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Fed fallout set to run further

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By Han Tan, Chief Market Analyst at Exinity Group

Market screens worldwide were flashing red on Thursday as investors and traders worldwide come to terms with the Federal Reserve’s willingness to be more aggressive in getting inflation under control.

Asian stocks were falling alongside European and US futures, which should see the S&P 500 re-enter correction territory.

Yields on the 10-year US Treasury are cooling slightly after Wednesday’s spike towards the 1.90% mark, although the benchmark dollar index (DXY) is still pushing higher. King dollar’s surge has already contributed to spot gold’s largest single-day drop since November, as the precious metal is dragged closer to the $1800 mark.

Markets ramp up Fed tightening timeline

Jitters in equity markets were already clear at the start of the week when the VIX spiked to its highest level since October 2020.

Fed Chair Jerome Powell’s latest hawkish pivot has coerced markets into believing that looming rate hikes could happen more frequently and the Fed balance sheet reduction will happen sooner-than-expected. Such a scenario may have well jarred the trapdoor below risk assets wider.

Since the start of the week, markets have fully priced in an extra Fed rate hike by February 2023, bringing the tally to five over the next 12 months.

The tightening cycle is expected to kick off in March, with Chair Powell implying as much at his press conference. There’s even the chance that the FOMC raises rates by 50-basis points at the next meeting, double the customary 25-basis point moves, if elevated inflation continues.

The central bank will then commence its quantitative tightening after raising rates. The earlier-than-expected withdrawal of the Fed’s supportive polices and potentially faster pace of rate hikes suggests there’s more room for equities to fall.

Fed speak, inflation data triggers volatility

In between FOMC meetings, policymakers and market participants are set to be data-dependent, keeping a watchful eye on the latest signals on consumer prices and adjusting their US monetary policy outlooks accordingly. The commentary out of Fed officials will also be gleamed for clues for policymakers’ biases towards monetary policy tightening.

Notable shifts in this hawkish narrative are set to trigger further bouts of volatility until markets can come to terms with higher rates. More aggressive revisions to the Fed policy outlook would leave tech and growth stocks susceptible to further declines while the greenback could advance to new cycle highs on the back of rising Treasury yields, at the expense of gold prices.

However, with key yield curves flattening further on the back of the latest FOMC meeting, markets are increasingly wary on the prospects of a Fed policy mistake that curtails growth in the world’s largest economy. If these concerns are taken up a notch, that could spur demand for safe haven assets.

 

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Exinity ME Ltd, a company registered under the Laws of the Abu Dhabi Global Market (ADGM), is authorised and regulated by the Financial Services Regulatory Authority (FSRA)