Sive Morten
Special Consultant to the FPA
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Fundamentals
Markets prepare to the Fed meeting next week, and CPI numbers this week has become the major driver probably. ECB statement was unsigned, but situation for EUR could change if EU approves bond-issue programme to finance government support to the economy. Next week, beyond the Fed meeting, we also get important data of PPI and Retail Sales. Currently the US population loyalty to rising inflation is challenging and people start loosing patience.
Market overview
The U.S. dollar rose on Monday, lifted by safe-haven flows, as investors weighed the effects on global economic growth of oil prices that hit 14-year highs after the United States and European allies considered banning Russian crude imports.
According to Goldman Sachs, a sustained $20 oil rise shock would lower real economic growth in the euro area by 0.6% and by 0.3% in the United States. But in a more adverse scenario if Russian gas shipments via Ukraine were curtailed, then euro area GDP could fall by as much as 1% from gas alone.
Potentially more damaging for European banks in the longer run are the risks of delayed central bank rate hikes, dwindling prospects of returning excess capital to shareholders, and the threat of stagflation, whereby prices rise as growth stalls.
That hurts banks because higher benchmark rates help them generate greater profits on the spread between rates charged on lending and those paid out to depositors. A likely freeze on corporate fundraising could also hit banks, such as Barclays and Deutsche Bank, which have significant capital markets businesses.
Global financial conditions have reached their tightest since May 2009, according to a widely watched Goldman Sachs index, a possible sign of a world economic slowdown. Financial conditions reflect the availability of funding in an economy and, perceived as strongly correlated with future growth, are watched closely by central bankers. How loose or tight they are dictates spending, saving and investment plans of businesses and households.
Goldman's index rose to 100.92 points as of Thursday, 130 basis points tighter than before February 24th.
The tightening is an unwelcome development for a world economy already threatened by the knock-on effect of surging commodity prices and supply chain setbacks.
Goldman Sachs, which uses metrics such as exchange rates, equity swings and borrowing costs to compile the most widely used financial conditions indexes, has in the past shown a 100-basis-point tightening in conditions crimps growth by one percentage point in the coming year.
Richard McGuire, head of rates strategy at Rabobank, expects conditions to tighten further.
None of the metrics Goldman tracks signal relief. The dollar is near two-year highs, world stocks have fallen more than 10% this year and companies' borrowing costs are sharply higher as investors assess the hit to companies' profits.
The euro retreated from its overnight gains on Thursday following the European Central Bank's announcement it will phase out its stimulus in the third quarter, while the dollar strengthened after a strong U.S. inflation report. The statement from the ECB, which left the door open to an interest rate hike before the end of 2022 as soaring inflation outweighs concerns about the fallout from Russia's invasion of Ukraine, briefly sent the euro higher, before market sentiment turned negative.
The European Central Bank will stop pumping money into financial markets this summer, it said on Thursday, paving the way for an increase in interest rates as soaring inflation outweighs concerns about the Russia - US conflict. While a handful of policy doves at Thursday's meeting argued the war justified a pause for thought, they were outnumbered as worries about inflation, which hit a record 5.8% in February and is seen rising further, dominated the debate.
While the bank announced modest growth downgrades for this year and next, it ramped up inflation forecasts more strongly and now expected price growth of 5.1% this year, 2.1% next year and 1.9% in 2024. This fulfils the only outstanding condition that the ECB has set for its first rate hike in over a decade, namely that inflation is seen stable at its 2% target.
Indeed investors ratcheted up their bets on rate hikes after the ECB's decision and now expect it to increase its rate on deposits by nearly 50 bps by the end of the year. This would take it back to zero after eight years in which banks were charged for parking their idle cash at the ECB.
The bank confirmed plans to wrap up its 1.85 trillion euro Pandemic Emergency Purchase Programme at the end of the month and said purchases under the older and stricter Asset Purchase Programme (APP) will be smaller than previously planned. It said any adjustments in interest rates would take place "some time" after the end of asset buys, a change from the previous formulation that purchases would end "shortly before" a rate move.
In a Reuters poll, nearly two-thirds of respondents said the APP would be shut by end-September, with nearly half saying it would be in that month. The euro quickly firmed on the ECB decision, seen as a modest victory for conservative policymakers, and bond yields rallied.
Geopolitical turmoil may be setting the stage for more gains in the dollar, upending investor expectations for a weaker greenback as geopolitical uncertainty and worries over European growth raise the U.S. currency’s appeal. The U.S. Dollar Currency Index , has surged 3% year-to-date to its highest level in 21 months, buoyed in part by investors seeking shelter from market volatility that has hammered stocks across the globe and fueled wild swings in commodity prices. Russia calls its actions in Ukraine a "special operation."
