Daily Market Comment – Fed gears up for battle, markets tremble

  • Fed meeting today will be critical - all eyes on taper speed and dots
  • Dollar climbs, stocks dive after US producer prices surge
  • UK inflation spike revives BoE rate bets, gold rolls over
Fed in the spotlight

The Federal Reserve is widely expected to accelerate the pace at which it dials back its asset purchases today, opening the door for raising interest rates earlier. An onslaught of impressive economic data and intensifying inflationary pressures have left policymakers little choice but to take their foot off the gas, to avoid having to slam on the brakes later and risk shocking markets. 

With an expedited taper looking like a done deal, the real questions heading into this meeting are exactly how much faster asset purchases will be wound down and how many rate increases the FOMC will signal for next year. Back in September, the ‘dot plot’ of rate projections pointed to 50-50 chances for just a single rate hike in 2022. 

Money markets are currently pricing in almost three hikes, so it is almost certain the ‘dots’ will be revised sharply higher to reflect economic reality. Considering the strength of recent data, from the labor market to consumption to inflation, the most realistic outcome is the Fed roughly doubling the speed of tapering and signaling two hikes for next year. 

That combination would likely be enough to put the shine back into the dollar, especially if Chairman Powell strikes a concerned tone on inflation during his press conference. For the dollar, it’s not only that the Fed has its finger on the rate-hike trigger, but also that central banks in Europe and Japan are nowhere close to that point. 

US producer prices soar, markets shiver 

Traders got a taste of how markets might react to the Fed yesterday after US producer prices rose at the fastest clip since records began a decade ago. The risk is that omicron pours more fuel on this cost-push inflationary fire, by reviving lockdowns in manufacturing centers like China and keeping supply chains under duress. 

Markets reacted swiftly, with the dollar racing higher alongside Treasury yields while stocks took a hit as investors positioned for a more hawkish Fed, although some of these moves retraced later on.

Stock markets feel increasingly unstable as the tech generals have also started to roll over lately, eroding the final pillar of support that was holding the indices standing. The training wheels are coming off now that the powerful forces of monetary and fiscal policy are fading, leaving equities to rely mostly on earnings growth heading into next year. With valuations stretched, that’s a real risk.

Gold takes a hit, pound jumps

Gold suffered some serious injuries as the dollar and Treasury yields charged higher in the wake of the spike in producer prices, which cemented expectations of a hawkish twist from the Fed. In general, bullion has fallen out of favor again now that real yields have started to creep up from depressed levels. This could be a prelude for next year.

The British pound found some relief after the nation’s inflation stats for November exceeded forecasts, reinvigorating bets that the Bank of England might raise rates this week. That said, the Bank doesn’t seem in a hurry to act now that omicron has entered the equation, so this data might have simply set the pound up for a bigger fall tomorrow. 

Finally, US retail sales will hit the markets ahead of the Fed meeting, alongside Canada’s latest inflation numbers. In China, the batch of data released overnight was very disappointing, highlighting that the slowdown in the property sector has already started to infect the broader economy. 

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