The best spreads to trade are…
21 January 2022
Euro and British Pound, what has emerged from the meetings
7 February 2022
We already had a foretaste of this on 5 January, when the published minutes of the December 14-15 meeting revealed a consensus that the Fed would begin tapering its $4.5 trillion in Covid-era asset purchases sooner and faster than investors had anticipated. Confirmation came yesterday with Powell stating that asset purchases, which are running at a monthly pace of $60 billion, will drop to $30 billion in February and stop in early March.
The Fed is therefore changing course and becoming much more hawkish, after the immobility that had characterised the US central bank's monetary policy for several months ("[...] while these supply effects are prominent for now, they will abate, and as they do inflation is expected to drop back toward our longer-run goal", as Powell optimistically declared at the September meeting).
There were those on Wall Street who thought the Fed might stop asset purchases a month earlier, which would signal an even greater degree of urgency. However, the Fed is about to make a sharp reversal in its policy, from asset purchases to rate hikes to balance sheet reduction.
"There's a substantial amount of shrinkage in the balance sheet to be done," Powell said at his press conference. He added that his assumption is that the Fed will discuss balance sheet policy for at least the next two meetings before announcing its plan. This would mean that an announcement on the start of a gradual reduction in the balance sheet could come as early as the 14-15 June meeting. A reduction that could start softly during the summer and increase in the autumn.
Chapter rates. The Fed said that a key rate increase of 0%-0.25% "will soon be appropriate with inflation well above target and the labour market approaching maximum employment (and a "very large wage increases"). This indicates that the first quarter-point rate increase will take place at the Fed's next meeting on 15-16 March.
This was very likely even before the meeting, now it has become a certainty. Indeed, the "bet" for investors is not whether the Fed will raise rates in March, but by how much. Below is the CME Group's FedWatch. The probability that the Fed will raise rates in March by 25 basis points is 83.8%, down from 87.7% the previous day. The probability of a 50-basis point hike is 16.3%, up from 5.6% 24 hours earlier.
Not only that. Taking the chart of the 30-Day Fed Funds futures, more precisely the ZQF22-ZQZ22 spread (the January 2022 expiry minus the December 2022 expiry), you can see that at the moment the forecast of a 100-basis point (i.e., 1%) rise in interest rates in 2022 is 100%.
But it may not stop there. In fact, the CME Group's FedWatch indicated that markets now see almost a 50% chance of rate hikes of five quarters of a point this year (i.e., 1.25%), up from around 33% the previous day.
And Eur-Usd? Here's the chart.
With yesterday's meeting, a fundamental resistance was formed at 1.12410. While it is true that materially the first rate hike will only take place in March, in practice the announcement was made yesterday. The rise of the Eur-Usd, which I had predicted could reach the 1.15500/1.16000 area, was stopped at a high of 1.14828 by the Fed's meeting, which had already brought dollar purchases a few days before it took place.
Now, the situation of the currency pair has resumed the bearish trend, with first targets in the area 1.10800/1.11400 (already reached today) - 1.10200 - 1.09400 - 1.08200/1.08650.
Stock market. The main risk now, according to most policymakers, is that inflation will continue to rise too much under favourable financial conditions. If that were to happen, the Fed would be forced to become even more hawkish, and that is a typical recipe for a recession.
The last time the Federal Reserve combined a rate hike with a tightening of the balance sheet, the stock market crashed. That was in the autumn of 2018. And that was until, in early 2019, rate hikes turned into cuts and the Fed renewed its bond purchases.
Not surprisingly, yesterday after the interest rate announcement, Wall Street extended gains only to collapse into negative territory once Powell's press conference began.
What happened at the last Federal Reserve meeting and how this will affect Eur-Usd. We already had a foretaste of this on 5 January, when the published minutes of the December 14-15 meeting revealed
I am a macroeconomic and financial analyst with over 30 years’ experience, including two years as a fund manager. I specialise in currencies and commodities, and I am the author of several successful books on trading, macroeconomics, and financial markets.
2 Comments
superb analysis
Thank you, Lin