How much further it runs may depend on the paths taken by the Federal Reserve and European Central Bank in their efforts to normalize monetary policy. While investors are betting the Fed will likely push through several rate increases this year to fight surging inflation, many believe the ECB faces a tougher slog, with soaring raw materials prices posing a greater threat to Europe’s energy-dependent economy. Bets on a widening gap in yields between the U.S. and euro zone have helped drag the euro near its lowest level against the dollar in more than two years.
While Leve had started the year expecting the euro to strengthen at the dollar’s expense, he has now trimmed exposure to European equities and is looking to hedge euro currency risk.
A sustained rise in the dollar could have broad implications for markets and the U.S. economy. Though a strong currency tends to weigh on the profits of domestic exporters, it could also help the Fed tame inflation, which recently logged its largest annual increase in 40 years. Conversely, a weaker euro could exacerbate already high consumer prices in the euro zone.
Markets are pricing the fed funds rate to rise by more than 165 basis points in the U.S. this year, starting with a widely anticipated increase at next week’s Fed meeting. ECB rate hike expectations firmed on Thursday, with markets pricing around 43 basis points' worth of interest rate hikes this year. Analysts at Nuveen said earlier this month that a Brent crude price of $120 per barrel would sap two percentage points from growth off the euro zone, compared to one percentage point from the United States, due in part to the country's greater domestic energy supply and lower taxes.
"There is much more fear on this side of the pond, and I think that's going to reflect itself in the ECB," Aashish Vyas, investment director at Resonanz Capital, a Frankfurt-based hedge fund investment advisor.
Robin Brooks, chief economist at Institute of International Finance, wrote earlier this week that the euro can fall below $1.00 as markets adjust to "a major adverse shock to the euro zone." The currency recently traded at $1.0987.
Some believe dollar strength will moderate later this year.
A report that the European Union may soon announce a plan to jointly issue bonds to finance energy and defense spending could be a boon for the euro and mark a turnaround for the single currency, after it dropped to its lowest level in almost two-years against the U.S. dollar. Bloomberg News reported on Tuesday that the EU may unveil a plan as soon as this week to jointly issue bonds to finance spending on a potentially massive scale as the region struggles with the fallout from Russia’s invasion of Ukraine.
An “appropriate package” was agreed to, it could boost the single currency in three ways.
Americans are giving President Joe Biden a break on inflation. War in Ukraine has led U.S. citizens to say they can stomach higher gasoline prices. But this new tolerance may not last. The consumer price index jumped 7.9% in the year to February reaching a 40-year high, the Labor Department said on Thursday. Gas accounted for almost one-third of monthly increases for all items.
That's usually a hot button for Americans. But nearly 80% of them support a ban on Russian oil imports even if it means higher energy prices, according to a recent Wall Street Journal poll. Biden got a 7-point bump from February to approval by 47% of voters in a survey last week by NPR/PBS Newshour/Marist.
One problem, though, is that the latest whopping inflation number predates the start of Russia's assault. In the two weeks since then, commodity prices have soared again, encompassing wheat, fertilizer and cooking oil in addition to oil and gas. As everyday items become more expensive, Americans may not be so forgiving.
U.S. consumer prices surged in February, forcing Americans to dig deeper to pay for rent, food and gasoline, and inflation is poised to accelerate even further as Russia's war against Ukraine drives up the costs of crude oil and other commodities. Lower-income households bear the brunt of high inflation as they spend more of their income on food and gasoline.
Prices for fruit and vegetables increased by the most since March 2010, while the rise in the cost of dairy and related products was the largest in nearly 11 years. Last month's CPI data does not fully capture the spike in oil prices following the outbreak of the war in Ukraine. Prices shot up more than 30%, with global benchmark Brent hitting a 2008 high at $139 a barrel, before retreating to trade around $112 a barrel on Thursday.
Soaring inflation is wiping out wage gains. Inflation adjusted average hourly earnings fell 2.6% on a year-on-year basis in February, the Labor Department said. Moody's Analytics estimates that inflation at February levels was costing the average household $296.45 per month, up from $276 in January.
Economists expect the annual CPI rate will peak above 8% in March or April and start to slow in the following months as the high readings from last spring drop out of the calculation.
