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Fed Chairman Powell came across as more dovish than expected by the market. He reassured markets mentioning decisions around balance sheet reductions will take 2-4 meetings. Powell also said inflation should remain above target until middle of the year, although inflationary pressures could last well into next year. A slightly more dovish tone was enough to make the tech-heavy Nasdaq pivot from its 0.60% intraday loss to gains of 1.2%.  

EUR/USD futures spread for December 2022 shows traders expect the US Federal Reserve to hike 4 times through the year, pricing a hike in March at an almost certainty. Hedging costs for Euro investors are rising as market participants increasingly bet on the Fed taking a firmer action to slowly withdraw its record monetary stimulus, in an attempt to address concerns of inflation. Similarly, the rise in the yield of the US 10 Year Treasury Note has not gone unnoticed, causing markets to whipsaw intraday yesterday. Investors are nervous that higher yields could pressure down asset prices, especially those that have benefitted most from record low interest rates. 

US Non-farm payrolls increased 199’000 versus consensus of 422’000 expected in December. The jobs report is mixed with US non-farm payrolls weaker than expected but the unemployment rate slumped to 3.9% (consensus was 4.1%). This is the first job report since variant Omicron has taken the US by storm. The report comes at a critical time as investors are reassessing how to price assets in an environment of rising interest rates. Odds of hike as soon as March are moving higher to a 90% chance. Overall, it doesn’t change the Fed outlook yet. More data is needed, and next week will be key, with US CPI in focus on Wednesday.

FOMC minutes highlighted a more aggressive plan for policy normalisation. The market re-priced odds at 60% chance of the Fed raising interest rate by 0.25% at its March meeting. The minutes of the 15 December meeting released yesterday afternoon, suggested three rate increase this year and three the following year as inflation concerns deepened. In our view the market is getting ahead of itself and the Fed could see some comfort in keeping a more accommodative policy if markets and the overall macro environment weakens. The market could be setting itself up for a favorable surprise by the Fed.

Strong data and positive news on the omicron variant sent US 10 year Treasury yields surging higher to 1.67%, a level not reached since November 2021. US 2 year Treasury yields also followed the move up. Traders are re-pricing for a more aggressive Fed as the economy appears strong with a ISM manufacturing activity reading of 58.7 for last month. Additionally, data showed demand for workers in the US remained elevated in November, indicating the economy is strong. Investors remain very sensitive to signs of inflation and of a less accommodative Fed. The sudden move up in yields sent banking shares soaring and caused growth stocks to suffer.