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US bond yields retest February highs

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By Hussein Sayed, Chief Market Strategist at Exinity

US Treasuries came under pressure early Monday as investors saw some hopes for progress in the Russia-Ukraine talks, even as the war continues to rage. As a result, 10-year bond yields climbed another six basis points in Asia trade, testing 2.06% to recover all of the 40-basis point decline from mid-February to early March.

Stocks were mixed in Asia, with Hong Kong’s Hang Seng index dropping more than 5%, led by Chinese tech companies as the new Covid lockdown in Shenzhen put further pressure on the sector.

Meanwhile equities in Japan and Australia reacted to the more positive geopolitical news by flashing green.

US and European futures indicate an upbeat start for the session, but given that the list of risks continues to grow, expect volatility to remain elevated. Oil retreated by 3%, and gold declined slightly with other precious and base metals.

Fed decision on Wednesday

While the Russia-Ukraine conflict continues to be the main driver for  markets, Wednesday’s Federal Reserve interest rate decision will be of great importance to investors and traders.

The Fed is in a very tricky position right now. The war in Ukraine has sent energy and other commodity prices to unprecedented levels, which are heavily impacting US consumers.

Unfortunately, this external shock is out of the control of monetary policy which can do little to drag prices lower. Even before the conflict, inflation was sitting at multi-decade highs, and the war has only added fuel to the fire.

Tightening policy too quickly will not only upset financial markets, but would also increase the risk of pulling the economy into a recession. On the other hand, keeping policy loose will send inflation into double-digits, which holds even larger negative consequences.

Of course, the Fed doesn’t want to reverse all the recovery seen since the pandemic, especially when it comes to employment. So, finding a balanced approach will not be easy.

US futures are pricing in a 25-basis point interest rate rise in March, with another five hikes over the remaining six meetings this year. This will take interest rates from zero to 1.5% by year-end compared to 0.9% forecast in the Fed’s economic projections published in December.

There will be much focus on the updated “dot plot” which will reflect further tightening in 2022 and 2023.

The Fed’s balance sheet could even be of more importance than interest rates hikes. Chair Jerome Powell has indicated that reducing the balance sheet will commence after raising interest rates. Will he signal a plan to begin asset sales at this meeting?

The timing and the size of balance sheet reduction will likely have much more impact on markets than the first interest rate hike, and that’s what investors need to track closely in the upcoming Fed meetings.

For information, disclaimer and risk warning note, visit: https://exinity.com/en-ae

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)