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Equities under fire, dollar shines as yields soar


19 January 2022 Written by Anthony Charalambous  XM Investment Analyst Anthony Charalambous

Bets that the Fed will take a sledgehammer to crush inflationary pressures continue to escalate. More than four rate increases are now priced in for this year, which means traders have started to entertain the idea of either a fifth increase or a ‘double’ hike of 50 basis points to shock markets and pummel inflation expectations back down. This has translated into a mighty rally in US Treasury yields, which have powered higher to eclipse pre-pandemic levels with a little help from surging energy prices. It is really the breakneck speed of this move that has taken many investors by storm. 

Once the bond market starts to ring alarm bells, that fills the stock market with fear. That’s because many players aren’t willing to take on the risk or stomach the volatility of stocks if bonds start paying a positive return. Higher yields also make it more difficult to justify pricey valuations, hence why the purge usually begins with the riskiest companies. 

As such, it is the tech sector that has suffered the most damage, with the Nasdaq losing 2.6% yesterday and futures pointing to another bloody nose today. The battle could be decided around the 200-day moving average, a barrier the index has never violated during the pandemic recovery. 

Dollar shines, euro takes a hit

The FX market has pretty much stuck to the script of risk aversion this week. The dollar is leading the pack as rate differentials continue to widen in its favor and nervous traders look for shelter in the reserve currency. And while rising yields are usually anathema for the yen, that hasn’t played out this time, with its safe-haven qualities outshining its rate disadvantage. 

Instead, the biggest loser has been the euro. Even though European yields have also joined the global rally, with the German 10-year turning positive today for the first time since 2019, American yields are rising much faster. That has clipped euro/dollar’s wings. 

The bad news is that there’s more scope for losses. Money markets are currently pricing in 20 basis points of ECB rate increases by year-end, which seems rather unrealistic given the gloomy growth prospects in the euro area, even if inflation has fired up. 

Oil stays elevated, loonie awaits inflation test

Elsewhere, oil prices remain elevated near multi-year highs, benefiting from a combination of supply concerns and demand hopes. An explosion in a pipeline running from Iraq to Turkey was the latest episode in a series of production disruptions lately, while on the demand side, there are growing hopes the pandemic might be downgraded to an endemic soon.

As for today, British inflation data have already been released and showed another acceleration in price pressures. That has almost sealed the deal for a Bank of England rate increase next month, which is currently priced in with a 95% probability. And yet sterling has been unable to capitalize, mirroring the sour mood in equity markets instead. 

The spotlight will fall on the Canadian dollar later today as the nation’s latest inflation numbers could either lead traders to fully price in a Bank of Canada rate hike for next week, or turn the event into a coin toss. Finally, the earnings season will fire up with Bank of America, Morgan Stanley, Procter & Gamble, and ASML Holdings reporting their quarterly results.

By XM.com
#source

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