Post date: 10/01/2022 12:50
The most dramatic moves in financial markets last week took place in fixed income markets. Treasuries continue to get pummelled as the Fed steps away from the bid and no one else appears to be interested in buying them. What’s remarkable is how little the dollar has benefitted from the spike higher in both nominal and real yields, that left the 10 year Treasury flirting with two years high near 1.8%. The Euro held up remarkably well, finishing the week flat against the dollar, while sterling actually managed to eke out gains again and finish at the top of the G10 rankings. Emerging market currencies were mixed but, again, moves were not dramatic considering the turmoil in the bond market. Attention now shifts to the December inflation report out of the US, out Wednesday. Inflation reports will also be out in a number of emerging market currencies – any sign that inflation is peaking could be a catalyst for a rally. However, sentiment in the bond market is fragile after last week’s brutal sell off and another upward surprise in US inflation could test nerves there. If it were to happen, a disorderly sell off in bonds should be supportive for the US dollar, at least in the short term.
In a slow, post-Christmas week, sterling outperformed all of its major peers, still trading off the momentum of the Bank of England’s decision to lead the Big Three central banks in raising interest rates in December. The near unanimous 8-1 vote in December suggests to us that another rate hike in February now looks highly likely, with the market pricing in four full hikes over the course of 2022. This would be one of the most aggressive among all the central banks in the G10. This week is also light in macroeconomic news, aside from Friday’s November GDP data. We continue to see scope for sterling outperformance on the back of cheapo valuation and a relatively aggressive central bank.
Another month, another upside inflation surprise in the Eurozone. Contrary to market expectations, inflation rose again to hit 5% in the headline numbers and 2.6% in the core, providing further evidence that inflationary pressures are spreading also in the bloc. We think the next great shift in central bank policy will be the ECB’s recognition that policy tightening cannot wait until 2023. In this sense, Isabel Schnabel’s speech over the weekend highlighted the potential inflationary consequences of the shift to green energy, suggesting that a hawkish dissent is starting to develop within the ECB’s council. As and when the shift becomes more manifest, it could provide a strong boost for the common currency.
There were mixed signals from the two main components of the US payrolls report in December, the establishment survey (softer) and the household one (much stronger). All in all, the report suggests that the US is now close to a reasonable definition of full employment and that supply expansion will not be enough to alleviate inflationary pressures in the near term. The prospects for any sort of fiscal tightening remain remote, and this only adds to the pressure on the Federal Reserve to begin tightening policy sooner. We now expect a first hike in March, and think that four hikes throughout 2022 is a real possibility. Again, the inflation report on Wednesday remains a key focus for traders in every financial market. Expectations are for yet another increase to multi decade highs in both the headline and core numbers, and we see no reason to differ.