What Next, Chairman Powell?
This week will be an important one, with Fed Chairman Jay Powell testifying before the Joint Economic Committee in Washington DC, followed by Nonfarm Payrolls on Friday.
We have already recently written about central banks HERE, HERE, and HERE , and we’ve discussed how markets are furiously trying to understand where the current tightening cycle will end.
For months now the markets have been trying to ‘fight the Fed’, hoping for an end of the tightening cycle and pricing rate cuts shortly thereafter. As US inflation remains sticky to the upside and economic data still have some strength, this ‘fight’ has so far been won by the Fed. The Fed Funds terminal rate is now priced just short of 5.5%, and projected rate cuts have been pushed out to 2024.
So, what are the risks this week, and how could price action develop?
The main story of the past month has been the breakout in yields (both US Treasuries and German Bunds). In the 10y US yield, after the technical break above the trendline resistance at 3.65%, we have gone upwards in a straight line and passed the 4% big figure (see chart below).
We are seeing a small retracement lower in the past couple of trading sessions, but this is most likely a corrective move before one final push higher. This could be driven by profit-taking, positioning, or simply the market hoping for a dovish surprise from the Fed or the upcoming Nonfarm Payrolls release.
However, it’s most likely that this move is just a correction. Although some US economic data have recently been weak (for example Consumer Confidence and some PMIs), there is still no sign of inflation easing enough to cause the Fed to turn dovish. US employment is also relatively strong, with the unemployment rate at very low levels and NFPs printing comfortably above 200k.
What does this mean for equities and the Dollar? The S&P500 index has been very resilient, particularly in the past few sessions where yields have been dropping. However, it’s likely that any move towards the 4200 resistance level will be met with selling and the resistance should hold.
The US Dollar has been moving in tandem with yields, rallying nearly 5% in the first three weeks of February. The current pullback should find support at around 103.40-103.60, which is the 50DMA and the 38.2% Fibonacci retracement of the past month’s move higher – provided that there are no major surprises from Jay Powell or the NFPs this week.
The bottom line is that, on a macro level, there are very few reasons for Chairman Powell to change his rhetoric, and the markets are once again probably too early to price such a move. The move higher in yields & the USD (and lower in risk) should continue for the next few weeks, until we start to see the YoY US CPI figure dropping substantially.
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