The Bar High For Even A Subtle FED Pivot

MARKETS

US equities were weaker Tuesday, S&P down 1.2% after mixed earnings reports. US10yr yields are little changed ahead of the Fed, up 1bp to 2.81%.

European gas prices rose above EUR200/MWh for the first time since 9 March after Russia reduced gas flow through the Nord Stream pipeline. Leaving cross-asset traders doing little more than trading “pipeline risk.”

However, Nasdaq futures rebounded from intraday lows after Alphabet earning release. Investors are likely relieved that Google’s ad revenues were less battered than Snap’s were last week.

While a 75bp rate hike is largely priced into the curve, the bigger question for risk assets is how the Fed will guide expectations for September and beyond.

Markets are pricing at a slower pace of tightening before the Fed pivots to an easing stance in 2023. However, Fed Chair Jerome Powell has been pushing back against a recession outcome while highlighting an outsized focus on combating inflation. Cross asset price action suggests that traders think the bar may be significantly higher for even a subtle FED pivot if the pace of moderation in core inflation does not accelerate. Hence, the extent to which this equity bear market rallies transition into a more sustained uptrend depends mainly on how quickly CPI  inflation recedes.

OIL

Even though bullish sentiment is creeping back into the overall narrative as traders feel the latest sell-off is overdone, the stronger US dollar and concerns about weaker global demand continue to weigh on the oil market’s top side ambitions.

Indeed, there is scant hard evidence to suggest the widespread demand destruction that would explain the more than $20/b swing in oil over the last month or so. But with the market backdrop generally cautious amid the threat of recession due to aggressive front-loaded rate hikes, traders seem to need little justification to trim longs position into rallies ahead of another expected jumbo Fed hike, effectively keeping prices capped for now.

The FOMC forward guidance could negatively impact growth expectations, especially if they wax hawkish. But fortunately, the Fed is unlikely to surprise on the hawkish side after the flack they received after last month’s more jumbo surprise.

FOREX 

The USD is rallying into today’s Fed meeting along with headlines on reduced Nord Stream 1 capacity and EU countries looking to ration winter gas use.

While ECB rate hikes are helpful for the euro, they are not the dominant drivers. The single currency has been and will remain highly vulnerable to further gas shutoffs from Russia.