Wednesday, January 26

Rate hike bets are the battleground for traders after the Fed

Investors expect the Federal Reserve to manage the path to rate hikes as smoothly as its gradual reduction announcement, according to strategists who are cautiously optimistic that the coming months will see moderate gains for yields, the dollar and equities.

Friday’s labor report is seen as the next flash point for markets as rate traders remain relatively aggressive about the need for President Jerome Powell to avoid being too patient in raising borrowing costs to contain inflation. . Key risks surround rate hike bets, with the possibility that aggressive moves in that market could trigger new bond turmoil.

Powell announced the start of a reduction in bond purchases on Wednesday, but said officials can be patient when raising interest rates. US stocks closed at record highs, Treasuries retreated and the yield curve rose slightly, reversing some of its recent upward trend.

Here is a selection of comments on the outlook for the markets:

Yields, dollar to rise higher

Wells Fargo strategists, including Mike Schumacher:

“The key takeaway for us is that the Fed has introduced the possibility of speeding up, or possibly slowing down, the downsizing. Flexibility in downsizing puts more responsibility on economic data, specifically inflation and employment data, to stimulate dollar gains on expectations of faster or faster rate hikes. This raises the stakes for US employment reports this Friday and beyond.

“The reduction in asset purchases should drive yields gradually higher. We maintain our year-end target of 1.75-1.80% for the 10-year Treasury yield. The market is still priced too aggressively when it comes to future rate hikes. ”

Strategists at TD Securities, including Jim O’Sullivan:

“Yields and the curve should remain caught between cuts in auction size, reduced QE, a possible fiscal package in the coming weeks, and the initial market price review. This should keep volatility high, but with some upward pressure on rates as investors appreciate the cash flow effect of the downside and the start of the upside cycle. ”

“While the downsizing should steep the curve amid a net duration-heavy offer, any further advancement in the up cycle should flatten the curve. Given the already aggressive market price of the first hike in July 2022 and more than two hikes in 2022, we remain at the front. ”

Chris Zaccarelli, Chief Investment Officer, Independent Advisor Alliance:

“Given the uncertainty of inflation and interest rate trajectories for the next 12 months, we believe it is prudent to keep duration neutral or even slightly underweight.”

“It is also prudent to maintain exposure to equities, but continue to reallocate our portfolios to companies with stronger balance sheets and those with greater pricing power and away from those companies that are more speculative in nature.”

Rate hikes and inflation

Elliot Clarke, Senior Economist at Westpac:

“Therefore, communications after today’s meeting not only justify us sticking to our forecast for a first hike in December 2022, but also justify the belief that the rate hike cycle that follows will be modest in comparison. with history. Over the period, the main risk of this benign view of politics will be rising wages. If supply is insufficient for demand, then wage growth could rise to a level that not only offsets current inflationary pressures, but also allows for additional discretionary consumption. “
Steven Englander, G-10 Global Head of Currency Research at Standard Chartered Bank:

“We believe that the market reaction going forward will be heavily driven by the incoming data driving policy rate increases. These data could include robust employment data implying a quick focus on full employment or continued high inflation figures that suggest Powell’s optimism will be overstated. There’s a good chance that both will happen in the fourth quarter, so he sees the risk that today’s benign interpretation is transitory. ”

Paul Ashworth of Capital Economics:

“With wage growth at its strongest since the early 1980s, rising inflation expectations, and signs of a breakdown in cyclical price inflation, particularly incomes, the FOMC’s insistence that this is still just a temporary shock ‘related to the pandemic and the reopening of the economy’ appears to be dangerously behind the curve. But it could be a considerable time before the Fed is willing to admit that high inflation is likely to be more persistent. ”

Cautiously risk

Justin Tang, Head of Asian Research at United First Partners:

“No one will open bottles of champagne, but I think investors will allow themselves a glass or two. It will be a case of a rising tide lifting all boats, but stocks that have been strongly correlated with the inflation issue will be bought, such as technical ones. ”

Ilya Spivak, Director of Greater Asia at DailyFX:

“The response from risk sentiment should be quite soft because I think the Fed delivered as markets were generally anticipating, but again, with a slight risk bias. I think the drop in gold was particularly striking, as was the sell off of oil. Gold was interesting because it started to fall and had most of it ahead of the Fed. “
Banny Lam, Head of Research at CEB International Inv Corp .:

“Asian stocks should be looking higher today. The Fed seems to create expectations in the market that the decoupling of lower asset purchases and higher interest rates will remain intact. The negative real interest rate extension also provides continued support for Asian stocks. ”
Kerry Craig, Global Market Strategist at JPMorgan Asset Management

“This remains a very accommodative policy environment and one that will support the growth prospects in the coming quarters and the performance of risk assets such as equities and credit. For equity markets, the focus should be on where earnings growth will be greatest to offset the carryover of valuation on returns. So far this has meant focusing on the more cyclical developed markets in Europe and Japan, but we expect the catch-up in emerging Asia with its relatively better valuations to generate more interest for investors in the coming year. ”

Credit support

Mark Reade, Head of Fixed Income Documentary Research Mizuho Securities Asia

“After a period of initial interest rate volatility, this week’s dovish central bank rhetoric has helped calm nerves and tighten the curves again. Coupled with strong corporate earnings and decent global data, that provides a supportive backdrop for further compression of credit spreads. ”

“If inflation shows no signs of peaking or decreasing, then we could easily see a return to initial volatility. But we’ll probably have a while before that becomes obvious. ”

© 2021 Bloomberg

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