The Week Ahead
Central bank policy normalization will become increasingly thematic in the coming months as pandemic economic reopening continues; the Fed likely underpriced and commodity currency central banks like the RBNZ potentially overpriced.
Clearly – but possibly incorrectly – OIS markets draw straight line analogues from policy normalization after the Great Financial Crisis when the RBA hiked first, closely followed by the RBNZ, to hold exchange rate parity and then BOC followed after that. The BOE was unable to trigger a rate hike for the seven years up to Brexit, and the ECB – ignoring the first couple of awkward follow the leader hikes – ended up at the bottom of the chase pack along with the BOJ.
With fiscal stimulus likely to roll out towards the higher end of expectations in the US, there’s nothing that Fed Chair Powell can say – short of negative rate cut action itself – that would be a dovish surprise to the market. Ironically, the very taper tantrum risk that Powell is trying to avoid may be higher now.
Meanwhile, buried within the coordinated Fed speak (but not profoundly so) there are glimpses of what may be to come. While agreeing that it’s too early to discuss adjusting the Fed's bond-buying, FOMC’s James Bullard said the job recovery is currently four years ahead of the last recession, which implies it may closer to a hike than is presently priced into OIS markets. And when you link this with Raphael Bostic's comment on Jan 11 – likely the last Powell unshackled speech by a Fed speaker for a while – that normalization could come as early as mid-2022 if the recovery is better than expected. Richard Clarida's comment (Jan 13 Q&A) that 2% inflation for a year could be a condition for liftoff, then a hike around end-2022 doesn't seem so crazy.
Dec IMM 2022 3-month OIS implying a 27% probability of a hike is far too low and that eventual repricing will have implications for rates and the curve in the upcoming months; it will play a massive role in influencing the FED's ongoing decision process.
I don't think you can say investors have reached their limits in terms of positioning. Despite Chair Powell being at his dovish best on Wednesday, his comments didn't do anything to change the general trend in markets with neither fixed income nor gold able to hold onto gains.
The latest 30-year US bond auction hardly suggests investors are getting herded by the FOMC’s overly coordinated efforts to water down any market-based inflationary impulse as it tailed by 0.9bp, while the bid-to-cover was 2.18 – well below the recent average of 2.47.
So where to from here then? I think it will be very much dependent on the economic data, and until we see some significant changes on that front, a continuation of range trading beckons.
Currency markets are trading in relatively tight ranges, which makes sense given the FX market focus is on the post-bond market reaction to the US stimulus package where the asymmetric risk is in the other direction from where Chair Powell is trying to herd the market ahead of the next US stimulus tranche.
Gold remains mired in a world of cross-currents. While London has usually found a few golden nuggets in Chair Powell dovish retort, with the US dollar sailing on an even keel these days there was little fresh impetus to push bullion higher.
And with the pop on US yields after a shaky 30-year bond auction, traders began to factor the risk for higher yields around the next tranche of the US stimulus package. And to fog the view even more, oil prices fell overnight, watering down the inflation premium.
Crude prices needed a floatation device having attained the >$60/bbl. I suspect everything is in the price; in other words, the models have already discounted the expected demand improvement through 2021 and the data now needs to catch up. It’s almost an echo of what’s going on in stock markets, with both assets unsurprisingly tethered to one another.
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