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HomeContributorsFundamental AnalysisExpectations for Protracted Fed Hiking Cycle and Aggressive Risk-off Favoured Dollar

Expectations for Protracted Fed Hiking Cycle and Aggressive Risk-off Favoured Dollar

Markets

End last week it was confirmed that inflation remains the top concern, for markets and for central banks. On Thursday, the ECB admitted that price rises have become uncomfortably high, signaling a catching up move in policy normalization. 50 bps hikes are likely after a 25 bps lift off in July.

The ECB’s U-turn triggered a broad-bond market sell-off which was extended on Friday following stubbornly high May US inflation. The headline figure jumped 1% M/M to be up 8.6% Y/Y, the fastest pace since end 1981. Core inflation also printed higher than expected (0.6% M/M and 6.0% Y/Y). Inflationary pressures are becoming ever more broad-based and the monthly dynamics don’t provide much evidence of a sustained improvement anytime soon.

The US 2-y yield jumped an astonishing 25 bps. In a bear flattening move, the 10-y yield still gained 11.3 bps (30y + 3.3 bps). Three consecutive 50 basis points rate hikes for the upcoming meetings are now  fully discounted, with markets pondering the possibility of a 75 bps move in June or July. The German curve bear flattened with yields gaining 13 bps  at the 2-y/5-y, 8.6bps for the 10-y and 3.3 bps for the 30-y. T

he bond market sell-off again caused major damage equity markets. US indices tumbled between 2.73% (Dow) and 3.52% (Nasdaq). The EuroStoxx 50 lost 3.36%. Markets aren’t impressed by the ECB’s commitment to prevent intra-EMU fragmentation in the implementation of policy normalization. 10-y spreads for bonds of the likes of Greece (+19 bps ) and Italy (+7 bps) widened further.

Expectations for a protracted Fed hiking cycle and an aggressive risk-off favoured the dollar. DXY closed north of 104.(14). EUR/USD dropped about one big figure to close at 1.0519. The yen initially gained as Japanese authorities step up verbal interventions, but finally closed little changed at 134.4. Sterling slightly underperformed the euro (close EUR/GBP 0.854). The risk-off further affects Asian markets with Korea (-3.25%) and Japan (Nikkei -2.9%) underperforming. China ‘outperforms’ (CSI 300 -1.1%), but the country again stepping up lockdowns doesn’t provide comfort for global investors. ST US yields are rising further (2-y + 7 bps).

The dollar remains well bid. USD/JPY touched the 135.15 2002 top. Today’s eco calendar is thin, but markets will take a close look at ECB speak. Later this week, the Fed (Wednesday), the Bank of England (Thursday) and the Bank of Japan (Friday) will decide on monetary policy. The Fed will probably reiterate a bold anti-inflationary stance, but we don’t expect a 75 bps step already this week.

On the yields graphs, we keep a close eye on the US 10-y yield nearing key resistance at 3.20%/3.26% (top May/top 2018). For the TW DXY index (104.47), the mid-May top stands at 105. We still see this as strong resistance. The UK government preparing a new law to override parts of the Brexit deal probably won’t help sterling.

News Headlines

The first round of French parliamentary elections showed a neck-and-neck race between President Macron’s ruling Ensemble coalition and the red-green alliance Nupes led by extreme-left Mélenchon. Both gathered slightly over a quarter of the votes. Le Pen’s Rassemblement national came in third at around 20% with Les Républicains fourth at around 10%. Candidates who gathered at least 12.5% of the first-round votes will move to the second round run-off next week. This system generally favours the centre and ruling parties. Still, exit polls believe that Macron’s coalition is at risk of losing its outright majority in the 577-seat parliament (between 262 & 301) with Nupes providing strong opposition (between 164 & 208). Macron would then have to rely on the right to pass crucial legislation.

 The World Trade Organization’s 12th Ministerial Conference (MC 12) started yesterday in Geneva. WTO director-general Okonjo-Iweala is calling for an end to things like export restrictions and prohibitions in order to safeguard food security and avoid a repeat of the 2008-09 food crisis. She urged to accept compromises as the WTO works on a consensus-based model. The IMF indicates that at least 30 countries introduced such protectionist controls in the wake of the pandemic and following the war in Ukraine. The UN last week warned that a record 49mn people in 46 countries are at risk of succumbing to famine or famine-like conditions with 750k people already facing hunger..
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This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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