Jerome Powell delivers hawkish message

The chairman of the US Federal Reserve, Jerome Powell, as part of testimony to the US congress, suggested that interest rates might need to increase further and at a faster pace than previously anticipated. The hawkish message from Powell comes on the back of unexpectedly sticky inflation and a still-tight labour market, despite the cumulative 450bps increase in rates since the start of this tightening cycle. Markets are now expecting a 50bps rate hike at the Fed’s March 22 meeting, rather than the previously anticipated 25bps. The outcomes of two key data points, non-farm payrolls and CPI, are due to be released before the Fed’s meeting, and will be keenly watched by markets and commentators alike for further clues to the likely magnitude of the next rate hike.

Eurozone household inflation expectations fell in January according to the ECB’s inflation expectations survey. Households’ 12 month-ahead inflation expectations fell marginally, to 4.9% in the latest survey, from the 5% reported in the December survey. A more significant shift was seen in the 3 year-ahead inflation expectations measure, which declined to 2.5% in January from 3% in December. ECB officials are likely to take some comfort from the fact that expectations have declined despite recent news of higher-than-expected inflation in some of the bloc largest nations.

Data from the German Federal Statistical Office suggest that real factory orders rose 1.0% m/m in January, higher than consensus expectations for a -0.7% fall, but below the 3.4% m/m growth seen in December. There was a marked divergence between domestic and foreign orders, moving in opposite directions on the month. Domestic orders fell 5.3% m/m, while export orders rose 5.5% m/m. The relatively upbeat start to the year was driven by capital goods, including aircraft and spacecraft construction and motor vehicle engines.

Sri Lanka has cleared a significant hurdle to attaining a $2.9bn bailout from the IMF, with China (its largest creditor) indicating that it will support the nation’s debt restructuring. China’s assurances mean that Sri Lanka has the support needed from creditor nations. The IMF bailout should smooth the way for further funding.     

Today’s Economic Data and Events

• 11:00 German industrial production Jan: forecast 1.4% m/m
• 17:15 US ADP employment change Feb: forecast 200k
• 19:00 Bank of Canada rate decision

Fixed Income

• US Treasury yields soared on the back of Fed chair Jerome Powell’s hawkish commentary to the Senate Banking Committee, with the 2yr UST yield rising by 12bps to push above 5% for the first time since 2007. Yields are continuing to edge higher in early trade today, trading at 5.0485%. The 10yr yield showed more choppy action, closing the day ultimately unchanged at 3.9637%, just shy of the 4% handle. The moves in the Treasury markets helped to flatten the UST curve by 11bps to about 105bps.
• Market expectations for the March 22 FOMC meeting have now shifted to pricing a 50bps hike as a more likely outcome than the Fed repeating with another 25bps. Powell said in his commentary that the Fed may need to “increase the pace of rate hikes,” likely foreshadowing a need to move back to large hikes to tackle inflation.
• European bond markets generally closed stronger overnight with price action today to reflect the hawkishness from the Fed. The 10yr bund yield fell 5bps to 2.685% while the 10yr gilt yield closed lower by 4bps to 3.817%.
• Emerging market local currency bonds closed the day mixed with many emerging Europe bonds gaining. Yields on 10yr South African and Turkish bonds rose, however, by about 11bps each to 11.202% and 12.429% respectively.

FX

• Currency markets pulled lower against the dollar in response to the hawkish Fed tone. The broad DXY index added 1.2% overnight with much of the gain coming at the expense of EURUSD. The single currency fell by 1.2% to 1.0549, taking its losses for the year to 1.5%. GBPUSD also dropped sharply, down 1.6% to 1.183 while USDJPY added 0.9% to settle at 137.16.
• Commodity currencies also dropped in response to the hawkish tone from the Federal Reserve. USDCAD added 1% to 1.3754 while AUDUSD fell 2% to 0.6584 and NZDUSD dropped by 1.5% to 0.6107.

Equities

• Jerome Powell’s hawkish comments weighed on US equity markets overnight, with all three benchmark indices closing lower. The Dow Jones was the biggest loser, falling 1.7% on the day, while the S&P 500 lost 1.5% and the NASDAQ ended 1.3% lower.
• There was similar negativity in Europe, where the FTSE 100, the CAC, and the DAX dropped 0.1%, 0.5%, and 0.6% respectively. The composite STOXX 600 lost 0.8%.
• Locally, the ADX lost 0.5% and the DFM 0.8%. The Tadawul closed up 0.2% however.

Commodities

• Oil prices slumped along with most other risk assets in response to commentary from Fed chair Jerome Powell that suggested rate hikes would need to accelerate once again. Brent futures settled at USD 83.29/b, down 3.4% while WTI fell by 3.6% to USD 77.58/b. The OPEC secretary general, Haitham al Ghais, said that the producers’ alliance said that OPEC viewed a bifurcated oil market this year with Asia performing well while Europe and the US were slowing.
• Numbers from the API showed a drop in US crude stocks last week by 3.8m bbl though there were some modest builds in gasoline and distillate inventories.