2022 Weekly Views

Highlights

Rates

After the Fed 50bps hike, US bonds rallied across the curve with the 10-year falling below 3.5% on Thursday whilst the 2y ended tighter. Looking at the Bloomberg WIRP function of implied rate probabilities from the Fed Funds Futures, the terminal rate is now pricing at about 4.9% and that’s in the middle of the year, getting cuts then. This is in direct conflict with the 5.1% median dot from the Fed. On the opposite side, the ECB was successful to propel up market expectations for future rate hikes, with the peak in rate priced in at 3.2% after the announcement, against 2.9% earlier in the week. This also means that euro sovereign bond yields were sharply up after the ECB meeting (up 15bps to 2.10% for the 10-year Bund), while its US counterpart yield is higher. This dichotomy is likely linked to the very different inflation picture in the US (where some core components like goods are decelerating), while in Europe only energy prices are decelerating, with the rest still experiencing the pass-through of higher energy costs. Moreover, real yields (according to the Treasury Inflation Protected Securities (TIPS) yield curve) are well in positive territory in the US, with short-term TIPS yield almost at 3%. ECB’s plan for higher policy rates, with several more 50bps rate increases, along with the start of quantitative tightening in March 2023 at an EUR 15bn pace per month also puts significant pressure on periphery sovereign bonds. Next year is likely to prove challenging for the periphery bond market due to slowing GDP growth, large net issuances, and higher rates.

Market update

50 bps is the new norm

The S&P 500 closed the week at 3,852.36, -2.08% lower. The Dow Jones closed at 32,920.46, -1.66%, with the Nasdaq lower by -2.72%. The volatility index VIX closed the week at 22.62 down from 22.83. The Euro Stoxx 600 slipped -3.28%.

The 10-year UST closed at 3.48% down from 3.58% a week before. The yield curve is inverted with the yield spread between the 3-month and 10-year UST at -83bps. US Corporate Bond spreads: Investment Grade tightened 2bps at 202bps and High Yield tightened 6bps at 491bps. German 10-year Bunds yield closed at +2.15% up from +1.93% a week before. In Europe, Corporate Investment Grade spreads tightened 5bps at 182bps and High Yield spreads tightened 34bps at 522bps.

The US Dollar Index (DXY) depreciated -0.10% last week and closed at 104.70. The Euro closed at 1.0586 (+0.44% weekly); the Yen depreciated -0.03%, closing at 136.60 and the Swiss Franc appreciated +0.05%, closing at 0.9337. Gold closed at $1,793.08 depreciating -0.24%. Oil was up, Brent closed at $79.04 (+3.86%) and WTI at $74.29 (+4.60%).

Macroeconomy

The Fed

The Federal Reserve hiked rates by 50bps to 4.25-4.50%. The communication was hawkish as: 1) Powell wants more “substantial” evidence that inflation is falling (i.e. the last two soft CPI prints are not sufficient); 2) he rejected the current market pricing that rate cuts will soon come after the ‘peak rate’ is reached; and, 3) he stressed that financial conditions (understand: equity and debt markets) may have loosened too much (understand: improved) in the past few weeks. In terms of interest rate forecast, the ‘dot plot’ was also hawkish, as the Fed revised the 2023 median rate to 5.1% (from 4.6% in the September forecast). Going forward, Powell remains focused on the labor market metrics (as a source of potential inflationary pressures) as it is still too tight. He worries that high wage growth could spread into services inflation, which represents 55% of the core PCE inflation basket (rest is rents and goods).

European Central Bank

After two consecutive 75bps hikes, the ECB hiked all policy rates by 50bps. The new staff projections and the overall tone of the press conference were very hawkish. The “substantial upward revision” to staff projections for inflation was the biggest shocker, providing ample justification for the ECB to signal more tightening ahead. Euro area core HICP inflation was revised significantly higher in 2023, from 3.4% to 4.2%, and is expected to remain well above target throughout the forecast horizon, averaging 2.4% in 2025. Headline inflation is now projected to be 2.3% on average in 2025, although the quarterly profile shows HICP at 2.0% in H2 2025. The ECB pre-committed to raising policy rates “significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target”. President Lagarde clarified that it should be “obvious” to expect 50bps rate hikes for some time. She added that the ECB would likely have to raise rates by more than markets currently expected, hence signaling a higher terminal rate.

Bank of England

The BoE raised rates by 50bps to 3.5%, as widely expected. The nine-member committee was split: 2 members were against the rate hike, as officials tried to balance the risk of inflation getting entrenched against squeezing too hard on growth, with the UK economy entering a recession. But the communique was hawkish as the Bank worries about a tight labor market leading to higher wage growth, and a perpetuation of inflation. The Bank warned additional tightening is coming.

Swiss National Bank

The SNB raised its policy rate by 50bps to 1.0%, as expected. The hike is the third consecutive one in 2022 (50bps in June and 75bps in Sep.) after moving rates out of negative territory in Sep. The SNB mentioned that it was “countering increased inflationary pressure and a further spread of inflation”. The next steps will depend on what other central banks do, particularly the ECB, as well as the developments around the Swiss franc. The focus will probably be on the SNB’s balance sheet following the publication of interim results showing the central bank made a loss of CHF 142.4bn for the first three quarters of 2022. Furthermore, while rates remain the policy tool of choice at the moment, the SNB will continue to keep the door open to selling foreign currency if the Swiss franc were to weaken.

What to watch

• Monday: US ISM manuf. index (Apr.)
• Tuesday: Australia RBA decision (May); Euro area: final PMIs, M3 (Mar.), Bank Lending Survey (Q1), flash HICP (Apr.); US durable goods (Mar.)
• Wednesday: US FOMC decision (May); US ISM non-manufacturing index (Apr.)
• Thursday: Norway Norges Bank decision (May); Euro area ECB decision (May); US trade balance (Mar.)
• Friday: Germany factory orders (Mar.); US: nonfarm payrolls (Apr.)