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Market Update

Markets seesaw between anticipating Fed pivot and bracing for more aggressive rate hikes

Date:
October 31, 2022

Summary

Mixed economic data fuels speculation of a Fed pivot, dollar strength begins losing steam, and the energy outlook in Europe eases ahead of the FOMC meeting this week.

Economic Outlook

A flurry of economic data surrounding GDP, inflation, and wages was released last week both in the U.S. and abroad. Muddled results have markets seesawing between anticipating a Fed pivot and bracing for more aggressive rate hikes. Q3 GDP showed solid growth tempered with softening in some key areas. Real GDP was up 2.6% amid strong consumer spending. Residential investment fell 26.4%, indicating that the transmission of tight monetary policy and higher interest rates into the real economy is picking up traction. Personal Consumption Expenditures (PCE), the Fed’s preferred inflation metric, showed inflation up 0.3% this month and up 6.2% over the past year. Core PCE, which excludes food and energy, once again was higher than overall PCE as it registered a 0.5% jump in September. Higher core CPE suggests that inflation continues to be broad-based and helps justify the case for another large Fed rate hike next week.

Beyond the next meeting, Fed officials have begun the balancing act of laying the groundwork for slowing the pace of rate hikes without softening their near-term commitment to corralling inflation. In comments that arrived just prior to the media blackout period, Fed Presidents James Bullard and Mary Daly both suggested potential caution in 2023 while affirming aggressive rate hikes to close out this year. Currently, the market anticipates a hike of 75 basis points in November and 50 basis points in December followed by milder 25 basis point increases to begin 2023. The evolving sentiment stemmed the rise in rates, with the 5-year swap rate dropping steadily from north of 4.50% to as low as 4.10% last Thursday. Higher-than-expected inflation data across Europe to close the week modulated hopes of a Fed pivot and pared the 5-year’s decline as it rallied back to close out the week at 4.25%. The continued market uncertainty refocused many priorities within treasury. Recently, senior leaders joined a roundtable to discuss strategies for addressing these challenges and opportunities headed into 2023.

Dollar strength begins to lose steam

The dollar dipped to its lowest level in four weeks against the backdrop of softening U.S. economic data and improved sentiment towards European currencies. Markets continue to move past the turbulence caused by Liz Truss’s proposed fiscal policy and respond favorably to Rishi Sunak’s new approach as prime minister. Declining natural gas prices propelled the euro to 1.01 briefly before settling in just below parity to close out the week. Other major European currencies also climbed against the dollar. Bullish bets against the greenback began to contract but are still twice the average over the last five years according to CFTC data. For companies, this means while dollar strength is slowing, it will likely continue to be a major focus for managing FX risk.

(Related insight: Read “Managing FX risk in a strong U.S dollar environment”)

Natural gas prices in Europe ease ahead of winter

Benchmark European natural gas has declined over 40% in the past month, a welcome drop following months of concern over impending energy shortages during the winter months. Unseasonably mild weather across Europe and gas storage facilities reaching capacity spurned the drop. While the prices are down significantly, they remain more than three times higher than the 5-year average for this time of year. The fragile energy supply in Europe remains vulnerable to high demand over the winter and into 2023. Crude oil rose over the course of the week with Brent up 2% and WTI up 3% following generally strong GDP growth across the U.S. and Germany.

Looking Ahead

All eyes will be on the FOMC meeting this week. With a 75-basis-point rate hike the strong consensus, the market will closely monitor Chair Powell’s press conference for insight into future policy direction. The FOMC meeting will be bookended with other notable economic indicators - JOLTs and manufacturing data to start the week and October nonfarm payrolls on Friday.

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About the author

  • James Mallon

    Analyst

    Corporates | Kennett Square, PA

    James is an analyst on Chatham’s Corporates Sector, specializing in foreign currency, interest rate, and commodity hedging analytics and strategy.

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