FOMC minutes echo desire to tighten swiftly, crushing tech stocks
Dollar hovers near recent highs, yen still in the mud, oil retreats
Euro under pressure ahead of ECB minutes, French election in sight
Fed provides exit plan
The minutes of the latest FOMC meeting poured gasoline on the bond market bonfire yesterday, slingshotting US yields even higher as traders braced for a full-speed normalization of monetary policy. Officials highlighted the prospect of raising interest rates in 50 basis point increments and ‘generally agreed’ that the balance sheet should be reduced by roughly $95 billion per month starting in May.
That is a much faster clip compared to the last quantitative tightening round, which means the Fed will be withdrawing liquidity from the financial system at an unprecedented pace. Ultimately this process argues for higher Treasury yields on the longer end of the curve, spelling trouble for equity markets as investors move back towards the conservative side of the risk spectrum.
Consequently, Wall Street suffered another bruising session. The Fed-sensitive Nasdaq lost 2.2%, with tech and growth shares getting smoked. This is really the bear case for stocks - that the FOMC will actively try to lower asset prices in an attempt to tighten financial conditions, as former New York Fed boss William Dudley outlined recently.
The bull case is that inflation might cool later this year as fiscal and monetary stimulus fades, supply chains heal, and energy prices cool down - allowing the Fed to raise rates more slowly than what’s currently baked into money markets.
Dollar stays elevated, yen on the floor
In the FX domain, ‘king dollar’ has reclaimed its throne, steamrolling everything in its path with a little help from rate differentials that continue to widen to its benefit. The stars have aligned for the reserve currency, which is benefiting both from a robust US economy and the storm clouds gathering over Europe and China.
In contrast, the yen has drawn the shortest straw in this market rotation, as the Bank of Japan doubles down on its yield curve control strategy that prevents Japanese yields from participating in the global rally. In essence, the BoJ is saying it’s happy to lag behind every other major central bank and import some inflation, which will hopefully help break the deflationary mindset that’s tormented Japan for decades now.
The yen has lost a lot of ground this year and with the BoJ refusing to join the global normalization party, the only saving grace on the horizon is a potential ceasefire in the war that cools commodity prices and helps dial back expectations for rate hikes abroad.
ECB minutes in focus
In the commodity complex, oil prices took a sharp hit after the International Energy Agency announced that its member countries will step up their release of strategic reserves to counter the energy shortage. Meanwhile, gold remains trapped in its recent range, unscathed by the epic selloff in bond markets.
The minutes of the latest ECB meeting will be in the spotlight today. That’s the meeting where the central bank opened the door for raising interest rates this year, so traders will dissect the debate around the impact of higher inflation versus slower growth in the wake of the Ukraine crisis.
The single currency remains under heavy pressure, keeping one eye on the war and another on the looming French election. Opinion polls have narrowed lately and a victory for President Macron doesn’t look so certain anymore. Markets are starting to get nervous, something reflected in the ballooning spread between French and German bond yields as well as the spike in implied volatility in euro/dollar options, which signals growing demand for hedging.