European markets had a slightly more resilient tone yesterday, reversing some of their early week losses, however we still remain below the closing levels of last week, so it might be a little early to sound the all clear so to speak.
US markets also saw another rollercoaster session, opening sharply lower, as they looked to retest the lows of this week, and in a mirror of Monday, having fallen short of those lows, saw another late day turnaround.
“Sentiment continues to be driven by the cross currents of events on the Ukraine, Russia border, as well as the likely messaging from today’s Fed meeting,” commented Michael Hewson, chief market analyst at CMC Markets UK in London this morning.
“While equity markets have ebbed and flowed, bond markets have moved in lock step with the US 10-year yield oscillating between 1.7 per cent and 1.8 per cent,” he pointed out.
After yesterday’s negative finish in the US, which was led by another big loss for the Nasdaq 100, but a strong rally off the lows for the Dow, European markets look set for a positive start, Hewson added, as he looks ahead to two central bank meetings, from the Federal Reserve and the Bank of Canada.
Fed meeting today
The main focus is set to be on today’s Fed meeting, and the messaging that is expected to layout the rate path for the rest of the year, starting with a widely expected 0.25 per cent March rate hike.
“Last month’s Fed meeting saw the central bank accelerate its tapering program to $30bn a month, which it started this month, while adopting a more hawkish outlook when it comes to tackling the risks of rising inflation,” Hewson explained.
“Fed officials also brought forward their expectations of rate hikes to three in 2022, and three in 2023, with the change of tone indicating that the Fed was very much alive to the risk of higher prices and would act decisively if they deemed it necessary,” he noted.
“Since that meeting the debate has moved with the publication of the minutes spooking investors after it was revealed that FOMC members had actively been discussing how to reduce the size of the balance sheet after rate rises began, prompting concern that the Fed might start to go too quickly in normalising policy,” Hewson said.
“There is no question that Fed officials feel that they might be behind the curve when it comes to dealing with inflation risk, and the change of tone in the last six months has been startling.”Michael Hewson
He said markets are now at the phase where up to 4, and even 5 rate rises this year are being speculated upon by market participants, a scenario that would have been inconceivable back in September, when even the mere prospect of more than two rate rises was being greeted with concern.
“While no changes to policy are expected today, markets will be looking for clues as to how concerned Fed officials are about headline CPI at 7 per cent, and whether they might be leaning towards a potential 50bps hike in March, rather than the 25bps that is currently priced.”
Given the volatility this week, any sort of indication that Fed officials were leaning in this direction would be risky, Hewson pointed out, however it wouldn’t be beyond the realms of possibilities for them to put the idea out there.
“It would certainly be a surprise if they leaned away from their December guidance, of 3 rate rises this year and 3 for 2023,” he noted.
Another topic of interest will be how FOMC members weigh up the timing and scope of balance sheet reduction, in terms of whether we can expect it to start in H1, or H2.
“We have heard some outlier calls that the Fed should call time on tapering now given concerns it is already well behind the curve. This would be a huge surprise and would be counter to all of the recent messaging, which has been very consistent.”
“It would probably be unwise to go against that and would invite the type of criticism the Bank of England has had to contend with, due to its inconsistent messaging,” Hewson said.
“Whatever the Federal Reserve does or doesn’t indicate today, it will still invite criticism for either being too hawkish, or not hawkish enough,” he stressed.
This week’s volatility has certainly given FOMC members food for thought. Whether it will give them pause about the strength of their messaging is another matter.
“Sometimes it’s better to rip the band aid off and have done with it,” Hewson concluded.