Daily Market Comment – Fed chief signals faster taper, dollar not impressed

  • Fed Chair Powell says appropriate to consider accelerating taper process
  • Dollar spikes higher but cannot sustain gains, stocks close lower 
  • Heavy dose of economic data releases today, OPEC begins meeting
Powell turns hawkish

The Chairman of the Federal Reserve dropped a bombshell on global markets yesterday by signaling his central bank will consider accelerating the pace at which it withdraws liquidity from the financial system. Testifying before the US Senate, Powell stressed that inflation risks have intensified and that incoming data since the last FOMC meeting point to a rapid improvement in the economy. 

He also downplayed the Omicron variant as being a mere risk at this stage and explicitly said it could be appropriate to end asset purchases “a few months” earlier than planned. Several other Fed officials have expressed similar views about faster tapering recently, including Vice Chairman Clarida, Board Governor Waller, and regional presidents Daly, Bostic, and Bullard. 

Barring some catastrophe in Friday’s jobs numbers or next week’s inflation report, it seems like an acceleration of tapering could be announced at the next FOMC meeting in mid-December. The question that will keep traders guessing until then is exactly how much faster the Fed might dial back its bond purchases. 

Dollar not impressed

Markets reacted quickly. Fed futures contracts are currently pricing in two rate increases for next year and even odds for a third one, starting in June. Short-term Treasury yields soared to reflect this hawkish shift, although longer-dated yields fell as investors priced some inflation risk out of bonds now that the Fed is getting the normalization ball rolling properly.

Yet the dollar was not impressed. The reserve currency spiked higher initially but soon surrendered all its Powell-related gains to close the session in the red overall. It’s difficult to say whether this was because of a relief rally in the euro as oil prices plunged or whether month-end flows simply eclipsed everything else. 

Either way, the bigger picture for euro/dollar remains grim. A barrage of economic growth downgrades is likely imminent with restrictions returning across the Eurozone, while in contrast, the American economy is booming and there’s still room for markets to fully price in a third Fed rate increase for next year. 

There’s also an element of political risk in Europe ahead of next year’s presidential election in France after far-right journalist Eric Zemmour announced his candidacy yesterday. President Macron is leading in opinion polls but if the polls narrow heading into the election, a risk premium could be added to the euro as hopes of continued European integration are challenged. 

Stocks volatile, key data coming up

Between Omicron worries, the Fed potentially speeding up tapering, and fund managers trying to protect their yearly performance before closing their books later this month, there has been no shortage of volatility in stocks lately. But for all the headlines, the S&P 500 is only 3% away from its record highs. Not exactly panic territory. 

The market is essentially being held up by its generals - a handful of tech heavyweights. There has been a clear rotation to quality lately, with unprofitable ‘growth’ companies and small caps getting blasted while titans like Apple continue to forge ahead, carrying entire indices on their shoulders.

As for today, there are several events that could reignite volatility. The ISM manufacturing survey and the ADP jobs report from America will top the economic calendar, while Powell will appear before the House of Representatives for his second round of testimony.

In energy markets, OPEC will begin its two-day meeting. With concerns that Omicron will hurt demand and several nations releasing strategic reserves, the cartel has the perfect excuse to hit pause on its plans to steadily raise production. If so, that could bring some much-needed relief to oil prices.

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