Left Brainard, right Brainard

Brainard talks hawkish

The overnight session was dominated by comments from Fed Governor Lael Brainard, who set the cat amongst the pigeons of the equity and bond markets with some very hawkish comments. Ms Brainard suggested that a reduction of the Federal Reserve’s balance sheet, so-called quantitative tightening, could begin as early as next month and at a much faster pace than previous efforts. Additionally, Ms Brainard suggested the 0.50% hike was on the table as the Fed was prepared to take “strong action” to reign in inflationary pressures.

What makes the comments overnight so significant is that Ms Brainard is typically one of the most dovish of the FOMC members. If she has swung into the uber hawk camp, then markets need to take notice and that they did. Equity markets moved sharply lower while US yields across the curve, notably at the long end, rose notably. The 2’s-10’s inversion reversed into positive territory. At least the noise around that will thankfully die down for a while. The FOMC minutes, released this evening, will now make interesting reading.

Those of you who can remember the 80s and 90s, I know you are out there, will remember a time when the cost of capital was not zero per cent. Anyone who has been working since just 2000 probably doesn’t. The globalisation deflation, the QE honeypot looks close to being empty now as we return back to the future. The readjustment will be painful but is thankfully happening during an economic boom in parts of the world, softening the blow. I’m not sure we will get a soft landing, especially when Jerome Powell says we will, and nor am I sure the FOMO gnomes of the equity market will be able to continue ignoring reality, particularly if US yields continue to rise. Fed funds futures are already priced above the FOMC dot plot; I’m not sure that process is over.

Turning to Guns and Roses, the Reserve Bank of Australia decided it no longer needed a little patience on inflation in its post-rate decision statement. As predicted – correctly for once- the Australian dollar quickly rallied over 1.0% and local equity markets gave back all the day’s winnings. If an uber dovish central bank like the RBA is shifting its stance, we should all take note. Especially as Australia is about as insulated from the stagflation wave sweeping the world as any. Thanks to Lael Brainard, AUD/USD gave back nearly all its gains as the US dollar surged on higher US yields, but AUD remains a nice catchup interest rates play, after starting from out of the pit lane. Add in its resource base, a booming domestic economy and its distance from Eastern Europe, there’s a lot to like.

China returned from holiday today with things looking as nervous as ever. The South China Post did an excellent piece on the details of concessions by China over auditing audits. The executive summary is that individual companies have plenty of wiggle room on information disclosures, so the delisting threat hasn’t gone away. China’s Global Times is reporting that 60 Chinese cities have now loosened property restrictions to support the market. There is no sign of a resolution to the leverage woes of Evergrande et al either. The World Bank has cut its 2022 China growth forecast to 5.0%.

More pressingly, China’s covid-zero policy leaves Shanghai still locked down with cases rising still, and nerves fraying about further spreads and more sweeping lockdowns. China’s Caixin Non-Manufacturing PMI slumped to 42.0 in March from 50.1 in February. Covid-zero restrictions and fears, along with downstream impacts from Eastern Europe appear to be sapping consumer confidence. Unsurprisingly, China equities have opened lower today and it seems that LPR and RRR cuts can’t arrive soon enough. It will be interesting to see if China reverts to Plan A and hastens the weakening of the yuan, something that will have spillover effects across Asia.

The Asian calendar is quiet today with the Caixin Services PMI already out. German Factory Orders for February have definite downside risks now and may deepen the malaise of the euro. On the geopolitical front, the European Union and the United States are expected to widen Russian sanctions this afternoon. Most of it seems to have been leaked already, and I still believe that Russian energy will remain untouched by the Europeans. The force of TINA (there is no alternative) is strong with the Europeans.

Keep an eye on France as well which holds its first round of presidential elections this weekend. Marine Le-Pen, a far-right candidate, has been making hay with the cost of living and has made serious inroads into President Macron’s lead. That will be decided at the runoff election of course, but French banking stocks and government bonds have already taken a hit. It’s taken Trump and Brexit to shake financial markets out of their complacency around elections. Angry people vote, and fringe candidates are good at getting angry people to vote. A Le Pen victory on April 24^th would shake the foundations of Europe. It’s easy to dismiss that Macron will win the runoff, but we’ve been here before, haven’t we?

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