Over the past two years there has been a lot of speculation on when, and at what pace, interest rates will rise. Following the pandemic – with record amounts of stimulus and high levels of inflation – the interest rate cycle has become a reality, as we head into the final weeks of the first quarter of 2022.
END OF AN ERA
On Wednesday, the era of close-to-zero interest rates came to a screeching halt, when the Fed hiked interest rates for the first time since 2018 and laid out an aggressive plan which will drastically tighten monetary policy over the next year. The Fed is trying to counter higher inflation, a lingering consequence of the COVID-19 pandemic. The Bank’s Federal Open Market Committee (FOMC)kicked off the interest hiking cycle with a 25 basis point increase in the targeted Federal Funds Rate. This rather aggressive stance from the Fed, indicates that future rate hikes are anticipated a teach of the six remaining FOMC meetings for 2022, while another three hikes are expected in 2023. The rate increase was approved with only one dissention from St. Louis Fed President, James Bullard, who wanted a more aggressive 50 basis points increase.
During the post-meeting statement, the Fed adjusted its inflation forecast steeply upwards, largely as a result of Russia’s attack on Ukraine, while lowering its estimate of economic growth. This move highlighted the predicament the Bank faces, as it tries to counter price increases without tipping the US economy into recession. “The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” the Fed said in a statement after a two-day meeting. “The implications for the US economy are highly uncertain, but in the near term, the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”
The Fed was not the only developed market central bank to hike interest rates this week. The Bank of England (BoE) followed suit on Thursday. The BoE raised its Key Bank Rate by 25 basis points to 0.75% during its March meeting, in line with expectations. This marks the United Kingdom’s (UK’s) third consecutive rise in interest rates, taking borrowing costs back to pre-COVID levels.
The Russia-Ukraine war has fuelled UK inflation and accentuated the impact inflation is having on consumer activity as household incomes have been further squeezed. The BoE expects inflation to continue to increase in coming months. It is expected to reach around 8% in the second quarter, and perhaps even higher later this year. Based on its current assessment of the economic situation, the BoE Monetary Policy Committee(MPC) noted that further conservative tightening in monetary policy may be required in the coming months. However, both – hiking or not hiking – will come with their own set of risks, as the UK’s inflation and growth story unfolds.
Meanwhile, the BoE also addressed the Russia-Ukraine conflict, stating that: “The Bank of England condemns Russia’s unprovoked invasion, and the suffering inflicted on Ukraine. The Bank is working closely with the UK government to support its response incoordination with international authorities. The MPC supports this condemnation and welcomes these actions.” While the interest rate in the eurozone remains at record-low levels, the March 2022meeting of the European Central Bank (ECB) saw it unexpectedly speed up its asset purchase schedule, for the coming months. The Bank said that the Asset Purchase Programme could end in the third quarter if the medium-term inflation outlook does not weaken. During the press conference, ECB President, Christine Lagarde, noted that this move does not mean a tightening, but is rather a normalisation process due to high inflation. Lagarde also noted the ECB now sees inflation increasing to 5.1%, instead of3.2% as previously projected, while GDP growth for this year is now estimated to be slightly lower at 3.7% compared to the original prediction of 4.2%. Regarding the war in Ukraine, Lagarde said: “It will have a material impact on economic activity and inflation through higher energy and commodity prices, the disruption of international commerce, and weaker confidence.”
DATA IN A NUTSHELL
China’s industrial production rose by 7.5% year-on-year in January and February 2022combined, exceeding market expectations of 3.9%. This is its fastest pace since June2021, as the recovery in the economy gained momentum in the first two months of the year, with both manufacturing and mining output accelerating, while utilities production grew further. Meanwhile, unemployment in the world’s second largest economy grew to 5.5% in February, up from 5.3% in January and 5.1% in December. Sticking with unemployment, the UK unemployment rate declined to 3.9% in the three months to January, its lowest level in two years and below market expectations of 4%, as the UK labour market continues to recover.
The number of Americans filing new claims for unemployment benefits fell to 214,000in the week ended 12 March, its lowest level in 10 weeks, from a revised 229,000 in the previous period. US retail sales increased 17.6% year-on-year in February, following a14% rise in January, illustrating strong demand continues to drive up retail sales. Industrial production in the eurozone fell by 1.3% year-on-year in January, reversing from a 2% jump in December. It was a sharper decline than the market forecast of0.5%. Production of capital goods fell by 8.4%, while production of intermediate goods rose by 0.6%, durable consumer goods were up by 1%, energy was up 1.4% and non-durable consumer goods were also up, at 7%. The annual inflation rate in the eurozone rose to a new record high of 5.9% in February, from 5.1% in January, and above preliminary estimates of 5.8%. Energy continues to record its largest price increases, followed by food. The EU inflation rate is almost three times over the ECB’s target of 2% and is expected to rise even further as the war in Ukraine exacerbates the energy crisis, causing fuel costs to go even higher.
