Central bankers talk up tighter policy
Edward Bell - Senior Director, Market Economics
Published Date: 20 June 2022
- Central bankers took to public commentary at the end of week full of impactful monetary policy decisions. After hiking rates by 75bps at the June FOMC, Federal Reserve chair Jerome Powell said that the FOMC was “acutely focused on returning inflation to our 2% objective,” which may be a signal that the Fed is prepared to accept a considerable slowdown in the US economy or tick up in the unemployment rate if it brings inflation lower. Christopher Waller, a Fed governor, said the Fed was “all-in on re-establishing price stability.” This singular focus on inflation suggests to us that the Fed will continue to use heavy handed moves—such as another 75bps hike in July—to tame inflation. Indeed, Neel Kashkari, president of the Minneapolis Fed and historically one of the more dovish officials, said he could back another 75bps hike in July.
- For the European Central Bank, the focus is on ensuring that market volatility does not lead to a fragmentation of financial conditions for Eurozone members. Olli Rehn, a member of the ECB’s governing council, said the bank was “committed to contain unwarranted fragmentation,” central banker jargon for wider credit spreads in peripheral Eurozone economies. At the same time, Klaas Knot, a relative hawk on the ECB, said the bank could have to use several 50bps to bring inflation lower.
- Economic data was relatively slim at the end of what was already quite a volatile week. US industrial production rose by 0.2% m/m for May, helped higher by a 1% increase in utilities production as hot weather spurred more power demand. Manufacturing, however, was lower by 0.1% m/m. The soft data comes ahead of the aggressive hiking from the Fed in June and a further slowdown in activity could be expected in the next several months.
- The ministry of finance in the UAE announced plans for a second auction of treasury bonds on June 20th with a total size of AED 1.5bn split evenly over 2yr and 3yr maturities. The 2yr UAE treasury bond issued on May 9th settled with a yield of 3.416% at the end of last week while the 3yr closed last week at a yield of 3.57%.
Today’s Economic Data and Events
- US Treasuries sank for a third week running, according to a broad index of the securities. The large increase in rates from the FOMC and outline for further tightening over the rest of Q3 and potentially in the rest of the year as well will keep pressure on US Treasuries and continue to propel yields higher. On the 2yr UST, yields added almost 12bps last week to close out at 3.1785% while the 10yr yield gained 7bps to 3.2256%. Options markets are pricing in as many as 8 25bps hikes from the Fed by the end of the year, taking rates up to 3.6%, higher than the Fed’s own projection of 3.4% by the end of 2022 for the Fed funds rate.
- The rout wasn’t limited to the US though. European bond markets also closed sharply lower as a view of a more hawkish European Central Bank takes hold of markets. Yields on the 2yr Schatz rose by almost 11bps to 1.071% while the 10yr bund yield gained 14bps to 1.657%. In the UK, markets seem to be outpricing what the Bank of England is committed to doing with a 15bps rise in 2yr yields to 2.187% while the 10y gilt added 5bps to 2.496%.
- Emerging market bonds fell last week with a broad index of USD-denominated debt falling by 2% last week. Spreads over similar US Treasuries rose by 26bps last week to 374bps. Central banks this week include Morocco, Indonesia, Philippines, Turkey, Mexico and Egypt.
- In currency markets, the outsized hikes from the Fed eventually settled into investor views as it appeared there was some considerable profit-taking. The dollar rallied at the end of the week, helping to bring it higher against most peer currencies. EURUSD fell 0.19% last week to 1.0499 while GBPUSD dropped by 0.6% to 1.2241. USDJPY added another 0.45% last week, including a more than 2% rise on Friday alone to 135.02 as markets spurned the Bank of Japan’s persistent accommodative policy stance.
- Swiss franc was the outlier gainer against the dollar last week thanks to a surprise 50bps hike. CHFUSD fell by 1.8% to 0.9699. In commodity currencies, selling was consistent. USDCAD added almost 2% last week to close above 1.30 for the first time since early May while AUDUSD fell by 1.8% to 0.6932 and NZDUSD dropped by 0.68% to 0.6315.
- At this point it seems the less said about equity markets the better. Indexes were red across the board last week as investors absorbed the impact of much tighter monetary policy and decelerating growth. While there was some modest relief on Friday, it wasn’t enough to reverse heavy selling in US equity markets. The Dow ended the week down 4.8% while the S&P 500 closed lower by 5.8%. The NASDAQ sank by 4.8%.
- European markets also weakened with the FTSE down by more than 4% and the EuroStoxx off by 4.5%. The Hang Seng fell by more than 3.3% while the Nikkei dropped by 6.7%.
- Oil prices also ended last week lower as warnings that the market wouldn’t have enough supply in 2023 weren’t enough to push back against waning investor sentiment. Brent futures fell by more than 7% to USD 113.12/b, with much of the decline coming on Friday alone. WTI fell by more than 9% to USD 109.56/b with a near 7% drop on Friday alone. Even as front-month prices fell, time spreads still point to considerable tightness in oil markets: 1-2 month spreads in Brent closed at USD 2.73/b, not far off their close a week earlier.
- In the US, oil drillers added another 4 rigs last week to take the total oil drilling rig count to 584. While rigs have continued to move higher and higher this year, total US oil production growth has been relatively muted. Output rose to 12m b/d last week, barely above the 11.8m b/d recorded at the start of the year.
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