Sat, May 28, 2022 @ 23:10 GMT
HomeContributorsFundamental AnalysisWeekly Focus - All Eyes on Fed

Weekly Focus – All Eyes on Fed

Risk sentiment remained on the back foot this week, with market focus centring on a continued rise in global yields. US 10Y Treasury yields closed in on 1.9% – up 35bp since the start of the year – reflecting expectations for faster monetary tightening in the US. Markets are now pricing in four Fed rate hikes of 25bp this year, with a good probability that we will see more than two rate hikes in H1 22 or alternatively a 50bp hike. In our view the first year of the US money market curve is now fairly priced, especially as we expect the Fed to reduce the balance sheet (QT) in Q3 this year, but with upside risk of more Fed hikes in 2023 (read more in Yield Outlook: Market rates and yields set to continue rising, 19 January). Notably, yields are moving higher with stable to lower inflation expectations (break-evens), resulting in a sharp move higher in real rates, which was an important driver for the sour risk appetite. We have increased our 12M forecast for 10Y US Treasury yields to 2.25% and lowered our 12M EUR/USD forecast to 1.08.

The rise in US yields also spilled over into other markets, with 10Y German Bund yields turning positive for the first time since May 2019. Brent oil prices touched USD 89/bbl in light of improving demand expectations and equity markets remained volatile amid a lacklustre start to the Q4 earnings season. Rays of light came from China, where the central bank cut its key policy rates by 10bp, easing liquidity conditions further to support the economy during a year where stability is high on the agenda. German ZEW expectations also showed a welcome rebound in January, as investors still see Omicron as a temporary headwind to the global recovery. Meanwhile, US manufacturing seems to have started 2022 on a weak footing, with regional business surveys pointing to a noticeable drop in orders and shipments amid Omicron disruptions, with still high price pressures. Despite rumours about a hawkish twist, Bank of Japan kept a steady hand with no signs of discussions of a rate hike before the 2% inflation target is reached. ECB President Lagarde again rejected calls for faster policy tightening despite continued high inflation pressures, reiterating that cyclical conditions were weaker in the euro area than in the US.

A busy agenda awaits next week, with the highlight being the FOMC meeting on Wednesday. We expect Fed to keep policy rates unchanged, but reinforce signals for a March hike. We have changed our Fed call, now expecting four 25bp rate hikes this year and QT starting in September, with risks skewed towards more hikes and earlier QT (read more in Fed Research – Preview: End of money printing brrrrr – (at least) four 25bp rate hikes this year and QT in September, 18 January). On the macro front, flash PMIs for January in the euro area, UK and US will also draw attention, especially to gauge whether manufacturing is slowing and price pressures are easing. US GDP figures should still signal that the recovery continued at the end of 2021, but we will watch out how households reacted a new COVID-19 wave and rising prices in the December consumption data. Russia-Ukraine tensions also remain an important tail risk to watch for markets, as a decision about military intervention/sanctions will probably have to come sooner rather than later. Italy’s presidential election kicks off on Monday, with a clear risk of political uncertainty returning over the longevity of Italy’s unity government, if current Prime Minister Mario Draghi is elected as President.

Full report in PDF.

Danske Bank
This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (©) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.

Featured Analysis

Learn Forex Trading