Ka-Powell and the Hawkish Fed Roller Coaster Ride :50bp is The New 25bp

Global Macro and Stock Markets Analysis

Red flags are going up today. While one day certainly does not make a trend, when the market decides to focus on a super hawkish inflation-fighting Fed narrative stoking recession fears, it typically triggers significant shifts in investor behaviours and conversations, and markets then turn a lot more caution.

This week’s rally in US bonds stoked some dip buying on stocks on a peak CPI and thoughts of a price to perfection FOMC. However, that gave way to a chorus of Fed speak highlighted by Chair Powell’s 50bp is the new 25 bp inflation fighter rendition at an IMF event.

Traders were caught looking the other way, lulled into a false sense of inflation complacency when the NZD CPI missed estimates. The problem with that extrapolation is that one only has to go to your local shopping mall to realize that consumer prices in the US and around the world, topping or not, are not poised to converge to target anytime soon.

The speed of any decline in inflation is crucial if lower yields can return as a tailwind for equities. However, The Federal Reserve and the US inflation market are locked in a race to see who can out hawk the other. No matter how aggressive the market’s pricing of inflation, Fed members seem intent on pushing even further.

St Louis Fed President James Bullard has been the most outspoken on rates, this week even suggesting a 75bp rate hike could not be ruled out. While investors might take some of his comments with a pinch of salt, he is not wildly out of line with Chicago Fed President Charles Evans on Tuesday talked about getting rates up to neutral — 2.5% — this year and San Francisco Fed’s Mary Daly mentions the possibility of a 75bp hike which St Louis Fed’s James Bullard has so far only mentioned.

Oil Fundamental Analysis

After Tuesday’s sell-off, oil prices stabilized, supported by a significant draw in US inventories, and that planked the bid for the remainder of the week. The news flow on the supply side was mixed. Libya said Production has dropped by more than 550kb/d, but the Kazakh Energy Minister said the CPC export terminal could return to full capacity this week.

However, Russian Production decreased, pointing to self and official sanctions starting to bite oil prices bullishly.

It is Friday, and typically, no one wants to go short oil into the weekend for fear of dreadful Ukraine weekend headline risk. So that suggests to me that oil holds a bid barring awful news out of China on the Covid front, where there seems to be some light at the end of the lockdown tunnel.

Still, I think oil traders’ eyes will be on the May 9 Victory Day holiday in Russia as many are expecting an enormous surge in the conflict around this time. There’s increasing pressure on Russia to turn the tide in the war around this important holiday.

Indeed, this could raise the spectre of other nations joining the US and UK Russian oil embargo.

Gold Fundamental Analysis

Gold is finding support through the recession risk even though higher US yields have temporarily blunted gold top side ambition. Bullion provides a good hedge against hyperinflation, which creates risks to holding traditional assets. Still, with stagflation moving from a potential tail risk to reality, investors worldwide are turning to gold as a keen portfolio diversifier.

FOREX Fundamental Analysis

Japanese Yen

USDJPY has been remarkably resilient in the face of a powerful UST rally early in the week. Meanwhile, there is no material pushback against yen weakness from Yellen or Suzuki.

After Wednesday’s move down to 127.40/50, USDJPY again rallied on continued local Tokyo interest to buy USD. The pair traded from 127.80/90 up to a high of 128.60/70 (top of hourly cloud) before profit-taking.

In the US for the G7 finance ministers and central bankers meeting, Japanese Finance Minister Suzuki reiterated that excessive moves in currencies can have adverse effects and that he was watching JPY closely. He also mentioned that currencies were not an essential topic of discussion at the meeting.

Intervention remains unlikely at these levels, especially after the BoJ recently reiterated its desire to cap JGB yields under its YCC policy (four consecutive days of fixed-rate operations). Although I believe the BoJ holds the cards on the next big USDJPY move, higher US yields support the bid on dip mantra that is prevalent on USDJPY.

The pair opens Friday’s Asia session near 128. 40/50 and should push higher into the Tokyo fix on higher US yields and higher oil prices if current trading patterns hold.

For a look at all of today’s economic events, check out our economic calendar.