However, the market has said that on balance Mr Powell’s speech and Q&A session is consistent with a central bank warming to the idea of four hikes this year and certainly taking two off the table.
The belief that economic “headwinds have turned into tailwinds”, has resonated and the view that since December, and the prior set of economic projections, all new information has pointed to a stronger economy is modestly hawkish at the margin. Although, if this is a surprise one has clearly not been looking at the data flow. Some have focused to a response from the chair to a question regarding catalysts to hike more than three times in 2018, to which he replied “I would say that my personal outlook for the economy has strengthened since December. And again, each member of the FOMC is going to be writing down a new set of projections and a new estimate of appropriate monetary policy as we go into the March meeting, which begins three weeks from today, and so I wouldn’t want to prejudge that new set of projections, but we’ll be taking into account everything that’s happened since December.”
Of course, there is much more to his statement and the rhetoric, but the market reaction is what we should look at above all others. The interest rate futures markets are always a great place to start and we can immediately see the January fed funds futures contract, which encapsulates pricing around the December FOMC meeting, now sitting at 2.155% relative to the December median projections from the Fed collective of 2.12%. So this tells a story of a market strongly debating four hikes now. Eurodollar futures have priced an additional three basis points (or effectively 0.03ppt) through 2019, with four additional basis points through to the end of 2020. In the bond market, we can see reasonable selling across the curve, with the 10-year now at 2.89% (+3bp). So while inflation expectations have remained anchored the result has been a move higher in ‘real’ yields, with the 10-year ‘real’ Treasury yield sitting +4bp at 76bp.
The natural derivative of the rates and fixed income markets is the FX market and we can see broad USD outperformance, with the USD basket up 0.6% and it seems logical that while we are talking about near-term hikes to quell the sugar-rush inspired by fiscal reform, longer-term rate expectations are not going markedly higher. So a Fed chair who sits more in the 3-4 hike camp is only going to spur on those positioned for a flatter Treasury curve (I still like short 2-year Treasury’s, long 30-year Treasury’s) and this removes some of the appetite to be long USDs.
Technically, we see the USD dollar index pushing 90.00, but the real focus has to be on 90.27 (the neckline of the January/February double bottom), where a closing break would target the 92.50 to 93.00 region. EUR/USD has traded lower on the Powell speech and into $1.2221, which is not a million miles from the 9 February low of $1.2205, where a break should see the pair target sub-$1.2000, with the November uptrend at $1.2070 coming into play. AUD/USD has also found sellers on the session, hitting a low of $0.7793 and again the 200-day moving average (now $0.7782) is in range and could be breached should we get a poor Aussie Q4 CAPEX report tomorrow. So all-in-all, an interesting USD reaction and the mix of USD strength and selling in US fixed income has resonated with a decent pullback in emerging markets, with the EEM ETF (Emerging Market ETF) some 2.4% lower.
US equities have struggled with the tightening of broad financial conditions, with the S&P 500 down 0.8% and where we can see all sectors within the index lower, with 77% of stocks lower on the day and volumes fairly in-line with the 30-day average. High yield (HY) credit has struggled too, and we see HY spreads widening 5bp (the HYG ETF is lower by 0.3%), while we have seen some buying of volatility and the US volatility index (or “VIX”) sits at 17.5, showing some signs the traders expect higher volatility in US equities over the coming 30-days.
We can see the Aussie SPI futures have moved in appreciation with S&P 500 futures, and our opening call for the ASX 200 (based on the fair value weighting between the cash and futures markets) sits at 6031 - so we look set for a modest 0.4% drop here. Gold stocks should find sellers, with the gold price moving inversely to the move in ‘real’ (or inflation-adjusted) Treasury yields, while energy may also struggle with US crude prices falling over 1%. Aussie financials have driven the market gains of late, but CBA’s ADR (American Depository Receipt) suggests this index heavyweight should open in-line with the ASX 200 call, while BHP is expected to drop around 1.3%. REITs should see good selling too given its bond proxy status and where Aussie bonds are likely to follow that of its US peer and we should see the Aussie 10-year moving around 4bp higher today.
Naturally, the reaction to Powell’s speech through Asia will be interesting and as things stand we are looking for the Nikkei 225 to open closer to 22,230 and the Hang Seng to test 31,000. How Chinese mainland markets track today is anyone’s guess, but the ASHR ETF (DB x-trackers Harvest CSI 300 ETF) is 3.5% lower, so someone expects weakness here.