Jay Powell testified before the U.S. House of Representatives’ Financial Services Committee stressing the Fed needs a policy anchor grounded in continuity. Indeed, the tone of Chair Powell’s written testimony suggests that on the whole, the Fed policy isn’t about to shift abruptly under his leadership and that the pace of gradual rate hikes will continue to be the mainstay of the Fed narrative. However, his pointer at the topside potential for both inflation and growth suggests the risks as skewed for a bolder monetary policy response.
The shifting balance of risks has the market considering the possibility of more 2018 rate hikes than expected given his outlook on both growth and inflation. The Fed’s December economic outlook pointed to three rate increases this year, but with two surprisingly strong inflation prints between then and now, they have likely tipped the scales on the Feds inflation outlook.
In the aftermath, we are in the midst of vintage cross-asset rotation as front-end Treasuries sell-off, stock markets are discernibly lower, and commodities are tanking in response to Powell hawkishness. Denuded of any significant fireworks, however, the message from Powell’s testimony was clear. With the economy in full swing, monetary policy needs to get back in the game. In fact, he’s not too concerned about risk aversion but rather, factoring the economic upside from fiscal policy
After day one of the two-day policy test: Hawks 1 Doves 0
Equity Markets
US equity markets closed in a sea of red which is expected to engulf Asia markets today. No need to sugar coat this analysis as there was no rabbit out of the hat, just the big bad bear. Investors may have been expecting some response to equity market volatility, but that was apparently of little concern to Powell. Indeed, no sign of a “Powell Put” in play, which is trading well out of the money at this stage. With that in mind, the odds of four rates in 2018 rose to 33% from about 20% on Monday, according to CME Group’s data.
Oil Markets
The asset rotation out of commodity markets on the stronger USD narrative, combined with oil traders refocusing on shale production output, as the US is on course to be the world's largest oil producer has prices convincingly moving lower.
Also, suggestions OPEC could taper production cuts in early 2019 is weighing on sentiment this morning. Given that OPEC compliance is responsible for 40-50% of recent oil price appreciation, Saudi oil minister Khalid al-Falih's comments are not going without notice.
It’s a typical trader reaction, when markets flip upside down, all the negatives come to the fore.
Gold Markets
Gold found fresh session lows post-Powell testimony, bottoming around 1313.5 before finding a bid and consolidating around the 1318 level. All part and parcel of the classic asset rotation as the strong dollar pressured gold lower. While traders will wait for confirmation in tomorrow's Senate testimony which tends to be more telling, today’s discussion suggests we could see a higher interest rate profile and recovering dollar near term, which could trigger a more profound move lower on Gold. Not the best of outcomes for Gold bulls
Currency Markets
The Euro
The combination of a hawkish Powell and uber ECB hawk Weidmann coming out dovish has convincingly toppled the euro. Weidmann is in the running for the ECB president and likely becoming more moderate given that it's ECB hawkishness that sends the euro soaring which panics most ECB members.But let’s not lose sight of the fact that the recent German CPI missed expectations, suggesting inflation in the EU's largest economy is not an issue and there's no immediate need to raise rates
The Japanese Yen
Only moderate upward pressure on the USDJPY. It's almost as if everyone wants to stay away given that recent ranges continue to hold firm. Perhaps there's uncertainty over month-end flows or between equity sell-off vs higher US rate dynamics, but the balance of risk suggests a test of the 107.50-75 levels sooner rather than later.
The Australian Dollar
Commodity currencies took it on the chin overnight, though the Aussie remains tentatively supported above the primary .7775 level. But one thing that tends to hold true for the AUD, and it's hardly a scientific metric mind you, buy Aussie when you can’t find a bull.
The Malaysian Ringgit
The ringgit is holding up well this morning in pre-open trades, despite the market increasing bets on an additional US rate hike in 2018 and oil prices moving lower.
The ringgit external position remains very favorable and given market positioning is not excessive. One other Fed fund rate hike in 2018 will have less impact on the MYR than regional peers. Also, the BNM raised interest rates early this year and will do so again if inflation warrants. While a faster pace of US interest rate normalization is not an ideal platform for regional currencies, it’s not all doom and gloom for the ringgit.