Dollar Stands Tall, Stocks Rescued by Dip Buyers

• Dollar defends gains, awaits barrage of US economic data
• Stocks bounce back, yen retreats as nerves calm down
• Three major central bank meetings and tech earnings lie ahead

Risk tone improves

Market volatility has returned with a vengeance this month. A sharp repricing in the trajectory for interest rates has sent nervous investors scrambling to insulate their portfolios from any further damage, mostly by reducing leverage and moving higher along the quality spectrum.

Money markets have fully priced in five quarter-point rate increases by the Fed for this year and a similar path for economies like the United Kingdom, Canada, Australia, and New Zealand. This has propelled yields on government bonds much higher, which acts like gravity for riskier assets, knocking the wind out of the stock market.

The good news is that this correction reflects changing views about market conditions, not the real economy. Central banks are trying to raise rates precisely because their economies are solid enough to withstand that, so even though investors might protest, it is ultimately a healthy sign.

As long as recession alarms are not going off, any correction in equities seems like a longer term opportunity in a market that is still starved for yield, especially with valuations becoming more reasonable. This might be what helped Wall Street bounce back on Friday to close the week higher, along with some cheerful earnings from Apple.

Dollar remains elevated, yen retreats

The dollar has been a natural winner in this environment, benefiting both from bets that the Fed will take a sledgehammer to inflation and from the general flight to safety.

Traders have started to flirt with the idea that the Fed could kick off its tightening cycle in March with a shock-and-awe rate hike of 50 basis points after policymakers refused to rule that out. As such, this week’s data releases could be crucial for the greenback, with Friday’s employment report likely to steal the show.

Meanwhile, the beaten-down commodity currencies are enjoying a rare show of strength to start the week while the defensive Japanese yen is on the ropes, mirroring the improvement in risk sentiment. Even the beleaguered euro managed a small rebound after Mario Draghi stayed on as Italian prime minister, fueling hopes he might get to implement a growth-friendly agenda.

China slows, central bank fiesta ahead

Over the weekend, Chinese business surveys painted a grim picture of the world’s second largest economy as the draconian responses to covid outbreaks held back demand and exacerbated supply shocks.

Chinese markets will stay closed for the entire week in celebration of the Lunar New Year, along with other financial hubs across Asia in the next few days. This implies that liquidity will be even thinner during the Asian trading session, putting traders on alert for sharp moves or even flash crashes. 

There isn’t much on the agenda for today but the rest of the week promises to be very entertaining with central bank meetings in Australia, the Eurozone, and United Kingdom, the latest edition of nonfarm payrolls, and earnings results from tech heavyweights like Google and Amazon.  The Reserve Bank of Australia will get the show rolling early on Tuesday.

With the economy improving, there is growing speculation the RBA will end asset purchases immediately and signal that rate hikes are on the menu this year. However, that might not be enough to lift the aussie, as policymakers could also warn that the five rate hikes currently priced into markets by December are excessive.