Central bank bonanza delivers +25bps from the Fed, +50bps from the ECB (and BOE). US equities extend higher on narrative the Fed is almost done, soft lading hopes

By Stuart Talman, XE currency strategist

As expected, its been an actioned packed 24 hours, headlined by a central bank bonanza which has yielded widely expected rate hikes of 25bps from the Fed and 50bps from both the ECB and BoE.

Equity markets across the globe have ripped higher over the past two sessions on the narrative that major central banks are nearing the end of their aggressive tightening cycles and may have avoided causing serious harm for developed economies across the globe.

The risk rally initially propelled the New Zealand and Australian dollars higher, ascending to levels that last traded in June. However, the topside surge has lost some momentum during Thursday’s US session.

So, lets recap the central bank action and market reactions/implications starting in chronological order with the Fed.

The key developments/takeaways from the Fed decision/statement/presser

• The Fed hikes by 25bps to 4.50% to 4.75%
• Ongoing rate increases required
• Powell refrains from kicking back against easing conditions

Via both the statement and the FOMC presser, Jerome Powell and the Fed made it clear that whilst recent developments had been encouraging, they needed substantially more evidence to confirm that inflation was on the desired path to the Fed’s 2% target.

Early in his press conference when answering a question, Powell commented that the labour market remains out of balance and inflation is still too high.

Powell commented that “we still have work to do” and “the risk of doing too little is harder to manage than not doing enough”, implying that the Fed will continue to raise rates at the next couple of meetings.

Sounds hawkish, yeah?

Elements of the statement and Powell’s presser were clearly hawkish, however as US stocks accelerated to the upside and the dollar fell as Powell continued to answer journalists’ questions, the market adopted a dovish take.

Why?

It was widely expected that Powell would kick back against the recent easing in financial conditions that has occurred from mid-October onwards.

Back in August, Powell gave his infamous Jackson Hole address, warning all and sundry that a soft landing was looking unlikely and that the Fed would have to inflict pain on households, businesses, and the broader economy to win the inflation battle.

He talked up a mean game and the market responded accordingly – the S&P500 falling over 16% from late August to mid-October, the Kiwi logging cycle lows in the low 0.55’s during this period.

When asked earlier in his presser if he was concerned by the fact that financial conditions (US stocks, bond yields, the VIX) had eased back to levels last seen 12 months ago (before the Fed even embarked on its historically aggressive tightening cycle), Powell did not take the opportunity to push back.

From this point, US equities lurched higher, and the dollar fell.

Powell inadvertently sent the message that Fed was nearing the end of its tightening cycle, a softish landing may be possible and whilst he did comment that 2H rate cuts are unlikely – the market clearly does not believe him.

Powell’s comments and answers have extended the window for the (misplaced) soft landing narrative…..this won’t change unless the incoming data flow runs too hot (meaning the Fed will have to return to peak hawkishness) or the data flow becomes recessionary (we ain’t gonna get a soft landing).

The Nasdaq just had its best January in over 20 years….its 2021 all over again. Tech stocks rallying on the assumption that the Fed’s actions will fuel support the market.

From Monday’s low, the Nasdaq is up over 7%, the S&P500 over up 4%!

This has propelled the New Zealand dollar to its highest point since 03 June, yesterday’s highs logged a couple of pips below 0.6540. The Kiwi has been unable to maintain a foothold above 65 US cents, falling to near 0.6460 before climbing back into the 0.6490’s with a couple of hours remaining in the US session.

Heading across the Atlantic to the UK.
 
The key developments/takeaways from the BoE decision and presser:
 

• BoE hikes by 50bps to 4.00%
• Removes “forcefully” from statement
• Signals cycle-end is near

 
The Bank of England delivered its widely expected 50bps increase, viewed as a dovish hike by the market given the noted change in language in the accompanying statement.
 
Previously the UK central bank had included “forcefully” in the statement – used to describe that manner in which the BoE tightened to combat multi-decade high inflation.
 
The omission of this word signals that the BoE is now close to the end of this cycle, likely a final 25bps hike in March.
 
In response, the pound encountered heavy selling, the standout underperformer on the G10 leader board, GBPUSD falling from near 1.2400, looking poised to slip back below 1.2200.
 
The Kiwi has rocketed through key resistance at 0.5270 against the pound, NZDGBP logging overnight highs through 0.53. It’s an important technical topside breakout, likely the start of another leg higher after the pair had tracked sideways for the past couple of months.
 
Next up, the European Central bank.
 
The key developments/takeaways from the ECB decision and presser:
 

• ECB hikes by 50bps to 3.00%
• APP to decline by €15bn per month from MAR.
• Flags another 50bps to follow

 
Again, it was universally expected the ECB would adjust its key policy rate by 50bps. The ECB committed to another 50bps hike in March at which point it will then "evaluate the subsequent path of its monetary policy".
 
Whether or not the ECB chooses to pause following the March decision, it remains the most aggressive of all the developed central banks given it arrived later to the hiking party.
 
Following the ECB’s December hawkish shift, the bar has been set high for further hawkish surprises – evidenced by the euro’s reaction, retreating over half a percent against the dollar.
 
Having retreated the prior two days, NZDEUR fed back up towards the mid-point of its prevailing range, Thursday’s highs marked a few pips north of 0.5960. The pair has pulled back into the 0.5930’s ahead of Friday’s Asian session.
 
So, there you have it – the Fed and BoE are nearing the end of their respective cycles, whilst the ECB has a little more work to do.
 
Now that we’re past the first monetary policy decisions for the big three central banks, the attention now shifts to the incoming data flow.
 
US jobs numbers are released this evening, consensus expectations calling for jobs creation of 185K (down from 227K), the jobless rate to tick up from 3.5% to 3.6% and MoM average hourly earnings to remain steady at 0.3%.
 
Any deviation from the consensus likely to cause pronounced directional moves. The most market friendly result being a set of data points that print modestly weaker-than-expected.
 
The Kiwi likely ends the week maintaining a foothold above 64 US cents.

Stuart Talman is Director of Sales at XE. You can contact him here.