The Fed has announced the third consecutive 75bps rate hike this week, lifting the fed fund rate to 3-3.5%. It is the fastest pace of the tightening(*) cycle in history since the Fed started targeting the fund rate in 1980. The average 30Y fixed mortgage rate hit 6.29% this week, which is the highest since 2008. Debate is also raging over whether Fed can tame inflation without a spike in unemployment.
Japan Buy Yen: Japan government intervened in the currency market first time since 1998 after BoJ confirmed to maintain a low interest rate. The size of the intervention is not determined. Although its redundant reserves could possibly cap the decline in the yen, it could not change the trend as the downward pressures are mainly driven by the interest rate differences between Japan and US.
SNB: The interest rate was raised by 75bps in Switzerland, leading it to 0.5%. The Bank of Japan (BOJ) is now the only central bank left with a negative rate (-0.1%). Inflation in Switzerland remains low at around 3% on average this year due to its strong currency.
Private Equity: Investors are staying away from PE transactions and buyouts are tougher to do. PE transactions are down about 30% in 2022 so far. With the tightening policy, it is harder to reach an agreement on price as the equity valuations are lower with high debt costs.
Housing: Both buyers and sellers are trapped. With the high mortgage rate, buyers will pay extra in monthly payments than they were in last year for houses with the same price. For sellers, they are not willing to sell as they are not going to give up the low mortgage rate which they have locked in already.
(*)Quantitative tightening: Fed sells bonds or allows them to mature, reducing the lending amount from Fed to the economy. By withdrawing its loans, Fed reduces market liquidity and thus raised the cost of capital.
*Data as of market close. 5-day change ending on Friday.
VIEW FROM THE STREET
Goldman Sachs: The year-end target of S&P500 will lower to 3,600 as the rapid move in interest rate will weigh on equities valuation in the US. The downside skew is also driven by the rising recession likelihood, which would widen the yield gap and reduce corporate earnings. Investors are keeping an eye on the timing, duration, and magnitude of the potential recession.
Citi: Corporate earnings are not optimistic in the coming year. Expectation of aggressive rate hike, increasing inventories will reduce new orders and a cooling job market will affect real demand. Although companies can pass along the rising cost to consumers, profit growth has its limit when their pricing power is lost. If that happens, the production will have to slow, causing lower labor demand.
HSBC: US equities dropped sharply as bond yield rose due to the rate hikes of the global central bank. Sectors like technology and semiconductors are vulnerable to recession risks and rising yield, resulting in a larger decline in Nasdaq than in S&P500.
Morgan Stanley: The terminal fed fund rate is piercing 4% now. Whether the 10Y yield curve will break out or remain anchored is still uncertain. If it remains anchored, there will be a risk of yield curve inversion, which is rare and typically coincided with significant market drawdowns. Investors are wagering the Fed will not overtighten while the risk of a hard landing is rising. Citi: With 2Y treasury yield at 3.85% while equities are down for the year, it can attract more investor inflows, especially for the high-quality and short-duration spread products such as municipal bonds and corporates.
HSBC: European government bonds yield rose significantly due to the hawkish central bank policy. UK 10Y yield surged higher than German and French, stemming from the BoE rate decision and the vote to commence active bond sales in October.
Morgan Stanley: The market seems to be ignoring an important dynamic presented by the CPI report last month. The headline CPI remains high given the significant drop in commodity prices. Core CPI (excluding food and energy) jumped 0.6%, which is twice the forecasted figure. It remains high because of services inflation but not goods. As services are heavily affected by sticky items such as wages and rent, it probably takes longer time for Fed to achieve its 2% target.
J.P. Morgan: The 75bps rate hike is fully priced in the futures markets while some market participants were expecting a 100bps hike. The inflation report has made the trajectory of rates more uncertain, and the risk assets will continue to be indigestible until the direction of inflation becomes clear.
Goldman Sachs: High rents and food prices continue to keep US inflation elevated, even the recent drop in energy prices has already alleviated the pressure. Likewise, UK CPI was reported at 9.9%, contributed by the energy and food costs and accelerating service prices.
Citi: The hope of the Fed’s pivot is premature. Based on the current direction of inflation, it seems that further rate hikes are needed to achieve Fed’s 2% target. Whether 4-4.5% of the fed fund rate is enough to bring down inflation remains uncertain. Fed is expected to go into a holding pattern in the coming year to see the delayed effect of its monetary policy.
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