Despite high inflation, tighter monetary policy and the conflict in Ukraine, a recession is not expected. Demand for labor is strong, with a near record 11.3 million job openings at the end of January. Households are sitting on about $2.6 trillion in excess savings.
But U.S. consumer sentiment fell more than expected in early March as gasoline prices surged to a record high in the aftermath of Russia's war against Ukraine, boosting one-year inflation expectations to the highest level since 1981.
The third straight monthly decline reported by the University of Michigan on Friday pushed consumer sentiment to its lowest level in nearly 11 years. It said 24% of respondents "spontaneously mentioned the Ukraine invasion in response to questions about the economic outlook."
The University of Michigan's preliminary consumer sentiment index dropped to 59.7 in the first half of this month, the lowest reading since September 2011, from a final reading of 62.8 in February. Economists polled by Reuters had forecast the index falling to 61.4.
Economists said the continued slump in the University of Michigan's sentiment index was overdone relative to fundamentals and they expected the economy to continue growing.
BofA Securities in its latest research note on Wednesday highlighted liquidity strains in U.S. Treasuries. Over the last two weeks, the bank cited the wash-out of popular trades that reflect multiple rate hikes by the Federal Reserve this year, such as shorting the front-end of the Treasury curve, flatteners, as well as, shorting the belly of the U.S. TIPS market. The exit from these trades has left the Treasury market susceptible to liquidity issues, BofA said.
Aside from volatility, BofA cited the "uncertain utility" of U.S. Treasuries in portfolios given the surge in inflation. The risk-off environment has led investors to price out the more aggressive 50 basis-point hike at next week's FOMC meeting, although the rate hike cycle remains firmly on track.
BofA said 100 basis-points of tightening is clearly justified due to inflation and labor tightness. But beyond that, the bank said the rate hike path is contingent on the geopolitical state of the world, reflecting a Fed response that may start to show concern for slower growth against an inflation backdrop that could ease over the year.
The bank noted that without a ceasefire or sharp easing of geopolitical tensions, it expects U.S. Treasury illiquidity to persist. "Fed or Treasury actions may be needed to sustain U.S. Treasury market functioning."
COT Report
Despite the tough situation around the EUR, the overall net position has not dropped miserably. Recent CFTC data shows just minor increase of bearish positions on a background of small increase of the Open Interest. At the same time, it would be correct to treat sentiment as moderately bearish, as hedgers contract positions against EUR growth.
Speculators' net long bets on the U.S. dollar edged higher in the latest week, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position was $5.44 billion for the week ended March 8. Last week, speculators' net long position stood at $5.12 billion, the lowest level since mid-August 2021.
To be continued...
Markets prepare to the Fed meeting next week, and CPI numbers this week has become the major driver probably. ECB statement was unsigned, but situation for EUR could change if EU approves bond-issue programme to finance government support to the economy. Next week, beyond the Fed meeting, we also get important data of PPI and Retail Sales. Currently the US population loyalty to rising inflation is challenging and people start loosing patience.
Market overview
The U.S. dollar rose on Monday, lifted by safe-haven flows, as investors weighed the effects on global economic growth of oil prices that hit 14-year highs after the United States and European allies considered banning Russian crude imports.
"The conflict is continuing to lead to further surges across several commodities, which is threatening growth prospects for the year," said Edward Moya, a senior analyst at Oanda. There are a growing amount of jitters that will probably keep the dollar supported, as you're going to see the U.S. economy is still nicely positioned in the short term because it's not as dependent on Russian energy supplies as Europe is," Moya said.
According to Goldman Sachs, a sustained $20 oil rise shock would lower real economic growth in the euro area by 0.6% and by 0.3% in the United States. But in a more adverse scenario if Russian gas shipments via Ukraine were curtailed, then euro area GDP could fall by as much as 1% from gas alone.
Potentially more damaging for European banks in the longer run are the risks of delayed central bank rate hikes, dwindling prospects of returning excess capital to shareholders, and the threat of stagflation, whereby prices rise as growth stalls.
Prior to the conflict, markets had priced in the European Central Bank's deposit rate rising from -50 basis points (bps) to zero by year-end. They now expect only a 20bp increase, Berenberg analyst Michael Christodoulou said.
That hurts banks because higher benchmark rates help them generate greater profits on the spread between rates charged on lending and those paid out to depositors. A likely freeze on corporate fundraising could also hit banks, such as Barclays and Deutsche Bank, which have significant capital markets businesses.
"Debt and equity issuance by clients will be put on hold until there is greater certainty, and this could negatively impact overall revenues in underwriting," said Maria Rivas, senior vice president for global financial institutions at DBRS Morningstar.
