Fed chief Powell sends a ‘forceful’ message about slaying inflation
Stocks and risk-sensitive currencies tank, alongside yen and gold
Dollar is the only winner as it hits fresh two-decade highs
The Fed chief resorted to shock tactics on Friday, striking a forceful tone about his resolve to win the inflation battle and sending financial markets into a tailspin. His overarching message was that the Fed is committed to do whatever it takes to cool inflation even if that means a period of economic pain, as the alternative of letting inflation run rampant would be even more harmful in the big picture.
There was a sense of determination in his laconic speech that spoke louder than words, as he reinforced the notion that interest rates will need to be kept elevated for some time to avoid repeating the mistakes the Fed committed in the 1970s, when it backed off the brakes too early. In other words, the Fed won’t waver at the first sign of trouble - it will keep hammering away until the inflation monster is slain.
All this served as shock therapy for market participants, who immediately slashed their exposure to riskier assets like equities and loaded up on US dollars, as Powell dispelled speculation that a pivot is around the corner.
Stocks, sterling, and yen retreat
Stocks on Wall Street came under heavy fire, with the S&P 500 losing a staggering 3.4% and futures pointing to another round of selling today. The sharp moves suggest that some equity players were betting on cautious soundbites from Powell, and when they found none, resorted to purging their portfolios.
In the FX sphere, the main losers once the dust settled were the British pound and the Japanese yen. Confirming its sensitivity to any trouble in the equity arena, Cable fell through the trapdoors to touch $1.1650, a region last reached during the height of the pandemic. It is particularly concerning that Cable couldn’t rally much when equities enjoyed some relief lately, but shared in the downside as soon as risk sentiment turned sour.
Meanwhile, the yen has turned into a pure play for interest rates, slowly but surely losing its status as a safe haven asset. With bond yields moving higher in most of the world except for Japan, thanks to the central bank’s ceiling on domestic yields, the yen cannot catch a bid anymore even when equity markets go into panic mode.
Nowadays, dollar/yen simply mirrors any moves in US rates. Investors don’t seem eager to bet on any policy shifts from the Bank of Japan either when it meets next month as inflation remains stubbornly low, which implies a risk of continued yen selling heading into that event.
Dollar shines, gold turns down
The only beneficiary from the Fed’s shock-and-awe strategy was the US dollar, which hit a fresh two-decade high against a basket of major currencies on Monday. With an energy crisis raging in Europe and China’s property sector rolling over while the Fed remains on the warpath, the world’s reserve currency is enjoying the best of all worlds - a lack of alternatives, safe haven flows, and widening interest rate differentials.
Gold prices couldn’t escape unscathed either. The precious metal came under renewed selling pressure after Powell’s barrage and continued to lose ground on Monday, suffering at the hands of a supercharged US dollar and a sharp spike in real Treasury yields. Another battle for $1680 seems imminent, a region that has acted as a springboard for the price action several times over the last year and a half.
As for today, the economic calendar is low key but investors might tune in for a speech by Fed Vice Chair Lael Brainard at 18:15 GMT.