Patience Makes A Comeback

Global risk sentiment was reasonably buoyant Tuesday following a jubilant end to a disastrous month on Wall Street.

US equities’ two-day surge, punctuated late Monday by the biggest buy program in 11 months, wasn’t enough to save the S&P from its worst monthly performance since March of 2020.

Although Fed officials seem intent to discourage any additional prejudging of the policy path by markets, it’d be foolish to read too much into the manic bounce seen over January’s final two sessions. Realized vol needs to come down, and for that, some semblance of calm has to return to stocks.

“Trailing realized vol spikes [cause] mechanical exposure reduction from vol control,” Nomura’s Charlie McElligott wrote, adding that vol control shed more than $18 billion in US equities futures exposure over the last two weeks. Vol control would add exposure if daily changes can settle back into a more subdued range.

The RBA leaned dovish Tuesday, albeit while ending QE, as expected. Markets were spooked last week when data showed annual trimmed mean inflation in Australia jumped 2.6% in Q4, exceeding the midpoint of the RBA’s target range for the first time in seven years (figure below). But policymakers were largely undeterred in sticking with a version of the transitory narrative. “Patient” was the word of the day.

It’ll be some time before wages are growing at a rate that’s consistent with the bank’s CPI target, the RBA said. As for the end of QE, the statement sought to de-link the cessation of purchases from the rates path. Ending QE “does not imply a near-term increase in interest rates,” the bank insisted, emphasizing that the RBA “will not increase the cash rate until actual inflation is sustainably within the 2 to 3% target range.” Although inflation has picked up, “it is too early to conclude that it is sustainably within the target band,” according to the new statement. (Hats off for sticking with it. I guess.)

Between the RBA (which also suggested it might consider reinvesting proceeds from maturing assets rather than commencing runoff) and Monday’s less aggressive rhetoric from Fed officials, markets started February with something dovish to latch onto. But with the BoE poised to hike and key US data on deck, it could be an afterthought by the weekend.

It’s also not clear the Fed has much leeway when it comes to the kind of “patience” the RBA is exhibiting. “Gradualism has been the hallmark of the FOMC’s twenty first century approach to monetary policy tightening,” JonesTrading’s Mike O’Rourke wrote, before noting that “the pandemic and concerted deglobalization efforts by the US and China means inflation is likely to be more ‘sticky’ going forward.” That, he remarked, will likely “limit the FOMC’s ability to exercise the patience necessary for gradualism.”

Still, it does feel like market pricing for policy tightening has run as far as it can given currently available information. If something were to come along and force March to be fully priced for 50bps from the Fed, that would effectively be “max hawkish.” With runoff widely expected to commence in June/July (at the latest), and the Street coalescing around five hikes for 2022, there’s really nowhere to go other than fully pricing a “double-hike” in March. On the other side, there’s plenty of room for markets to reprice the Fed path lower.

“The Fed’s message has been clear that softer data may go on being ignored [but] with so much priced into the US curve, there’s less to hurt risk sentiment now,” SocGen’s Kit Juckes said Tuesday. “Rate markets [could] find some degree of stability with considerable tightening priced in and data providing room to pause for thought.”

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2 thoughts on “Patience Makes A Comeback

  1. The Fed has an idea what they need to do. And it is the street’s job is to form opinions on it. But for most of us, and even them it is a mug’s game. That said, it is part of their jobs to do this. Just keep the reality of it in mind.

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