Global financial conditions have reached their tightest since May 2009, according to a widely watched Goldman Sachs index, a possible sign of a world economic slowdown. Financial conditions reflect the availability of funding in an economy and, perceived as strongly correlated with future growth, are watched closely by central bankers. How loose or tight they are dictates spending, saving and investment plans of businesses and households.
Goldman's index rose to 100.92 points as of Thursday, 130 basis points tighter than before February 24th.
The tightening is an unwelcome development for a world economy already threatened by the knock-on effect of surging commodity prices and supply chain setbacks.
Goldman Sachs, which uses metrics such as exchange rates, equity swings and borrowing costs to compile the most widely used financial conditions indexes, has in the past shown a 100-basis-point tightening in conditions crimps growth by one percentage point in the coming year.
Richard McGuire, head of rates strategy at Rabobank, expects conditions to tighten further.
"Central banks are focused on inflation rather than growth so any hope of a conciliatory stance reflective of the fact that demand is weakening is likely to be disappointed," he said. You have to brace yourself for demand destruction either delivered by central banks, which in itself tightens financial conditions, or via eroded profit margins, negative real income growth without central bank growth," McGuire said. That can cause further market selloffs, another channel through which conditions tighten, he added.
None of the metrics Goldman tracks signal relief. The dollar is near two-year highs, world stocks have fallen more than 10% this year and companies' borrowing costs are sharply higher as investors assess the hit to companies' profits.
The euro retreated from its overnight gains on Thursday following the European Central Bank's announcement it will phase out its stimulus in the third quarter, while the dollar strengthened after a strong U.S. inflation report. The statement from the ECB, which left the door open to an interest rate hike before the end of 2022 as soaring inflation outweighs concerns about the fallout from Russia's invasion of Ukraine, briefly sent the euro higher, before market sentiment turned negative.
The European Central Bank will stop pumping money into financial markets this summer, it said on Thursday, paving the way for an increase in interest rates as soaring inflation outweighs concerns about the Russia - US conflict. While a handful of policy doves at Thursday's meeting argued the war justified a pause for thought, they were outnumbered as worries about inflation, which hit a record 5.8% in February and is seen rising further, dominated the debate.
The waning impact of the coronavirus pandemic on the economy, improved labour market conditions and the prospect of an easing of supply chain bottlenecks all showed the euro area was in fundamentally healthy shape, Lagarde added.
While the bank announced modest growth downgrades for this year and next, it ramped up inflation forecasts more strongly and now expected price growth of 5.1% this year, 2.1% next year and 1.9% in 2024. This fulfils the only outstanding condition that the ECB has set for its first rate hike in over a decade, namely that inflation is seen stable at its 2% target.
"Since the ECB now sees its inflation target effectively achieved, it is likely to raise its key interest rate twice this year, by 25 basis points each time," Commerzbank's chief economist, Joerg Kraemer, said.
Indeed investors ratcheted up their bets on rate hikes after the ECB's decision and now expect it to increase its rate on deposits by nearly 50 bps by the end of the year. This would take it back to zero after eight years in which banks were charged for parking their idle cash at the ECB.
The bank confirmed plans to wrap up its 1.85 trillion euro Pandemic Emergency Purchase Programme at the end of the month and said purchases under the older and stricter Asset Purchase Programme (APP) will be smaller than previously planned. It said any adjustments in interest rates would take place "some time" after the end of asset buys, a change from the previous formulation that purchases would end "shortly before" a rate move.
In a Reuters poll, nearly two-thirds of respondents said the APP would be shut by end-September, with nearly half saying it would be in that month. The euro quickly firmed on the ECB decision, seen as a modest victory for conservative policymakers, and bond yields rallied.
"All in all, today's decisions are a good compromise, keeping maximum flexibility in a very gradual normalisation of monetary policy," ING economist Carsten Brzeski said. "A first rate hike before the end of the year is still possible."
Geopolitical turmoil may be setting the stage for more gains in the dollar, upending investor expectations for a weaker greenback as geopolitical uncertainty and worries over European growth raise the U.S. currency’s appeal. The U.S. Dollar Currency Index , has surged 3% year-to-date to its highest level in 21 months, buoyed in part by investors seeking shelter from market volatility that has hammered stocks across the globe and fueled wild swings in commodity prices. Russia calls its actions in Ukraine a "special operation."
