Sive Morten
Special Consultant to the FPA
- Messages
- 18,659
Fundamentals
No doubt this week markets have got a few surprises that have led to volatility boost across the board. The first one is the ECB statement, of course, that was absolutely unexpected. Second is a strong NFP report, not only for January but also for Dec numbers strong upward revision. Additionally, we would say that wage growth was above expectations once again leading to more speculation around faster Fed rate hike, even in March.
Market overview
The dollar declined to a more than a one-week low on Wednesday after data showed a drop in U.S. private sector employment in January due to the increase in COVID-19 infections. However, the data is unlikely to prevent the Federal Reserve from hiking interest rates at the March 15-16 policy meeting. But the report has eased expectations of a large interest rate increase of half a percentage point.
In contrast, the euro gained for a third consecutive day, coming off a 20-month low last week, as eurozone inflation rose to a new record high last month. That fuelled bets the European Central Bank could raise interest rates sooner than expected.
Fed officials this week also backtracked on some of the central bank's hawkish comments, pushing the dollar lower. Although they said the Fed would raise interest rates next month, these officials have all but ruled out a 50-basis-point increase in the benchmark overnight interest rate in March and will keep their options open after that. Even St. Louis Fed President James Bullard, a voter this year on the policy-setting Federal Open Market Committee and one of the more hawkish Fed officials, also pushed back against a larger rate hike in March, noting that markets have on their own started to push up borrowing costs already.
In the euro zone, markets are expecting the ECB to turn hawkish after an annualized inflation number of 5.1% in January, up more than twice the ECB's 2% target.
The U.S. dollar will reign supreme for at least another 3-6 months, a Reuters poll of strategists found, saying it will take a significant change in market expectations for Federal Reserve rate hikes to push it higher. Indeed, while the dollar was not expected to make any significant headway from current levels, it was forecast to hold onto most of its impressive gains from 2021, according to the Jan. 31-Feb. 2 Reuters poll.
Multi-decade high inflation in the United States and swathes of the rest of the world has prompted the Fed and other central banks to dial back some of the stimulus measures enacted during the COVID-19 pandemic.
Over 75% of respondents to an additional question, 33 of 43, said the dollar's dominance would last at least another 3-6 months. Among those, 14 said that specific time period, 11 said 6-12 months and eight said more than a year.
Asked how many additional basis points of Fed tightening need to be priced in for this year for the dollar to trade significantly higher, 24 analysts returned a median of 62.5 basis points. That was on top of the roughly 125 basis points currently priced in for the year.
Federal funds futures imply U.S. interest rates will peak at just 1.75%-2.0% in the current cycle. That was lower than the 2.25%-2.50% economists predicted in a separate Reuters poll last month.
The euro was forecast to erase some of its losses for the year and gain over 1.5% over the next 12 months. Those gains would still fall short of recouping an almost 7% loss against the dollar last year.
The euro surged to a three-week high against the U.S. dollar on Thursday after comments from European Central Bank President Christine Lagarde fuelled expectations of faster policy tightening, as she focused on the prospect of eurozone inflation overshooting. She also did not repeat previous comments that interest rates in the region were not likely to rise this year.
Lagarde acknowledged on Thursday that eurozone inflation was running hotter than expected, with risks tilted to the upside. She also said the ECB, which left policy rates unchanged at Thursday's meeting, would not rush into new moves. When asked if the ECB was "very unlikely" to raise rates this year, Lagarde said it would assess conditions very carefully and be "data-dependent."
Eurozone money markets are currently pricing an 80% chance of a 10 basis-point hike in June and an almost 100% chance of 40 bps of hikes by year-end, from a 90% chance of 30 bps hikes before Lagarde's press conference.
(Lagarde comments at ECB press conference)
The U.S. dollar advanced from two-week lows on Friday after data showed the world's largest economy created far more jobs than expected, raising the chances of a larger Federal Reserve interest rate increase at the March policy meeting. Data showed U.S. nonfarm payrolls grew 467,000 jobs last month. Data for December was revised higher to show 510,000 jobs created instead of the previously reported 199,000.
Market participants were prepared for a weaker-than-forecast reading given the decline in the ADP U.S. private payrolls report released earlier this week. That report showed a decline due to the impact of the Omicron coronavirus variant.
