The Week Ahead

Markets started the week where they left off on Friday, firmly in risk-off mode, with tensions between Russia and Ukraine at the forefront of investors’ minds along with the FOMC meeting on Wednesday.

The sabre rattling continued with the US announcing it has put 8,500 troops on heightened alert for deployment to Europe a bid to deter a new Russian invasion of Ukraine. Biden also said that he had an 80-minute phone call with European leaders, and all agreed following the call to discuss strategy in response to Russia’s military build-up along the Ukrainian border. ‘I had a very, very, very good meeting. Total unanimity with all the European leaders. We’ll talk about it later’. 

However, look below the surface and there are varying views on how the EU should handle current crisis. Countries such as France and Germany are more cautious in their approach to Russia, while others, such as those in Eastern Europe or those that used to be part of the Soviet Union like the Baltics, are more aggressive. Obviously, the situation is not helped by the EU’s reliance on Russia’s gas supplies, around 40%, meaning that Russia can weaponize it. Germany’s situation is particularly difficult because the Nord Stream 2 gas pipeline, when approved, will transport gas directly into Germany from Russia and is designed to boost gas supplies throughout the EU.  

Reinforcing the improved Qatar-US relations - following Doha’s efforts in Afghanistan - Sheikh Tamim bin Hamad al Thani is due to meet with Biden in Washington later today. Reports suggest the key item on the agenda will be a discussion to build energy contingency plans to protect Europe in case of shortened gas supplies from Russia.

The IMF gave Boris Johnson yet another reason to party as they forecast that the UK will again be the fastest growing major industrial economy for a second year running, placing it at the top of the growth table in 2022. The Fund forecasts growth this year will come in at 4.7%, after last year’s 7.2% increase. The 4.7% prediction is 0.3% less than the IMF forecast last year.  

However, the IMF was much more aggressive in lowering its forecasts for the rest of the world, citing the ongoing disruption brought by restrictions to stop the latest Omicron variant, as well as surging energy prices along with continued supply chain bottlenecks along with worker shortages. The Fund now believes that global growth will be 4.4% this year, down 0.5% from its October forecast. The cut in this year’s forecast is largely led by the world's two largest economies - the United States and China. Next year’s forecast has been upgraded by 0.2% to 3.8%.  

The US had the biggest downgrade, down 1.2% to 4%, with China’s growth forecast being reduced by 0.8% to 4.8%. There were also 0.8% cuts in Canada and German growth, to 4.1% and 3.8% respectively, with Italy now at 3.8% and France 3.5%, both 0.4% lower.  

With regards to inflation, the IMF raised its 2022 forecasts for both advanced and emerging markets and developing economies, adding that it expects elevated price levels to persist. It now expects inflation to average 3.9% in advanced economies and 5.9% in emerging markets and developing economies in 2022, before subsiding next year. 

As was widely expected and signalled, in a unanimous decision, the Fed stayed pat on rates at their FOMC meeting on Wednesday. Now all eyes are focused on the next meeting in March, at which point the Fed signalled it will raise rates “assuming that conditions are appropriate for doing so”, and end bond purchases. In terms of the ~USD9tn balance sheet, the message was that run-off will commence once the rate tightening cycle “has begun”; amended from once the rate hike cycle is “well underway”. 
 
There was no mention of size or pace of balance sheet run-off, nor any clear guidance on whether the first hike will be a straightforward 25bps increase, or a 50bps hike (a suggestion that has been hitting newswires). The futures markets are pricing in a larger than 25bps hike in March (at 30bps), so a 20% chance of a 50bps rate rise. 

On the Fed’s dual mandate, Chair Powell noted that the US is in a “historically tight labor market” and there is “quite a bit of room to move without hurting jobs”. In terms of inflation Powell admitted the price surge has been “larger and longer lasting than anticipated”. He said the US economy “no longer needs sustained high levels of monetary policy support”. 

At the press conference, Chair Powell said the FOMC was of the mind to raise rates in March. On balance sheet rundown he said it will be predictable, but can’t say much on size, composition, or pace of balance sheet. Powell did say they will use at least one meeting after rate hike to decide on balance sheet (take place at least in the next two meetings). On inflation, the Chair said risks are still to the upside and high inflation could be prolonged.

Powell also got some questions on the possibility of a 50bp hike. He didn’t give a straightforward answer, saying that the Fed hasn’t made a decision around the increments yet – but he didn’t shut down the possibility all together. 

We also had US GDP figures showing that much better than expected growth, coming in at 6.9% for the 4th quarter of last year, well above eyed 5.5%. The economy grew 5.7% last year, the strongest in nearly 40 years. Biden was quick to take credit for the stunning performance, which he said was ‘no accident’. The Fed’s favoured inflation reading, PCE Core, was in-line with expectations, at 5.8% for 2021.

US Treasuries finished the week largely unchanged after a midweek sell-off. It was in equities that we saw more volatility, with the S&P swinging at least 2.25% everyday, however also ended up on Friday afternoon around where it started Monday morning.
 
This week, the US’ highlight will be Non-Farm Payrolls on Friday. We also have ISM Manufacturing and Services along with ADP employment numbers. The Bank of England meets on Thursday with a 25bps rise all but certain. Looking further out the market also has three more hikes fully priced in with 75% odds seen of a fourth that would take the policy rate up to 1.5%. On Thursday we have the ECB, with expectations that they will maintain their dovish tone. Ahead of that we have eurozone CPI data. In a holiday shortened week across most of Asia there are Japanese retail sales, consumer confidence, unemployment rate and PMI.
 
Fixed Income Team