Fed Chair Powell’s U-Turn On Inflation Is The Obvious Driver

Markets

European stocks recovered in absence of any Omicron-related headlines. Main equity indices gained up to nearly 3% for the EuroStoxx50 in a calm European trading session. Core bonds and EUR/USD treaded water. Dynamics again changed during US dealings. A strong November US ADP employment report (534k) and manufacturing ISM (61.1 from 60.8) provided more evidence of better-than-expected Q4 growth momentum, but was still ignored. Risk sentiment dwindled once the US (and the UK and Switzerland and Brazil…) reported its first Omicron case. Main US equity indices turned intraday gains of around +2% into losses of a similar magnitude. Deteriorating risk sentiment coincided with a recovery in core bonds while EUR/USD no longer profited from those market settings. The pair closed the day near opening levels around 1.1330. US Treasuries outperformed German Bunds. The US yield curve bull flattened with yields shedding 1.4 bps (2-yr) to 5.2 bps (30-yr). Underlying dynamics for a second session show inflation expectations falling faster than the recovery in real yields. Fed Chair Powell’s U-turn on inflation is the obvious driver. These dynamics will probably start benefiting the dollar if continued. In nominal terms, the US 10-yr yield tested November low at 1.41% while the 30-yr yield closed below the lower bound of the sideways trading channel in place since July (1.78%). It temporary traded at the lowest level since January. The German yield curve bear flattened with yields rising by 0.5 bps (10-yr) to 2.4 bps (2-yr). (US) market moves after the European bell obviously suggest a softer equity and yield opening this morning.

Cleveland Fed Mester joined the chorus of Fed members, including Chair Powell, who are open to scaling back asset purchases sooner than planned. “Making the taper faster is definitely buying insurance and optionality so that if inflation doesn’t move back down significantly next year we’re in a position to be able to hike if we have to”. That’s as clear a message a central banker can deliver. We expect the Fed to double down on its tapering efforts from January with net purchases ending in March. Today’s eco calendar is thin with weekly jobless claims and more Fed speeches. OPEC+ holds its monthly meeting and might decide to halt the reversal of earlier production cuts. Brent crude fell from $80/b to $70/b the past week. (US) risk sentiment might remain shaky on the combination of Omicron and a hawkish Fed. Rising real (US) rates should bring the dollar back on track after last week’s corrective action.

News headlines

November South Korean CPI accelerated from 3.2% Y/Y to 3.7% Y/Y, marking the fastest pace of price rises since December 2011 and beating market expectations by a substantial margin. Inflation has now been running above the 2% target of the Bank of Korea for the eighth consecutive month. After the publication of the data, the BOK indicated that inflation might surpass the annual forecast of 2.3% it made only last week as supply bottlenecks could last longer than expected. Still it expects inflation to gradually slow due to the global oil price trend and as the effect of a lower fuel tax kicks in. Last week, the BoK raised its policy rate by 0.25% to 1.0%. Higher than expected inflation might cause the BOK to make some follow-up rate hikes. The next policy meeting is scheduled for January 14.

According an announcement in Turkey’s Official Gazette, President Erdogan appointed Nureddin Nebati as minister of treasury and finance. He will replace Lutfi Elvan who resigned yesterday. The exit of Elvan is the latest episode in the battle within the Turkish government and the central bank with respect to president Erdogan’s aim for lower interest rates despite run-away inflation. Elvan recently advocated that the CBRT should be able to do what is needed to slow price increases in line with its mandate, a view that is not in line with president Erdogan’s view. The Turkish lira is again losing ground this morning after the CBTR yesterday executed FX interventions to support the lira which this week dropped to all-time lows against the dollar and the euro. EUR/TRY currently trades near 15.22.