Average hourly earnings, a measure of wage inflation and a closely-watched metric, also rose 0.7% last month, and 5.7% on a year-on-year basis.
In the afternoon session, U.S. rate futures implied more than five rate hikes this year, or about 134.4 basis points in policy tightening. The probability of a 50 basis-point increase next month rose to nearly 40%, from just 18% before the data release.
The Conclusions
So, we have very important new inputs, mentioned above. If we group different questions on this subject, we actually should get two major concerns - whether ECB raises rates later in the year and whether Fed is ready for a more aggressive rate change, starting in March. And, in general, whether EUR/USD remains in favor of the latter or starts to change through the year.
Let's first take a look at the ECB surprise. First is, we should not overvalue this event. Just because the reaction was too emotional while background brings not a lot of changes. It's done nothing yet, only rhetoric provided, but the market already jumped for 100 pips. Definitely, some emotional steam should be out of the pot to get a fair EUR price.
Investment banks brought forward their calls on European Central Bank interest rate hikes after a hawkish turn from the ECB that opened the door to the possibility of increased borrowing costs this year. Sources told Reuters after the meeting that a decision to dial back stimulus now looked likely in March, starting with a faster-than-expected wind-down of the bank's bond purchases, which according to ECB guidance need to end before rate hikes. Policymakers would decide in March to end the asset purchase programme by June and raise its deposit rate by 25 bps each in September and December, they forecast.
Goldman Sachs analysts said on Friday that they expected the ECB to raise interest rates by 25 bps each in September and December, putting the bank's policy rate at 0% by the end of the year. After two hikes this year, Goldman Sachs expected a pause until June 2023, followed by hikes every six months until a terminal rate at 1.25% in June 2025.
Deutsche Bank, BNP Paribas, BofA, and Commerzbank also amended their forecasts late on Thursday to expect lift-off to start in September with two, 25 basis-point hikes by the end of the year, and expecting bond purchases to end in the second or third quarter. BNP Paribas expected a further two hikes in 2023, with potential for further policy tightening thereafter. Deutsche Bank expected rates at 1% before end-2024. Commerzbank expected rate hikes to pause next year and only resume in the second half of 2024.
Others, such as JPMorgan and Danske Bank, were slightly more cautious, expecting only one 25 bps rate hike in December. ING and Citi economists also said they saw room for one rate hike this year.
Eurozone companies expect wages to rise by 3% or more this year as workers demand to be compensated for inflation and it becomes more difficult to find staff such as builders and software engineers, the European Central Bank said on Friday. Wage growth is a crucial indicator for the ECB in assessing the future path of inflation and setting the timing of what would be its first rate hike in over a decade.
"The case for higher wages is extremely good as we are seeing tighter labour markets in places like Germany and the Netherlands. The question is whether it will be a one off?" said Piet Haines Christiansen, chief strategist, Danske Bank.
What about the Fed?
The Federal Reserve can move sooner to start reducing its bond holdings than in the past and aggressive action to shrink the U.S. central bank's portfolio could allow it to take a shallower path on interest rate increases, Kansas City Fed President Esther George said on Monday.
George said a different approach in which the central bank pairs a "steep path" for rate increases with more modest reductions to the balance sheet could lead to more financial risks. She said such a scenario where the Fed is raising short-term interest rates while maintaining a large balance sheet "could flatten the yield curve." That could, in turn, lead to "reach-for-yield behavior from long-duration investors."
The world's top central banks are about to embark on "the largest quantitative tightening in history", analysts at Morgan Stanley said on Friday, estimating that $2.2 trillion worth of support would disappear over the next 12 months.
But the real rethink is still coming around what happens after this year. Longer-term futures prices that show the peak in short-term interest rates around the winter of 2024/25 have now slipped back below 2% - a full 50 basis points below where the Fed sees this so-called "terminal rate" and almost 20 bps off January's highs.
The "real" inflation-adjusted 10-year Treasury yield has also dropped back from pre-pandemic levels and shed almost 25bp in less than two weeks to -0.75%. And that yield has not been positive on a sustained basis since before COVID hit.
