Powell sets the record straight

Powell says March hike to go ahead

Jerome Powell sparked more volatility in markets overnight, as if we needed more, by quite clearly stating that the Federal Reserve would not be deterred from hiking at this month’s FOMC meeting, despite uncertainty surrounding the Ukraine situation. His remarks suggested a 25 basis point hike was coming, taking 50 bps off the table.

His remarks sparked more tumult in bond markets, which this week, have been behaving like the caffeine-addled tail-chasing fast-money gnomes of the equity market. US yields plummeted on Tuesday as markets removed rate hike expectations, only to fully reverse that move overnight, US 10 and 30-year treasuries adding a whopping 17 basis points. Additionally, the Bank of Canada also hiked by 0.25% overnight with more hikes to come. Additionally, the clutching-at-straws equity rally was given renewed momentum as a 0.50% hike in March became 0.25%.

Confusingly, for those programmed to more mechanical movements by asset classes, that fit nicely into that finance textbook from the first year of university, bond yields plummeted on Tuesday, but so did equities. Yesterday, US bond yields rocketed higher, but so did equities. Meanwhile, oil and commodity prices kept reaching through the sky through the whole thing.

So, what’s going on? I believe it’s best to look at them in isolation as those lovely mechanical connections, like so many things in the world right now, are either broken or severely worn out. Looking at equities, it is clear the perpetual mega-bulls of the past two years are continuing to fight a rear-guard action, using their previously successful buy-the-dip playbook, refusing to accept that the central bank cookie jar is near empty and that Ukraine-Russia has changed everything. With that in mind, a massive amount of peak-Ukraine FOMO is going on. At the first sign of any glimmer of resolution, investors pile into equities. Yesterday, that cue was another meeting to be apparently held by Ukraine and Russian officials on the Belarus border today. Mr Powell further justified their worldview by saying only a 0.25% hike was on the table this month. 0.25% is less than 0.50% equals lower rate hike equals already long peak-Ukraine FOMO equals buy equities. Simple, isn’t it?

Now bond markets. Bond investors have been pricing in substantial rate hikes by global central banks, most especially the Fed, over the past few weeks. Yields have risen across the curves and bond investors have probably gone quite underweight in anticipation of this fact. With inflation skyrocketing everywhere, it is quite reasonable to assume that the world’s central banks have mostly made a complete dog’s breakfast of actual inflation outlook. The Russian invasion of Ukraine saw some haven inflows into US bond markets, but bond markets overall didn’t respond aggressively initially.

That changed this week, as the weekend sanction frenzy showed the West meant business and bond markets scrambled to reprice rate hike expectations around the world, most especially in the US, the Dark Tower of global monetary policy. Having pushed yields sharply lower in the assumption the Fed would blink on hiking, Mr Powell blindsided the street by saying in fact they would hike this morning. Cue a mad rush for the exit door to reprice the Fed not hitting the W for Wimp button at the first sign of trouble. If anything comes of today’s meeting on the Belarus border, you can guarantee yields will rise again, and equities too.

The key to this whole puzzle that is being overlooked is what shape the US yield curve, and others, will look like as the Ukraine situation evolves. There is little doubt that a stagflationary wave is on the way to the world, it’s really just a question of how big it will be. Only a complete loss of nerve by the West will change that. If central banks prioritise fighting inflation in 2022, having failed the world on that front in 2021, then hiking into a stagflationary environment likely means they are accepting some sort of recession is necessary to sort the whole mess out. Before everyone panics, there are recessions. Recessions can be a mild headache, or a vicious migraine, and everything in between. But in this case yield curves, including the US, are likely to turn NEGATIVE. The pain of higher reference rates will lift short-end rates, while longer-dated yields, pricing in recessions, and slower growth and future inflation, will fall.

A glance at oil prices and commodity prices in Asia today, tells me the bond markets and equity markets are both running around like headless chickens at the moment. The underlying trend is there for all to see. Some sort of recession is on the way, it’s just how deep it’s going to be. And that dear readers, is why bond yields can fall, (in parts of the curve), and equities can fall at the same time. In the meantime, unless the meeting today produces a miracle, the day in the sun for equities looks like yet another sucker’s rally. As I have stated before, volatility will be the winner in 2022.

In Asia today, the pre-Ukraine data releases continue to show a positive picture, though. South Korean GDP outperformed, continuing a strong week of data, but gains may be limited ahead of the 9^th of March elections, and an electorate angry at the cost of living and housing. A familiar tale globally. In China, Caixin Services PMI disappointed, printing at 50.2. Omicron fears, a soft property market, and a weak run for equities could be crimping consumer confidence. However, an official commenting that he could see the end of the Covid-zero policy may limit any negative fallout.

Australia may be underwater at the moment, but it remains the lucky country. Market Service PMI leapt to 57.4 in February and January’s Balance of Trade exploded higher to AUD 12.90 bio, with exports leading the way. If there is one country that standing to benefit from the global mess now, it is Australia. It’s got lots of the things that everybody wants to buy with Russia out of the picture, even coal. China may yet rue its diplomatic petulance over Australian import bans. Pop in a post-flooding construction boom and even the RBA may need to throw in the towel on its uber-dovish outlook and start hiking. The Australian dollar could be a winner in 2022. The Wallabies might even win the Bledisloe Cup. Strange times indeed.

European markets will continue to be buffeted by Ukraine headlines, while the US sees the second day of Powell testimony and the release of ISM Non-Manufacturing PMIs and Factory Orders. The PMI sub-indexes will tell the real story, which will likely be one of omicron being omigone in American eyes. That sets us up for US Non-Farm Payrolls tomorrow evening, with the risks skewed to the topside and potentially more bond market volatility.

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