Investors are hoping the Federal Reserve can manage the path toward rate hikes as smoothly as its taper announcement, according to strategists who are cautiously optimistic the coming months will see moderate advances for yields, the dollar and equities.
Friday’s labour report is seen as the next flash point for markets, given rates traders remain relatively aggressive about the need for Chair Jerome Powell to avoid being overly patient about hiking borrowing costs to restrain inflation. The key risks surround rate-hike bets, with the potential that aggressive moves in that market could set off fresh turmoil in bonds.
Powell announced a start to a reduction in bond purchases Wednesday but said officials can be patient on raising interest rates. U.S. stocks closed at records, Treasuries retreated and the yield curve saw a modest steepening — reversing some of its recent flattening trend.
Here’s a selection of comments on the outlook for markets:
Yields, dollar to edge higher
Wells Fargo strategists, including Mike Schumacher:
“The key takeaway to us is the Fed has introduced the possibility of accelerating, or conceivably slowing, tapering. The flexibility on tapering puts more onus on economic data, specifically inflation and employment data, to spur dollar gains on expectations of sooner/faster rate hikes. This raises the stakes for this Friday’s and subsequent U.S. employment reports.
“Reduced asset purchases should push yields gradually higher. We maintain our year-end target of 1.75-1.80% for the 10-year Treasury yield. The market is still priced too aggressively when it comes to future rate hikes.”
TD Securities strategists including Jim O’Sullivan:
“Yields and the curve should remain caught between auction size cuts, QE tapering, a likely fiscal package in coming weeks, and the market’s repricing of the front-end. This should keep volatility elevated, but with some upward pressure on rates as investors price in the flow effect of tapering and the start of the hiking cycle.”
“While tapering should steepen the curve amid heavy net duration supply, any further pulling forward of the hiking cycle should flatten the curve. Given the market’s already aggressive pricing of the first hike in July 2022 and more than two hikes in 2022, we remain long the front end.”
Chris Zaccarelli, Chief Investment Officer for Independent Advisor Alliance:
“Given the uncertainty of the inflation and interest rate paths for the next 12 months, we believe it is prudent to keep duration neutral or even slightly underweight.”
“It is also prudent to maintain equity exposure, but to continue to reallocate our portfolios to companies with stronger balance sheets and to those with stronger pricing power and away from those companies that are more speculative in nature.”
Rate Hikes and Inflation
Elliot Clarke, senior economist at Westpac:
“Not only do today’s post-meeting communications therefore warrant us holding onto our forecast of a first hike in December 2022, but they also justify believing the rate hike cycle that follows will be modest versus history. Throughout the period, the chief risk to this benign view on policy will be wage gains. If supply proves insufficient for demand, then wages growth could be bid up to a level that not only offsets current inflation pressures, but also allows for additional discretionary consumption.”
Steven Englander, global head of G-10 FX research at Standard Chartered Bank:
“We think future market reaction will be heavily geared on an incoming data that advance policy rate hikes. These data could include strong employment data that imply a quick approach to full employment or continued high inflation numbers that will suggest Powell’s optimism will overdone. There is a good chance that both will be the case in Q4, so see a risk that today’s benign interpretation is transitory.”
Paul Ashworth of Capital Economics:
“With wage growth at its strongest since the early 1980s, inflation expectations rising and signs of a breakout in cyclical price inflation, particularly rents, the FOMC’s insistence that this is still just a temporary shock ‘related to the pandemic and the reopening of the economy’ looks to be dangerously behind the curve. But it could be some considerable time before the Fed is willing to admit that elevated inflation is likely to be more persistent”
Cautiously Risk On
Justin Tang, head of Asian research at United First Partners:
“No one will be cracking open champagne bottles, but I think investors will allow themselves a drink or two. It will be a case of a rising tide lifts all boats but stocks that have been strongly correlated to the inflation theme like techs will be bought.”
Ilya Spivak, head of Greater Asia at DailyFX:
“The response from risk sentiment should be fairly mild because I think the Fed delivered as markets were anticipating overall– But again, with a slight risk-on bias. The plunge in gold I think it was particularly eye-catching, as well as the selloff in oil. Gold was interesting because it started falling and had the bulk of it ahead of the Fed”
Banny Lam, head of research at CEB International Inv Corp.:
“Asian equities should point to upside today. The Fed seems to create market expectations that the decoupling of asset purchases reduction and rate hike remain intact. Widening negative real interest rate also provide continued support to Asian equities.”
Kerry Craig, global market strategist at JPMorgan Asset Management
“This is still a very accommodative policy environment and one that will support the growth outlook in the quarters ahead and the performance of risk assets like equities and credit. For equity markets, the focus should be on where earnings growth will be highest to offset the valuation drag on returns. So far this has meant focus on the more cyclical developed markets of Europe and Japan, but we expect the catch up in emerging Asia with its relatively better valuations creating more interest for investors in the year ahead.”
Supportive for Credit
Mark Reade, head of fixed-income desk research Mizuho Securities Asia
“After a period of front-end rate volatility, this week’s dovish central bank rhetoric has helped to settle nerves and re-steepen curves. Together with strong corporate earnings and decent global data, that provides a supportive backdrop for further credit spread compression.”
“If inflation shows no signs of peaking, subsiding, then we could easily see a return of front-end volatility. But we probably have a while before that becomes obvious.”
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