And aside from the eurozone, where the least amount of tightening is priced for this year, 2-to-10 year yield curves - the gap between yields on both maturities and often seen as a harbinger of growth or recession ahead - are flattening fast.
Investors say where the dollar goes from here will be determined in part by real yields, or what a holder of U.S. government bonds expects to receive adjusted for inflation - which has eased in recent days after surging last month.
Rising real yields tend to boost the dollar’s allure to investors and have been a source of support for the greenback in the past. Though they have come off recent highs in the last few days, some are betting real yields will continue rising in the months ahead if the Fed maintains its hawkish stance, dragging the dollar higher.
Most currencies will struggle to gain against the dollar in the coming months, as monetary tightening expected from the Fed will provide the greenback enough impetus to extend its dominance well into 2022, strategists polled by Reuters said.
Thanos Bardas, senior portfolio manager at Neuberger Berman, expects the yield on 10-year TIPS to reach 0% over time, from an average of -1% over the last 18 months of so. The dollar typically rallies versus other currencies during this adjustment," Bardas said. Bardas, like other investors, is also watching the difference between the yields in the United States and those in other major economies to get a clue on the dollar’s direction.
On Wednesday, the gap in the U.S. and German 10-year government bond real yields stood at about 115 basis points in the dollar's favor, close to the widest it has been since March 2020.
There are still 2.8 million fewer jobs than before the pandemic hit the U.S. economy in March 2020, but the jobs gap is narrowing steadily.
To St. Louis Federal Reserve President James Bullard, one of the Fed's most strident supporters of earlier and faster policy tightening, it wasn't clear what starting with a bigger bang would accomplish. Since late last year markets have been tightening financial market conditions on their own, anticipating Fed actions that have not been taken yet. The yield on the benchmark 10-year Treasury note rose Friday to 1.9%, the highest it's been in over two years.
At this point "It is not clear what you are buying with a 50 basis point move," Bullard told Reuters Tuesday. "In a way, we have done a lot of the work already and I am not sure it behooves us to do a dramatic funds rate increase" in March. But the January data might cause the Fed to reassess somewhat. Policymakers had expected the recent surge of coronavirus cases to at least slow hiring. Instead, the economy powered through and wages continued rising.
Others agreed.
To be continued...
No doubt this week markets have got a few surprises that have led to volatility boost across the board. The first one is the ECB statement, of course, that was absolutely unexpected. Second is a strong NFP report, not only for January but also for Dec numbers strong upward revision. Additionally, we would say that wage growth was above expectations once again leading to more speculation around faster Fed rate hike, even in March.
Market overview
The dollar declined to a more than a one-week low on Wednesday after data showed a drop in U.S. private sector employment in January due to the increase in COVID-19 infections. However, the data is unlikely to prevent the Federal Reserve from hiking interest rates at the March 15-16 policy meeting. But the report has eased expectations of a large interest rate increase of half a percentage point.
In contrast, the euro gained for a third consecutive day, coming off a 20-month low last week, as eurozone inflation rose to a new record high last month. That fuelled bets the European Central Bank could raise interest rates sooner than expected.
Fed officials this week also backtracked on some of the central bank's hawkish comments, pushing the dollar lower. Although they said the Fed would raise interest rates next month, these officials have all but ruled out a 50-basis-point increase in the benchmark overnight interest rate in March and will keep their options open after that. Even St. Louis Fed President James Bullard, a voter this year on the policy-setting Federal Open Market Committee and one of the more hawkish Fed officials, also pushed back against a larger rate hike in March, noting that markets have on their own started to push up borrowing costs already.
In the euro zone, markets are expecting the ECB to turn hawkish after an annualized inflation number of 5.1% in January, up more than twice the ECB's 2% target.
The U.S. dollar will reign supreme for at least another 3-6 months, a Reuters poll of strategists found, saying it will take a significant change in market expectations for Federal Reserve rate hikes to push it higher. Indeed, while the dollar was not expected to make any significant headway from current levels, it was forecast to hold onto most of its impressive gains from 2021, according to the Jan. 31-Feb. 2 Reuters poll.
Multi-decade high inflation in the United States and swathes of the rest of the world has prompted the Fed and other central banks to dial back some of the stimulus measures enacted during the COVID-19 pandemic.
