Aggressive Tightening Sees Risk Appetites Evaporate

Overview: It might not have seemed that way in the cloud of hours following the FOMC conclusion, but risk appetites are taking the day off. Asia Pacific equites were mixed, but Europe’s Stoxx 600 is off nearly 2% to completely give back yesterday’s gains, which were the first in seven sessions. US futures are off 2-3%. Benchmark 10-year yields have jumped and are mostly 15-18 bp higher in Europe and the US. The dollar is broadly higher. Among the majors, the Swiss franc, bolstered by the SNB’s largely unexpected decision to hike rates by an aggressive 50 bp, is the strongest currency (~1.5%) followed by the Japanese yen (0.8%). The Scandis and dollar bloc are suffering the most. Among the emerging market currency complex, the free-floating accessible currencies, like the Mexican peso and South African rand have been tagged the hardest. Gold is consolidating around $1830, while July WTI is trading near two-week lows below $115. It peaked a couple of days ago near $123.70. US natgas is up 3% for the second consecutive day. The combination of the LNG fires in Texas that supplies about 10% of Europe’s natgas and Russia playing games is sparking a huge rally in Europe’s benchmark. It is up 13% today after more than 19% yesterday and nearly 15.5% on Tuesday. Iron ore fell for the sixth session and is off almost 12% in this run. Copper is poised for an outside down day. July wheat is stabilizing after falling for the past two sessions. 

Asia Pacific

Japan's May trade deficit swelled to JPY2.38 trillion (~$17.7 bln), the largest since 2014. Exports grew 15.8% year-over-year, faster than the 12.5% pace seen in April, but a bit slower than economists projected. Still, it was a 2.4% month-over-month increase. On the other hand, imports surged an unprecedented 48.9% from a year ago after a 28.3% rise year-over-year in April. Higher oil and coal prices, worsened by the weaker yen drove the jump in imports. Exports to China remain depressed by the Covid lockdowns and slipped by 0.2%. Imports from China jumped by almost 26% after falling in April. Separately, the BOJ's meeting concludes tomorrow and is expected to standpat. 

Australia's May employment report was stronger than expected and it reinforced expectations that the central bank will hike by at least another 50 bp when it meets early next month. Economists in Bloomberg's survey expected a 25k increase in May employment and Australia reported a 60.6k increase that totally accounted for a a rise in full-time positions (69.4k). The participation rate jumped to 66.7% from 66.4%. It stood at 65.9% before Covid. The unemployment rate was unchanged at 3.9% (compared with 5.1% at the end of 2019).

Despite firmer US Treasury yields, the dollar is trading heavily against the Japanese yen. It is reached a seven-day low near JPY133.10 in the European morning, having been turned back from JPY135.60 yesterday. The greenback is finding a bid in the European morning, and the JPY134.00 area may offer initial resistance. A break of the JPY133 area, though, could see a quick move toward JPY132. The Australian dollar extended yesterday's gains to reach $0.7035 before the risk-off mood sapped the enthusiasm and saw it fall back to the $0.6950 area. The $0.7000 may cap it now and the risk is a push toward $0.6925. The greenback fell to a new low for the week against the Chinese yuan (~CNY6.6920) but rebounded to nearly CNY6.7175. The PBOC set the dollar's reference rate at CNY6.7099, a little stronger than the bank models (Bloomberg survey) pointed to (CNY6.7088). Hong Kong Monetary Authority hiked the base rate 75 bp to 2.0%. We are waiting for confirmation, but it appears that the HKMA may have intervened for the third consecutive session today to defend the peg by selling US dollar and buying Hong Kong dollars.


A few hours after the Atlanta Fed's GDP tracker than had been estimating Q2 US GDP at 2.5% as recently as mid-May, and shaved the last bit to zero after the disappointing retail sale report, the Fed delivered a 75 bp rate hike. A few days ago, the UK unexpectedly reported the second consecutive monthly contraction in GDP. The market has about a 40% chance that the Bank of England, which has hiked by 25 bp three times already this year (and began the cycle with a 15 bp move last December) will opt for a 50 bp move. Three members have been advocating (dissenting) in of 50 bp moves, and they may do so again on a quarter-point move. The swaps market has 125 bp of tightening discounted for the three meetings beginning with today's and another 65 bp in Q4. The base rate is seen finishing the year near 2.85%, somewhat above the neutral rate thought to be around 2%. The terminal rate, in about a year's time, is seen at 3.35%, which is about 100 bp higher than a month ago.

The Swiss National Bank surprised the market. It hiked the deposit rate by 50 bp, leaving it at minus 25 bp. In fairness, there had been some speculation of a rate increase, given the central bank's assessment that the currency was "highly overvalued", it was thought more likely to wait for the ECB to move first (next month). In announcing its decision to hike rates for the first time in 15 years, the SNB lifted its inflation forecast, dropped reference to the exchange rate, and promised to remain active in the foreign exchange market. The euro plunged from around CHF1.04 to briefly trade below CHF1.02, a two-month low. This year's inflation forecast was raised to 2.8% from 2.1%, and 1.9% next year and 1.6% in 2024 (both had been at 0.9%). 

