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Dollar rips higher as traders crank up Fed rate bets

XM.COM

Fed chief Powell highlights prospect of faster rate increases

Dollar cruises higher, yen annihilated, gold escapes unscathed

Stock markets close in the red but display some resilience too

Powell turns up the heat

The Federal Reserve keeps warning investors that it will need to pull out the big guns in its battle against inflation. Chairman Powell made it clear yesterday that his central bank is willing to do whatever it takes to ensure the US economy returns to price stability, emphasizing the option of raising rates in 50 basis point increments if needed.

While he did not say anything particularly new, his tone spoke volumes. The Fed wants to tighten financial conditions as quickly as possible. Over time, that will slow down the economy and inflation, hopefully without derailing the recovery. Talking a big game on rate increases also means the market will do the Fed’s ‘dirty work’ and price in all the tightening immediately, way before policymakers actually pull the trigger.

The reaction was swift, with traders cranking up their bets for rate hikes. Money markets are currently pricing in another seven and a half quarter-point rate increases for this year, which would bring the federal funds rate to 2.25% - 2.5% by December. Six of those hikes are priced over the next four meetings, so traders expect the Fed to strike its hardest in the coming months.

Dollar smiles, yen cries

The shockwaves rippled through the US bond market, sending Treasury yields soaring to pre-pandemic levels and turbocharging the US dollar as rate differentials widened to its benefit. This phenomenon was on full display against the Japanese yen, with dollar/yen smashing through the 120 region.

The Bank of Japan’s yield curve control strategy keeps a ceiling on Japanese yields, so whenever foreign central banks move towards higher rates, the yen’s interest rate disadvantage becomes even worse. Yen bulls are abandoning ship and this will probably be a persistent theme until the BoJ scraps yield curve control, which doesn’t seem imminent.

In the commodity sphere, gold has been remarkably resilient. Even though soaring yields and a stronger US dollar should be grave news for the yellow metal, bullion has escaped with only minor injuries so far. Safe haven demand seems to be negating the impact of tighter monetary policy.

Investors are looking for a hedge that will protect their portfolio against geopolitical turmoil, and since holding bonds can be very painful in an environment of rising rates and raging inflation, many are warming up to gold instead.

Stocks ignore the Fed too

Another asset class that managed to absorb the Fed’s hawkish twist without any real damage is equities. Wall Street closed lower on Monday but only barely. Even the tech sector did not suffer as much as one would expect given the size of the move in rates. There was some encouraging news out of China about supporting the economy, but nothing to justify this relative strength in equities globally.

Rather, this has to be seen from a cross asset perspective. If bonds are selling off thanks to the Fed and commodity trades are so overcrowded already, investors are left with little choice but to stick with stocks for the long haul and simply stomach any volatility.

As for today, the economic calendar is low key. Some remarks by ECB President Lagarde at 13:15 GMT and the Fed’s Williams at 14:30 GMT are the only events that might attract some attention.

Source: https://www.xm.com/research/analysis/marketComment/xm/daily-market-comment-dollar-rips-higher-as-traders-crank-up-fed-rate-bets-157222
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