INTEREST RATE HIKE SPARKS EQUITYRELIEF RALLY
Europe’s major stock indices were varied on Thursday, with Germany’s DAX down by0.7%, the UK’s FTSE 100 up 0.5% and the pan-European STOXX 600 little changed, following interest rate hikes by the Fed and BoE. Meanwhile, Russian and Ukrainian officials converged on a 15-point draft plan for a ceasefire, which included Ukraine’s “neutral” status, although Ukrainian officials were sceptical that Putin would commit to a cessation of hostilities, as Russia continued to target more civilian infrastructure with bombings on Wednesday.
US stock futures stabilised early on Thursday after a strong finish on Wednesday, as investors digested a long-anticipated interest rate hike and the latest projections from the Fed. Futures tied to the three major indices drifted mostly sideways. In regular trading on Wednesday, the Dow Jones rose 1.55%, the S&P 500 advanced 2.24% and the Nasdaq was up 3.77%. The Fed hiking its benchmark interest rate, spurred a relief rally in equities. The Japanese Nikkei 225 Index jumped 3.46% while the TOPIX Index gained 2.47% on Thursday, with both indices hitting their highest levels in more than two weeks. Sentiment was also boosted by hopes of a breakthrough in the Russia-Ukraine talks and the Japanese government’s decision to end all remaining COVID quasi-state of emergencies on Monday. Japanese technology and manufacturing stocks led the advance, with strong gains from SoftBank, Tokyo Electron, Recruit Holdings, Nidec Crop, Fanuc Corporation and Hitachi.
COMMODITY PRICES EASE
Brent crude futures rose above $103 per barrel on Thursday, after falling for three straight sessions, as the International Energy Agency (IEA) warned that around three million barrels per day of Russian oil output could be shut-in, due to Western sanctions. This number exceeds the estimated one million barrel per day drop in demand as a result of higher prices. The move followed a 13% slide from earlier in the week, amid a surprise jump in US crude inventories, signs of progress in Russia-Ukraine peace talks, and fears of slowing demand in China due to COVID-induced lockdowns. IEA data showed, on Wednesday, that US crude stockpiles climbed by 4.3 million barrels last week, defying analysts’ expectations for a decline of 1.4 million barrels. Brent futures are now trading about 28% below the recent high of $139.13 reached on 7 March and are expected to return to levels last seen in late February.
Gold gained ground, to trade above the $1,940 per fine ounce level on Thursday, after the metal hit a two-week low of $1,895 in Wednesday’s session. The jump in the gold pricewas on the back of a weaker dollar and its status as an inflation hedge. Gains were capped by signs of progress in the Russia-Ukraine talks, while higher US interest rates increase the opportunity cost of holding non-yielding bullion. Nickel futures fell by the 8% limit, set by the London Metal Exchange (LME), when the market re-opened on Thursday, as participants rushed to liquidate long positions. On Wednesday, the LME halted nickel trading on its electronic system within a minute of opening, due to a technical glitch and after prices fell by the 5% maximum allowed.
Later the exchange widened the trading limit to 8%, which is still much lower than the 15%allowed for other metals. Nickel trading was halted from 8 to 16 March, after prices briefly topped the $100,000 mark. Western sanctions against Russia sparked concerns over availability of the metal. Russia accounts for about 10% of the global nickel supply. Nickel, however, was already rallying before Russia’s invasion of Ukraine, as robust demand from the stainless steel and battery industries drained inventories, which now stand at 76,830tons in LME-registered warehouses.
Coal Futures, which are still trading around 275% higher than a year ago, fell to a two-week low of $340 per ton in the third week of March, tracking a general slowdown in energy costs amid hopes for a diplomatic solution to the Russia-Ukraine war. At the same time, a resurgence of Coronavirus cases in China, the biggest producer and consumer of coal, is raising concerns over lower demand. China’s coal output rose 10.3% from a year earlier in the first two months of 2022, after Beijing asked miners to ramp up production for the winter season and amid an export ban in Indonesia. On the other hand, coal demand from Europe remains elevated due to supply-chain disruptions and low inventories. Coal isn’t part of Western sanctions on Russia, but buyers in Europe and Asia are scrambling to address their exposure to imports from the country.
DOLLAR FALLS ON MARKET’S INCREASEDRISK APPETITE
After falling 0.6% on Wednesday, the US Dollar Index was little changed at around 98.4on Thursday, as the Fed announced a 25 basis point rate hike. The dollar, however, weakened against riskier currencies which gained on hopes for a compromise between Russia and Ukraine.
The pound reversed early gains to trade slightly lower at $1.31 on Thursday, after the BoE lifted interest rates to pre-COVID levels. At the same time, the Central Bank warned the Russian invasion of Ukraine will likely push inflation higher and slow growth. Inflation is now forecast to rise to 8% in the second quarter, around 1% higher than expected in February.
The euro traded at $1.10, above the recent two-year low of $1.08, as diplomatic efforts to end the war in Ukraine continue and traders digest the recent Fed move. The euro continues to take its direction from the unfolding geopolitical tension in the region.
The pound started the day trading at 1.3147/$ and 1.1842/€.
Written by Citadel Global Director, Bianca Botes.
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