Someone at the European central banks told the press that the ECB was working on a new mechanism to be used after the Asset Purchase Program wound down to prevent fragmentation of divergences in the debt market that distorted the transmission of monetary policy. Leave aside that the issue was raised last year, and a compromise was struck that allows the central bank discretion in the reinvesting of maturing proceeds. Still, nothing was forthcoming from the ECB. Then at the start of the week, the ECB's Schnabel, seemingly made a virtue out of necessity, arguing it was not tactically astute to preemptively reveal a new tool, and the tool would need to be designed for the specific challenge.

Yesterday, it tried playing investors by (needlessly?) announcing an emergency meeting and then failed to deliver anything but internal instruction to devise a new tool. The debt markets held on to significant gains, but the euro, which briefly poked above $1.05 was sold below $1.04 by the close of the European session. A new tool will likely look like old tools--the European Stabilization Mechanism and the Outright Monetary Transactions. Recall that theoretical purchases under OMT were not to ease policy through expanding the balance sheet. Instead, the program called for the sterilization of the impact. Also, rather than buy long-term securities, OMT was aimed at the shorter end of the curve (1-3 years). Lastly, the rub is often conditionality that is attached. The arguments may turn on the strings that the creditors insist on, and as we have seen in the past, if the conditions are too severe, the facility will not be used. 

The euro is trading within yesterday's range (~$1.0360-$1.0510). It made little headway after finishing the North American session near $1.0445. It reached almost $1.0470 before being pushed to $1.0380. Consolidation may be the best that can be hoped for today. The euro reversed lower from CHF1.0480 yesterday and dropped to slightly below CHF1.0170. The lower Bollinger Band is around CHF1.02 today. The demand for sterling after yesterday's 1.5% gain has dried up. It briefly traded above $1.22 yesterday but sterling remains below there today. It tested the $1.2050 area in late Asian turnover and looks vulnerable from a technical perspective for a retest later today. Lastly, note that the Hungarian central bank hiked the one-week deposit rate by 50 bp to 7.25%. It was the second hike in three weeks and surprised the market. The forint traded at record lows against the euro earlier this week and is at its best level for the week following the unexpected rate move.


The Federal Reserve hiked the target rate by 75 bp and warned investors and businesses to be prepared for a bumpy landing. The median forecast sees slower growth, more inflation, and higher unemployment. Chair Powell seemed to tie the decision to hike 75 bp instead of 50 bp to the CPI report and the inflation expectations surveys. It may be ill-advised to tie a rate decision which has a variable lag before impacting the economy, with a high-frequency economic report and one that is subject to revisions. One consequence is that the next CPI report (July 13) and the University of Michigan survey (July 15) will command more attention than usual. 

While Powell stressed that the Fed is "strongly committed" to achieving its inflation target, the market took away a more dovish message. The Fed funds futures market downgraded the chances of a 75 bp follow-up hike at the next meeting (July 27) to about 60% from nearly 100%. The implied yield of the December Fed funds futures fell 14.5 bp yesterday, snapping a five-day advance and only the second decline since May 26. The peak rate is now seen a little below 4%. It finished Tuesday at 4.25%. In March, many critics pushed against the median forecasts that showed higher interest rates, slower growth but little changed unemployment rates. What seems incongruous now is Powell's repeated observation of the strength of the economy. We noted the Atlanta Fed's GDPNow sees the economy stagnating this quarter after contracting in the first quarter.

Today’s economic calendar features what is expected to be the third consecutive monthly decline in housing starts and the second for permits. The weakness is coming from elevated levels. The June Philadelphia Fed survey is due. The Empire State survey earlier this week disappointed. The US also reported weekly jobless claims. Tomorrow sees May industrial production figures and Powell makes remarks at a conference on the US dollar. Canada, Mexico, and Brazil's calendars are light. Brazil's central bank delivered the widely expected 50 bp hike yesterday to lift the Selic rate to 13.25%. The central bank is seen nearing the end of its tightening cycle and signaled that it will raise rates by 50 bp or less at its next meeting in August.

The recovery in the Canadian dollar that yesterday's price action gave some hope for has stalled. The US dollar was repelled after it approached CAD1.30 yesterday and settled a little below CAD1.29. However, with risk appetites drying up, the Canadian dollar is under pressure again. A push above CAD1.30 targets last month's high closer to CAD1.3075. Similarly, the greenback is recovered from yesterday's downside reversal against the Mexican peso. It found support near MXN20.22 and has surged above MXN20.56 in the European morning. The Tuesday-Wednesday high was near MXN20.69. Above there, the next chart points of note are near MXN20.85. The dollar found support near BRL5.0 yesterday. Assuming this area holds, the greenback can re-test the BRL5.13-BRL5.15 area.



Aggressive Tightening Sees Risk Appetites Evaporate Aggressive Tightening Sees Risk Appetites Evaporate Reviewed by Marc Chandler on June 16, 2022 Rating: 5
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