By Michael Brown, Senior Research Strategist at Pepperstone
DIGEST – A sell-off across DM fixed income pressured equities yesterday, while the dollar gained ground against most peers. Now, all eyes are starting to turn towards Wednesday’s FOMC decision.
WHERE WE STAND – I feel like every market participant needs to write out 100 times “I promise not to over-interpret moves during the month of December”.
While that’s, frankly, a pretty good mantra to have at the best of times, given the tendency to pin any old narrative on the price action, it’s even more applicable right now. Given that the festive season is upon us, markets are – to coin a technical term – thin as hell, with many participants having already shut up shop for the year, and those that haven’t possessing little conviction to do anything at all ahead of the FOMC tomorrow.
Altogether, that means not only that there is little desire to fade any moves that do take place, but also that there is relatively little value or signal to be extracted from the noisy price action that we do see.
In terms of that action, the quite clearly dominant theme yesterday was the broad-based sell off in DM fixed income, with momentum on that front clearly still with the bears. The latest trigger seemed to be comments from the ECB’s Schnabel, who noted her comfort with investors’ bets that the ECB’s next move would be a hike (long into the future), clearly cementing her place as a massive hawkish outlier on the Governing Council.
Anyway, those comments form Schnabel did put exert some notable pressure on EGBs, with the 10-year Bund yield climbing to 9-month highs north of 2.85%, while softness was seen everywhere else too, as the 10-year Gilt yield climbed back above 4.50%, and the benchmark 10-year Treasury yield neared 4.20%. Meanwhile, money markets also repriced policy expectations in a hawkish direction too, with the EUR OIS curve now implying about a 20% chance of an ECB hike by the end of next year, while the market also now discounts less than 75bp of easing from the Fed by the time 2026 is over.
At risk of stating the obvious, all of that seems rather over-the-top, and out of line with where that pricing ‘should’ be sitting. To give just one example, with the ECB forecasting an inflation undershoot for at least the next two years, a 25bp hike any time soon is almost certainly out of the question. Again, though, this isn’t the sort of environment where participants are going to be especially keen to step in front of market moves once they get going, hence momentum rather running away with itself yesterday. Once the event risk of tomorrow’s FOMC has been navigated, though, you could well see fixed income dip buyers looking to enter the fray once more.
Elsewhere, pretty much everything traded as you’d expect given the aforementioned moves in the Govvies arena, a reassuring bit of evidence that cross-asset correlations haven’t completely died, despite being incredibly weak at times over the last year or so.
As such, the dollar gained ground across the board, with the DXY testing its 50-day moving average to the upside, with the buck taking advantage of the higher yields seen across the Treasury curve. That said, the FX market as a whole is still very rangebound indeed, and will probably remain so into year-end, barring a huge surprise from one of the final G10 central bank meetings of the year.
Meanwhile, equities also faced a few headwinds, with stocks wobbling a little on both sides of the pond, amid notable pressure on the tech sector from those higher yields. Still, with spoos up 5% from the closing low in mid-November, and having notched 4 straight daily gains into yesterday’s session, a little pause for breath here, around the 6900 mark, isn’t exactly a terrible thing. My view remains a constructive one, with the path of least resistance continuing to lead to the upside into year-end, not only with the fundamental bull case remaining a very robust one, but with positive late-December seasonality, continued corporate buybacks, and FOMO/FOMU flows all providing a helping hand to the rally too.
LOOK AHEAD – As the FOMC begin their 2-day policy meeting, focus has, almost solely, now pivoted to the commentary and guidance that will accompany the announcement of a 25bp fed funds rate cut tomorrow evening. Once more, anticipation ahead of the ‘main event’ of the week will likely lead to conviction being capped throughout today.
That said, we do have the latest US JOLTS job openings data to get through, with openings expected at 7.15mln in October, and with the September report to be released at the same time, having been delayed as a result of the government shutdown. Meanwhile, a 10-year Treasury auction is on the slate later on, following a well-received 3-year sale yesterday, plus there’s a busy day of central bank speakers including four members of the BoE’s MPC, plus new RBNZ Governor Breman making remarks.