- Markets fully price in four Fed rate hikes for this year, lifting yields
- Stocks under pressure, dollar recovers, gold surprisingly resilient
- Oil hits new highs, yen retreats after BoJ does nothing
Fed worries hit stocks
It has been a stormy couple of weeks for financial markets, with almost every asset class getting rocked by expectations that the Fed will need to normalize monetary policy more aggressively to cool inflation. The US labor market is so tight that wage growth has started to fire up, igniting worries of a wage-price spiral and by extension leading market participants to fully price in four rate increases for this year.
This has propelled US Treasury yields much higher, and when the bond market begins to rumble, it feels like an earthquake for assets such as equities. This is especially true for the riskiest corners of the stock market, for example companies without consistent cash flows whose valuation can change dramatically if interest rates move higher.
As such, global equity markets are a sea of red on Tuesday, feeling the heat of higher rates as the yield on 10-year Treasury bonds continues to ascend beyond pre-pandemic levels. The tech-heavy Nasdaq is leading the way lower, with futures pointing to losses of around 1.5% when US markets open today after a long weekend.
Currencies cautious, but oil defies the gloom
This sense of caution has spilled over into the FX arena as well. The US dollar is naturally outperforming, enjoying the perks of widening rate differentials between America and the rest of the world. Meanwhile, commodity-linked currencies like the Australian dollar are trading heavy.
The yen has been unable to capitalize on the gloomy mood and is under pressure instead, suffering a double whammy from rising foreign yields and the Bank of Japan’s reluctance to provide any signals that policy normalization is on the cards.
But oil prices apparently didn’t get the memo. Despite all the risk aversion, crude prices briefly touched new seven-year highs today, drawing power from renewed tensions in the Middle East and a rosier outlook for demand amid hopes that Omicron could be the beginning of the end for the pandemic.
Loonie in focus, gold holds its ground
With oil prices roaring back, the Canadian dollar has staged a powerful rally in recent weeks, turbocharged by expectations that the Bank of Canada will raise rates next week to counter inflationary pressures. The economy has improved at such a dramatic pace that markets are currently pricing in an 80% probability for a hike this month, in defiance of the BoC’s latest guidance that April is the earliest possible date.
However, that seems like a bridge too far considering that wage growth is not impressive and that many provinces recently reintroduced tough restrictions to fight Omicron. Hence, the risk-to-reward profile for the loonie heading into next week’s decision doesn’t seem very attractive. The picture will become clearer tomorrow with the release of the nation’s latest inflation data.
Finally, gold prices have shown remarkable resilience in the face of ‘bad news’ lately. Even though both nominal and real US yields have stormed higher, bullion has remained unfazed within a narrow range, which is an achievement in itself. If intensifying speculation for Fed rate hikes and soaring yields are not enough to sink gold, most of the negativity might be priced in already.