Going into the US Fed meeting this evening, markets are already stewing over. The sell off over the past week in US equity markets has been well noted, with crypto also not immune to this risk off purge. In terms of reasons, we acknowledge the high inflation prints are a problem, but the market knew about this back in December. Ramping up of hike expectations is different though, and this has only really kicked in since late December. Tensions with Russia are also not helping.
Bringing that all together, here are a few things to keep an eye on for this evening.
The Fed this evening arguably could struggle to stem the slump in equities, even if they tempering down their rhetoric to be more accommodative. The most positive signs for equity traders would be a lack of any further increase in the speed of tapering off asset purchases. Ultimately, the longer this process takes, the longer it’ll take for the central bank to be in a position to hike rates. This would be seen as positive for equities, with lower rates for longer aiding the pass through of higher financing costs to be kicked down the line.
The other element around rate hikes will be seeing how the short end of the yield curve reacts to the statement. If the curve steepens but at longer (eg. 2yr) maturities, equities should remain fairly supported. but if we see the short end of the curve steepen (anything up to 12 months out), then this could put further downward pressure on stocks.
From our point of view, we struggle to see the Fed being more hawkish than they already are, so don’t see equities at risk. However, with the market clearly already very sensitive and pessimistic, it wouldn’t take much in the way of hawkishness to send the market another leg lower.
For the USD, the bar on being hawkish again means that we don’t see a high probability of USD strength following the meeting. We would prefer to be short going into it, as the market has already priced in almost four rate hikes this year.
A key point to watch for FX traders will be any indication of the size of hikes in the near term. There is some speculation that a 50bps rate hike in March is coming, instead of a 25bps hike followed by another later in the spring. If it looks like 50bps is due in March, this would give some strength to the dollar in the short term.
Ultimately, we feel this is unlikely but do flag it as something to watch out for.
Final thoughts on the US Fed
Overall, we flag up noting the updated pace of asset tapering, along with any intent to raise rates as soon as this is finished. Any indication or leaning towards an aggressive March hike is key, followed by how the rest of the short end of the yield curve reacts.