Over 75% of respondents to an additional question, 33 of 43, said the dollar's dominance would last at least another 3-6 months. Among those, 14 said that specific time period, 11 said 6-12 months and eight said more than a year.
Asked how many additional basis points of Fed tightening need to be priced in for this year for the dollar to trade significantly higher, 24 analysts returned a median of 62.5 basis points. That was on top of the roughly 125 basis points currently priced in for the year.
Federal funds futures imply U.S. interest rates will peak at just 1.75%-2.0% in the current cycle. That was lower than the 2.25%-2.50% economists predicted in a separate Reuters poll last month.
The euro was forecast to erase some of its losses for the year and gain over 1.5% over the next 12 months. Those gains would still fall short of recouping an almost 7% loss against the dollar last year.
The euro surged to a three-week high against the U.S. dollar on Thursday after comments from European Central Bank President Christine Lagarde fuelled expectations of faster policy tightening, as she focused on the prospect of eurozone inflation overshooting. She also did not repeat previous comments that interest rates in the region were not likely to rise this year.
Lagarde acknowledged on Thursday that eurozone inflation was running hotter than expected, with risks tilted to the upside. She also said the ECB, which left policy rates unchanged at Thursday's meeting, would not rush into new moves. When asked if the ECB was "very unlikely" to raise rates this year, Lagarde said it would assess conditions very carefully and be "data-dependent."
Eurozone money markets are currently pricing an 80% chance of a 10 basis-point hike in June and an almost 100% chance of 40 bps of hikes by year-end, from a 90% chance of 30 bps hikes before Lagarde's press conference.
(Lagarde comments at ECB press conference)
The U.S. dollar advanced from two-week lows on Friday after data showed the world's largest economy created far more jobs than expected, raising the chances of a larger Federal Reserve interest rate increase at the March policy meeting. Data showed U.S. nonfarm payrolls grew 467,000 jobs last month. Data for December was revised higher to show 510,000 jobs created instead of the previously reported 199,000.
Market participants were prepared for a weaker-than-forecast reading given the decline in the ADP U.S. private payrolls report released earlier this week. That report showed a decline due to the impact of the Omicron coronavirus variant.
Average hourly earnings, a measure of wage inflation and a closely-watched metric, also rose 0.7% last month, and 5.7% on a year-on-year basis.
In the afternoon session, U.S. rate futures implied more than five rate hikes this year, or about 134.4 basis points in policy tightening. The probability of a 50 basis-point increase next month rose to nearly 40%, from just 18% before the data release.
The Conclusions
So, we have very important new inputs, mentioned above. If we group different questions on this subject, we actually should get two major concerns - whether ECB raises rates later in the year and whether Fed is ready for a more aggressive rate change, starting in March. And, in general, whether EUR/USD remains in favor of the latter or starts to change through the year.
Let's first take a look at the ECB surprise. First is, we should not overvalue this event. Just because the reaction was too emotional while background brings not a lot of changes. It's done nothing yet, only rhetoric provided, but the market already jumped for 100 pips. Definitely, some emotional steam should be out of the pot to get a fair EUR price.
Investment banks brought forward their calls on European Central Bank interest rate hikes after a hawkish turn from the ECB that opened the door to the possibility of increased borrowing costs this year. Sources told Reuters after the meeting that a decision to dial back stimulus now looked likely in March, starting with a faster-than-expected wind-down of the bank's bond purchases, which according to ECB guidance need to end before rate hikes. Policymakers would decide in March to end the asset purchase programme by June and raise its deposit rate by 25 bps each in September and December, they forecast.
Goldman Sachs analysts said on Friday that they expected the ECB to raise interest rates by 25 bps each in September and December, putting the bank's policy rate at 0% by the end of the year. After two hikes this year, Goldman Sachs expected a pause until June 2023, followed by hikes every six months until a terminal rate at 1.25% in June 2025.
Deutsche Bank, BNP Paribas, BofA, and Commerzbank also amended their forecasts late on Thursday to expect lift-off to start in September with two, 25 basis-point hikes by the end of the year, and expecting bond purchases to end in the second or third quarter. BNP Paribas expected a further two hikes in 2023, with potential for further policy tightening thereafter. Deutsche Bank expected rates at 1% before end-2024. Commerzbank expected rate hikes to pause next year and only resume in the second half of 2024.
