Fundamental Analysis of Markets
Tuesday, US equities plummeted, with the S&P 500 losing 1.3 percent. US 10-year rates increased 15 basis points to 2.55 percent after Fed Governor Brainard cited Paul Volcker on runaway inflation and urged the Fed to rapidly reduce its balance sheet (more below). 2yr yields increased 9bps, reintroducing marginally positive territory to 2s10s. Germany's 10-year bunds increased 11 basis points to 0.61 percent. Oil is down 1.7%.
Equities fell sharply as incoming Fed Vice Chairman Lael Brainard made more hawkish-than-expected comments about the rate of balance sheet reduction, driving the UST 10-year yield higher.
Nothing is conclusive, but the Federal Reserve appears to be on track for an aggressive rate hike path in the near term. Thus, with the aggressive Fed once again biting at stock market investors' heels, US stocks plummeted overnight.
Despite the tape's risk-off move, financials remain a relative outperformer (on a margin). The big increase in the US 10y +16bp and the steepening in the 2s10s overshadow the tape's stagflation concerns-tilt.
Meanwhile, the market may have expected Fed Governor Brainard to deliver more balanced remarks — instead, they received statements on the hawkish side from someone like Brainard. She was not excessively hawkish, but she also did not give anything on which the doves could hold.
Liquidity remains scarce, and no one appears willing to take the other side as air pockets become more accessible.
According to reports, the EU intends to propose a phase-down of mandatory coal imports from Russia, with details still being worked out. Additionally, the EU is anticipated to bar the majority of Russian trucks and ships from entering the bloc.
Oil is slightly down as the market views the proposed penalties against Russia as being limited to coal, while leaders remain divided on how to handle Russian crude. US National Security Advisor Jake Sullivan, however, has stated that Washington will announce additional sanctions on Russia this week, including additional oil sanctions.
The United States' appeal for a coordinated SPR release last week fell on deaf ears, with no OECD countries adopting the idea thus far. Although the Japanese Industry Minister stated that the details of the IEA-led reserve release are still being worked out, oil prices have remained relatively stable.
Forex
Central banks are still attempting to strike a balance between combating inflationary supply shocks on the one hand and not worsening growth or demand shocks on the other. Europe appears to be having the most difficulties balancing the two, which means Thursday's ECB minutes will be closely watched. They come ahead of the current FOMC minutes, which are scheduled to be released later today. On that call, and in light of Vice-Chair Leal Brainard's remarks yesterday as a plate warmer, we should anticipate hawkish FOMC minutes focused on accelerating the run-off of the balance sheet.
The Australian rates market underperformed on a less dovish RBA. Economists now anticipate a May or June rate hike by the RBA. Nonetheless, traders can shrug their shoulders, as the AUD has been one of the best performing G10 currencies over the last month, owing to strengthening terms of trade and more aggressive RBA pricing, with a cash rate of roughly 3.25 percent priced by end-2023.
The rates markets, on the other hand, are suddenly second guessing themselves, and for good cause. A 3.25 percent cash rate would increase the mortgage repayment share of income for a new borrower to an equal record high of 35% (70 percent pre-tax) and cause a housing market correction, so throwing the economy into recession and prompting an RBA "stop out" policy.
Fortunately for bulls of the AUD, the rate hike channel is only one component of the long AUD trade. Nonetheless, terms of trade are a big driver and should support the AUD on falls, even more so now that China is attempting to shift its policy lever in favor of commodities.
Fundamental Analysis of the Japanese Yen
USD/JPY sold off overnight from 122.80/90 to a low of 122.375 before establishing a foundation and bouncing. While official comments may evoke a kneejerk reaction on the spot, the risk of the BoJ changing policy or intervening directly in FX markets is low.
USD/JPY should remain supported on dips as both US rates and energy prices continue to rise.
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