Equities fell and bond yields rose, as the hawkish Federal Reserve (Fed) fears resurfaced before Wednesday’s FOMC decision.
The Fed starts its two-day meeting, and expectations are mixed. The Fed could call the end of the aggressive rate tightening and signal slower rate hikes to enter the final phase of policy tightening, before pausing.
So, we are at that point, where, after this week’s 4th consecutive 75bp rate hike, the Fed could hint at a 50bp hike in December. Then, the season finale would come with a couple of 25bp hikes in the first quarter of 2023, then a pause.
But there is a risk in there. The risk is, because investors are waiting in ambush for the Fed to soften its tone, any sign of a less hawkish Fed could send both the bond and equity markets rallying.
And that’s exactly what the Fed doesn’t want to happen. A broadly cheerful market rally would boost inflation expectations, and inflation. And inflation is nowhere close to the Fed’s 2% policy target.
Therefore, if we see a determined inflation warrior that is ready to send everything under the bus to fight inflation, then we could call the end of the latest bear market rally and expect fresh lows in this selloff cycle.
If however, Powell sounds reasonably hawkish, we shall see consolidation, with hope of further recovery.
The S&P500 tests the 100-DMA to the upside for the first time in a month, and recovered around half of losses it made since the summer peak. Another selloff could send the S&P500 down to 3400 level, following an ABCD pattern since March.
Inflation that comes from nowhere
The Eurozone inflation hit a record high of 10.7% in October, versus 10.2% expected by analysts, and the European Central Bank (ECB) Chief Christine Lagarde said that inflation came from nowhere, ignoring a decade-and-a-half of aggressive bond buying that threw the foundations of the present spike in inflation, boosted by the pandemic, the war and a global energy crisis
The Eurozone yields spiked on expectation that higher inflation would mean higher ECB rate hikes in the future. But the euro didn’t gain, as currency traders priced in the rising recession fears that come along with the higher interest rates. The EURUSD is now back to testing its 50-DMA, and with investors broader moving back to the US dollar, to protect themselves against a hawkish Fed statement tomorrow, we could see the pair sink below the 50-DMA, which stands near 0.9890.
The Reserve Bank of Australia (RBA) raised the interest rates by 25bp as expected and said there will be more rate hikes, but the whole thing will depend on economic data… a similar blah blah to what we heard from the ECB last week. The AUDUSD gained, because the US dollar was softer this morning.
In Switzerland, the Swiss National Bank announced a 142 billion franc loss in the first nine months of the year; melting currency valuations, especially the melting euro, was to blame.
In precious metals, gold remains under pressure. The $1615 is the next important support. If the US dollar strengthens as a result of a sufficiently hawkish Fed statement this week, gold bears could pull out the $1615 support and tip a toe into the $1500s for the first time since April 2020.