the euro’s stability. We think the messaging was excessively negative, and this week’s GDP data should remain fairly positive and provide support for a currency that has become the cheapest among G10 ones, with the possible exception of the Japanese yen.
The euro bucked the general currency trend last week and managed to eke out some gains against the US dollar, making it the best performing currency in the G10 last week for the first time in a good while. No doubt the chorus of hawkish statements by ECB officials suggesting that a hike in July is a done deal and that June cannot be ruled out helped, as did the increasingly stretched market positioning, where the euro has come to be seen as a one-way bet and traders are increasingly short. Expect more ECB officials, including President Lagarde on Wednesday, to reinforce this narrative and potentially help the euro stabilise.
The Federal Reserve meeting on Wednesday provided some very short-lived relief to markets when Chair Powell appeared to take 75 basis point hikes off the table for now. However, risk assets and US Treasuries reversed course quickly and resumed their sharp sell-off the following day, and tech stocks and speculative favourites generally got pummelled for the rest of the week. The payrolls report on Friday sent the same message of the last few months: the US is at or beyond full employment, no further help will come from expanding the labour force, and wages continue to lag prices. The latest one could be a silver lining of sorts for the Fed and, should we see any signs that price pressures are peaking in Wednesday’s CPI report, as markets expect, Treasury markets could see some relief, and the relentless dollar rally could falter.