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Yields penny finally drops for US markets ahead of Fed minutes

An electronic prices board

European markets slipped back yesterday, with the FTSE 100 slipping below the 8,000 level and posting its biggest decline in two weeks, despite better-than-expected flash PMI numbers data. While a positive development, this served to help push yields higher in anticipation that central banks might have to be slightly more hawkish when it comes to raising rates in the coming weeks, and looks set to weigh on markets further later this morning.

This has certainly been borne out in Asia trading after the RBNZ hiked rates by 50bps, with the prospect of more to come. These moves by central banks can come across as counterintuitive, given that the reason for the improvement in economic activity is due to sharp declines in energy prices, which is also exerting downward pressure on inflation, although core inflation isn’t coming down yet.

Today’s final Germany CPI numbers for January look set to reinforce that with a decline to 9.2% from 9.6% in December, however due to the lag effect, core prices are still rising which means higher rates for longer. The latest IFO business survey for February is also expected to show a continued improvement from January’s numbers, with the business climate expected to rise to 91.2, from 90.2, and expectations to rise to 88.2 from 86.4.

US markets also fell sharply yesterday with the S&P 500 falling to a one-month low, and its worst one-day decline this year, as equity markets start to move into line with recent bond market moves. 

In the immediate aftermath of the recent 25bps Fed rate hike, there appeared to be a type of cognitive dissonance when it came to what the market wanted to hear from the Federal Reserve, and what the US central bank was trying to say. To borrow a line from the film Cool Hand Luke, “what we’ve got here is a failure to communicate”. Long story short, the market thought that the inflation job was done, or at least close to it, even though the recent non-farm payrolls report, and ISM services report muddied the waters in that regard.

For all of Fed chair Jay Powell’s insistence that more rate hikes were coming at his post meeting press conference, and that the Fed was not looking at cutting rates this year, his failure to push back emphatically on direct questions about market expectations of rate cuts this year, created an even greater divergence between market pricing on rates, and the Fed’s expectations of how the economy was likely to evolve. 

Since that meeting, things have moved on somewhat with a succession of Fed officials pushing back on the dovish narrative, insisting that rates are likely to stay higher for longer, which has seen yields push strongly higher in the almost three weeks since then. It is also important to remember the release of the latest minutes needs to be set in the context of the fact that the meeting came before the recent jobs, ISM, and retail sales data. That said, the recent intervention by non-voting member, Cleveland Fed president Loretta Mester last week, that she saw a compelling case for a 50bps move at the last meeting, was an unexpected intervention to the cosy consensus that had developed around the 25bps narrative. This was compounded by another non-voting member, James Bullard of the St Louis Fed, who suggested 50bps in March could be a consideration. 

This raises two questions, one is to how many other Fed members saw a compelling case for a 50bps move at the last meeting, and two, how much could that have shifted over the last few weeks in light of the recent strength of US data. The minutes should answer the first question; the second question will need to see more data, but given recent evidence, anything that could be considered hawkish from the release of today’s minutes will be magnified even more given the strength of recent data. It’s also probably safe to assume that most Fed officials will probably still see the December dots as an accurate representation of future rate hike expectations. 

EUR/USD remains under pressure while below resistance at the 50-day SMA currently at 1.0730. The bias remains for a move towards the 1.0480 level, while below the 1.0800 area.

GBP/USD – having failed to fall below the 200-day SMA we’ve seen a squeeze back towards the 50-day SMA at 1.2180. We need to see a move through 1.2200 to target a move back towards 1.2300.

EUR/GBP – slid below the 0.8860/70 area yesterday dropping below the 50-day SMA at 0.8810 area, and slipping towards the 0.8760 area, where we have the next support. Resistance comes in at the 0.8870 area.

USD/JPY – continues to make gains pushing up to a new two-month high at 135.25 area, as it looks to edge towards the 200-day SMA at 136.70. Interim support at 133.60, and below that at 132.60, and 50-day SMA.  

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