Others, such as JPMorgan and Danske Bank, were slightly more cautious, expecting only one 25 bps rate hike in December. ING and Citi economists also said they saw room for one rate hike this year.
Eurozone companies expect wages to rise by 3% or more this year as workers demand to be compensated for inflation and it becomes more difficult to find staff such as builders and software engineers, the European Central Bank said on Friday. Wage growth is a crucial indicator for the ECB in assessing the future path of inflation and setting the timing of what would be its first rate hike in over a decade.
"The case for higher wages is extremely good as we are seeing tighter labour markets in places like Germany and the Netherlands. The question is whether it will be a one off?" said Piet Haines Christiansen, chief strategist, Danske Bank.
What about the Fed?
The Federal Reserve can move sooner to start reducing its bond holdings than in the past and aggressive action to shrink the U.S. central bank's portfolio could allow it to take a shallower path on interest rate increases, Kansas City Fed President Esther George said on Monday.
George said a different approach in which the central bank pairs a "steep path" for rate increases with more modest reductions to the balance sheet could lead to more financial risks. She said such a scenario where the Fed is raising short-term interest rates while maintaining a large balance sheet "could flatten the yield curve." That could, in turn, lead to "reach-for-yield behavior from long-duration investors."
The world's top central banks are about to embark on "the largest quantitative tightening in history", analysts at Morgan Stanley said on Friday, estimating that $2.2 trillion worth of support would disappear over the next 12 months.
But the real rethink is still coming around what happens after this year. Longer-term futures prices that show the peak in short-term interest rates around the winter of 2024/25 have now slipped back below 2% - a full 50 basis points below where the Fed sees this so-called "terminal rate" and almost 20 bps off January's highs.
The "real" inflation-adjusted 10-year Treasury yield has also dropped back from pre-pandemic levels and shed almost 25bp in less than two weeks to -0.75%. And that yield has not been positive on a sustained basis since before COVID hit.
And aside from the eurozone, where the least amount of tightening is priced for this year, 2-to-10 year yield curves - the gap between yields on both maturities and often seen as a harbinger of growth or recession ahead - are flattening fast.
Investors say where the dollar goes from here will be determined in part by real yields, or what a holder of U.S. government bonds expects to receive adjusted for inflation - which has eased in recent days after surging last month.
Rising real yields tend to boost the dollar’s allure to investors and have been a source of support for the greenback in the past. Though they have come off recent highs in the last few days, some are betting real yields will continue rising in the months ahead if the Fed maintains its hawkish stance, dragging the dollar higher.
Most currencies will struggle to gain against the dollar in the coming months, as monetary tightening expected from the Fed will provide the greenback enough impetus to extend its dominance well into 2022, strategists polled by Reuters said.
Thanos Bardas, senior portfolio manager at Neuberger Berman, expects the yield on 10-year TIPS to reach 0% over time, from an average of -1% over the last 18 months of so. The dollar typically rallies versus other currencies during this adjustment," Bardas said. Bardas, like other investors, is also watching the difference between the yields in the United States and those in other major economies to get a clue on the dollar’s direction.
On Wednesday, the gap in the U.S. and German 10-year government bond real yields stood at about 115 basis points in the dollar's favor, close to the widest it has been since March 2020.
There are still 2.8 million fewer jobs than before the pandemic hit the U.S. economy in March 2020, but the jobs gap is narrowing steadily.
To St. Louis Federal Reserve President James Bullard, one of the Fed's most strident supporters of earlier and faster policy tightening, it wasn't clear what starting with a bigger bang would accomplish. Since late last year markets have been tightening financial market conditions on their own, anticipating Fed actions that have not been taken yet. The yield on the benchmark 10-year Treasury note rose Friday to 1.9%, the highest it's been in over two years.
At this point "It is not clear what you are buying with a 50 basis point move," Bullard told Reuters Tuesday. "In a way, we have done a lot of the work already and I am not sure it behooves us to do a dramatic funds rate increase" in March. But the January data might cause the Fed to reassess somewhat. Policymakers had expected the recent surge of coronavirus cases to at least slow hiring. Instead, the economy powered through and wages continued rising.
Others agreed.
To be continued...
