Sentiment Wavers As Fed Hike Fears Finally Sink In

“Higher for longer” Finally Resonates

Written on 28/02/2023 by Lukman Otunuga, Senior Research Analyst at FXTM

It took some time and there have been a few false dawns over the last few weeks. Markets, and especially risk assets, have been overlooking the constant hawkish Fedspeak for some time. A chorus of officials have been declaring that interest rates will need to go higher due to persistent inflationary pressures.

But stock markets especially, begged to differ hoping that inflation would fall sharply in the coming months. With the Fed’s favoured inflation measure confirming high and sticky price pressures on Friday, plus numerous strong data points this month, markets have now finally bowed to the hawkish noise and the dollar has rebounded sharply.

After looking slightly comatose in November and December, the US economy has picked itself off the floor and come roaring back to life so far this year. Evidence of this has come thick and fast, witness the over half a million job gains in the headline Non-Farm Payrolls data, the six-point jump in ISM services to a highly respectable expansionary level of 55.2, the stellar retail sales, albeit weather-assisted and a surge in light vehicle sales.

Even the troubled housing market and manufacturing sector had something to cheer about recently with the highest level in one measure of homebuilder sentiment since last September and manufacturing production increasing 1%. Rarely do so many indicators point in the same direction.

Dollar Bulls Dominate February

Together with that hawkish Fedspeak, with some officials putting 50bp rate hikes back on the table next month, markets have strongly repriced the Fed rate hike cycle with the peak rate up towards 5.50% in the summer. The 10-year US Treasury yield, a widely followed proxy for global borrowing costs, has hit levels not seen since November and is a whisker away from the key 4% level.

Dollar bulls have responded handsomely this month with the DXY rising some 2.5% in February and arresting four consecutive months of declines, after falling to 100.82 a few weeks ago. The buck has also reassumed its throne at the top of the G10 currency chart. How high this rally can go is the “64-million dollar” question (pardon the phrase!).

Monetary policy is highly data dependent, and we have key job and inflation releases still to come ahead of the next FOMC meeting on 22 March. If this incoming data starts to paint a different picture, then we could see some unwinding of these recent hawkish bets on the Fed hitting 5.50% in the Fed funds rate. That said, seasonals over the next few months are seen to be relatively positive for the greenback. The underlying, fairly grim geopolitical situation might also help underpin support for the world’s premier reserve currency.

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