How much further it runs may depend on the paths taken by the Federal Reserve and European Central Bank in their efforts to normalize monetary policy. While investors are betting the Fed will likely push through several rate increases this year to fight surging inflation, many believe the ECB faces a tougher slog, with soaring raw materials prices posing a greater threat to Europe’s energy-dependent economy. Bets on a widening gap in yields between the U.S. and euro zone have helped drag the euro near its lowest level against the dollar in more than two years.
"The view at the start of the year that the euro would appreciate after a couple of months of dollar strength has taken a bit of a setback," said Bipan Rai, North American head of FX strategy at CIBC Capital Markets.
"Everything that created that bullish case for the euro earlier this year now creates a very bearish case," said Eric Leve, chief investment officer at wealth and investment management firm Bailard.
While Leve had started the year expecting the euro to strengthen at the dollar’s expense, he has now trimmed exposure to European equities and is looking to hedge euro currency risk.
A sustained rise in the dollar could have broad implications for markets and the U.S. economy. Though a strong currency tends to weigh on the profits of domestic exporters, it could also help the Fed tame inflation, which recently logged its largest annual increase in 40 years. Conversely, a weaker euro could exacerbate already high consumer prices in the euro zone.
Markets are pricing the fed funds rate to rise by more than 165 basis points in the U.S. this year, starting with a widely anticipated increase at next week’s Fed meeting. ECB rate hike expectations firmed on Thursday, with markets pricing around 43 basis points' worth of interest rate hikes this year. Analysts at Nuveen said earlier this month that a Brent crude price of $120 per barrel would sap two percentage points from growth off the euro zone, compared to one percentage point from the United States, due in part to the country's greater domestic energy supply and lower taxes.
"There is much more fear on this side of the pond, and I think that's going to reflect itself in the ECB," Aashish Vyas, investment director at Resonanz Capital, a Frankfurt-based hedge fund investment advisor.
Robin Brooks, chief economist at Institute of International Finance, wrote earlier this week that the euro can fall below $1.00 as markets adjust to "a major adverse shock to the euro zone." The currency recently traded at $1.0987.
Some believe dollar strength will moderate later this year.
Steve Englander, head of global G10 FX research at Standard Chartered, believes the Fed will deliver less rate hikes than expected and the war in Ukraine will ebb, leaving the euro at $1.14 by year-end.
But in the near term, there may be a little bit more pain for the euro, said Paresh Upadhyaya, director of fixed income and currency strategy at Amundi US. Just north of parity is probably the trough in the euro," said Upadhyaya, who is maintaining a short euro position for now.
A report that the European Union may soon announce a plan to jointly issue bonds to finance energy and defense spending could be a boon for the euro and mark a turnaround for the single currency, after it dropped to its lowest level in almost two-years against the U.S. dollar. Bloomberg News reported on Tuesday that the EU may unveil a plan as soon as this week to jointly issue bonds to finance spending on a potentially massive scale as the region struggles with the fallout from Russia’s invasion of Ukraine.
“This could represent a game changer for the euro,” Citi FX analyst Vasileios Gkionakis said in a report, assuming that the news is confirmed at this week’s EU emergency summit in Versailles and that the “timing/size are prompt/meaningful.”
An “appropriate package” was agreed to, it could boost the single currency in three ways.
Firstly, it would cushion the supply-side impact on growth in the region. By cushioning growth it would also make it easier for the European Central Bank to bring forward expectations on stimulus withdrawal. Also, “on a broader basis, this would constitute another act of debt-mutualization; hence, positive for EU and euro-sentiment,” Gkionakis said.
Americans are giving President Joe Biden a break on inflation. War in Ukraine has led U.S. citizens to say they can stomach higher gasoline prices. But this new tolerance may not last. The consumer price index jumped 7.9% in the year to February reaching a 40-year high, the Labor Department said on Thursday. Gas accounted for almost one-third of monthly increases for all items.
That's usually a hot button for Americans. But nearly 80% of them support a ban on Russian oil imports even if it means higher energy prices, according to a recent Wall Street Journal poll. Biden got a 7-point bump from February to approval by 47% of voters in a survey last week by NPR/PBS Newshour/Marist.
One problem, though, is that the latest whopping inflation number predates the start of Russia's assault. In the two weeks since then, commodity prices have soared again, encompassing wheat, fertilizer and cooking oil in addition to oil and gas. As everyday items become more expensive, Americans may not be so forgiving.
U.S. consumer prices surged in February, forcing Americans to dig deeper to pay for rent, food and gasoline, and inflation is poised to accelerate even further as Russia's war against Ukraine drives up the costs of crude oil and other commodities. Lower-income households bear the brunt of high inflation as they spend more of their income on food and gasoline.
