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Dollar cools, equities storm back ahead of Fed decision


Fed set to raise interest rates today, dot plot to drive markets

Global stocks come back swinging, euro licks its wounds

Russia might default on debt, Germany announces spending plans

Fed - talk is cheap

The Federal Reserve is widely expected to raise interest rates today. A quarter-point rate hike is already fully priced in, so the market reaction will boil down to what Chairman Powell says during his press conference, the details around balance sheet reduction, and the updated ‘dot plot’ of interest rate projections.

Since the latest dot plot pointed to only three rate increases for this year but market pricing currently implies seven, it is almost certain the dots will be revised higher. The question is exactly how much higher - will the FOMC signal four, five, or six hikes for this year?

Most investors seem to expect four or five but there’s a solid argument it might be six. The US economy is firing on all cylinders, with a tight labor market and a healthy consumer being complemented by sizzling hot inflation. And with commodity prices spiraling higher, more inflation is in the pipeline.

A hawkish message on interest rates would also strengthen the dollar, which in turn would help calm inflationary forces without tightening so much - killing two birds with one stone. With the yearly inflation rate headed for double digits, it makes more sense from a risk management perspective to ‘talk a big game’ about future tightening here.

Of course money markets are already pricing in four hikes over the next three meetings, so it won’t be easy for the Fed to surpass those expectations. Signaling six hikes for this year and revising the terminal rate higher could do the trick.

Equities bounce back

Meanwhile, market participants are in a better mood. It’s difficult to say whether it is the reversal in energy prices or hopes for a breakthrough in the Ukraine peace negotiations or Chinese authorities promising to roll out more stimulus, but something has reawakened animal spirits.

European equities are almost back to pre-war levels despite the ongoing rally in sovereign yields. In Hong Kong, markets closed higher by a stunning 9%, with devastated tech shares spearheading the charge after China’s Vice Premier pledged to juice up economic growth as well as introduce market-friendly policies.

Euro shines despite Russia default risk

Over in the FX complex, the euro is enjoying its moment in the sun, outshining all its major competitors on Wednesday. This is strange considering that there haven’t been any huge developments in the war. The retreat in energy prices and Germany’s signals that it will ramp up public spending may be what’s behind this.

The German finance minister will unveil the nation’s budget plans until 2026 today. Big spending increases on defense and clean energy have already been telegraphed. The problem for the euro is that the risk of a European recession is uncomfortably high, and certainly much higher than in America. That might become clearer next week, when the Eurozone’s latest PMI business surveys are released.

For now, the risk is a Russian default. Moscow is due to repay two maturing bonds denominated in US dollars today and if it decides to pay in roubles instead, that would be considered a de-facto default on its debt, triggering a 30-day grace period. In this case, the question would be whether this sets off a domino effect across credit markets and who is exposed the most.

Source: https://www.xm.com/research/analysis/marketComment/xm/daily-market-comment-dollar-cools-equities-storm-back-ahead-of-fed-decision-156868
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