"Consumers' shock at rapidly rising gas prices at the pump will continue to put pressure on the Fed and policymakers to do something, anything, to slow down the speed at which prices everywhere are moving higher," said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance in Charlotte, North Carolina.
Prices for fruit and vegetables increased by the most since March 2010, while the rise in the cost of dairy and related products was the largest in nearly 11 years. Last month's CPI data does not fully capture the spike in oil prices following the outbreak of the war in Ukraine. Prices shot up more than 30%, with global benchmark Brent hitting a 2008 high at $139 a barrel, before retreating to trade around $112 a barrel on Thursday.
Soaring inflation is wiping out wage gains. Inflation adjusted average hourly earnings fell 2.6% on a year-on-year basis in February, the Labor Department said. Moody's Analytics estimates that inflation at February levels was costing the average household $296.45 per month, up from $276 in January.
Economists expect the annual CPI rate will peak above 8% in March or April and start to slow in the following months as the high readings from last spring drop out of the calculation.
Despite high inflation, tighter monetary policy and the conflict in Ukraine, a recession is not expected. Demand for labor is strong, with a near record 11.3 million job openings at the end of January. Households are sitting on about $2.6 trillion in excess savings.
"The cost to consumers is high," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania. "However, there are also reasons to be optimistic that consumers can weather a temporary spike in gasoline prices, as household balance sheets in aggregate are in great shape. Gasoline spending as a share of total nominal consumption is low."
But U.S. consumer sentiment fell more than expected in early March as gasoline prices surged to a record high in the aftermath of Russia's war against Ukraine, boosting one-year inflation expectations to the highest level since 1981.
The third straight monthly decline reported by the University of Michigan on Friday pushed consumer sentiment to its lowest level in nearly 11 years. It said 24% of respondents "spontaneously mentioned the Ukraine invasion in response to questions about the economic outlook."
The University of Michigan's preliminary consumer sentiment index dropped to 59.7 in the first half of this month, the lowest reading since September 2011, from a final reading of 62.8 in February. Economists polled by Reuters had forecast the index falling to 61.4.
Economists said the continued slump in the University of Michigan's sentiment index was overdone relative to fundamentals and they expected the economy to continue growing.
"The relationship between spending and sentiment is loose, particularly in the short-run, and real disposable income growth and other determinants of household budgets and finances are more important," said Scott Hoyt, a senior economist at Moody's Analytics in West Chester, Pennsylvania. "Support will also be coming from plentiful jobs and abundant available cash and credit for many. The volatility of income expectations may suggest consumers are struggling to understand how labor market tightness and inflation will impact their budgets."
BofA Securities in its latest research note on Wednesday highlighted liquidity strains in U.S. Treasuries. Over the last two weeks, the bank cited the wash-out of popular trades that reflect multiple rate hikes by the Federal Reserve this year, such as shorting the front-end of the Treasury curve, flatteners, as well as, shorting the belly of the U.S. TIPS market. The exit from these trades has left the Treasury market susceptible to liquidity issues, BofA said.
Aside from volatility, BofA cited the "uncertain utility" of U.S. Treasuries in portfolios given the surge in inflation. The risk-off environment has led investors to price out the more aggressive 50 basis-point hike at next week's FOMC meeting, although the rate hike cycle remains firmly on track.
BofA said 100 basis-points of tightening is clearly justified due to inflation and labor tightness. But beyond that, the bank said the rate hike path is contingent on the geopolitical state of the world, reflecting a Fed response that may start to show concern for slower growth against an inflation backdrop that could ease over the year.
"This...creates scope for higher structural inflation and constrains the potential response of the nominal UST curve in a risk-off dynamic," BofA said.
The bank noted that without a ceasefire or sharp easing of geopolitical tensions, it expects U.S. Treasury illiquidity to persist. "Fed or Treasury actions may be needed to sustain U.S. Treasury market functioning."
COT Report
Despite the tough situation around the EUR, the overall net position has not dropped miserably. Recent CFTC data shows just minor increase of bearish positions on a background of small increase of the Open Interest. At the same time, it would be correct to treat sentiment as moderately bearish, as hedgers contract positions against EUR growth.
Speculators' net long bets on the U.S. dollar edged higher in the latest week, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position was $5.44 billion for the week ended March 8. Last week, speculators' net long position stood at $5.12 billion, the lowest level since mid-August 2021.
To be continued...