The Federal Reserve is expected to raise interest rates in the coming week

A trader on the NYSE, March 11, 2022.

Source: NYSE

Investors may accept the Federal Reserve’s first post-pandemic interest rate hike as uncertainty surrounding the Ukraine crisis continues to loom over markets.

The Fed has made clear its intention to raise its target federal funds rate by a quarter of a percentage point from zero, and it is expected to announce the move at the end of its two-day meeting on Wednesday. The central bank is also expected to release new forecasts for interest rates, inflation and the economy.

There are a few economic reports of note in the week ahead, including the Producer Price Index on Tuesday, Retail Sales on Wednesday, and Existing Home Sales on Friday.

“Earnings are over. Monetary policy is obviously going to be important here. I don’t see the Fed surprising anyone next week,” said Steve Massocca, managing director of Wedbush Securities. “It’s going to be a quarter point and then go into the background and watch what happens in Europe.”

Stocks fell last week, with the Nasdaq Composite being the worst performer with a 3.5% decline. Meanwhile, the small-cap Russell 2000, which outperformed all three major indexes, lost 1% on the week.

A surge in oil prices spooked investors, with crude hitting $130 at the start of the week but falling back below $110 on Friday.

The S&P 500 was down around 2.9% for the week. Energy stocks were the best performers, up nearly 1.9% and the only major positive sector.

fed in advance

The impact of Russian sanctions on commodity markets and the lack of clarity over the outcome of the war in Ukraine are likely to keep financial market volatility high.

The central bank’s statement and comments from Federal Reserve Chairman Jerome Powell on Wednesday will be watched closely for indications of how Fed officials view the Ukraine crisis and how it could affect their outlook and the future. interest rate trajectory.

“His advice probably won’t be that different from what he had to say in the [Congressional] testimony. Fundamentally, the downside risks to the growth outlook have increased. Upside risks to inflation have increased,” said Mark Cabana, head of U.S. short rate strategy at Bank of America.

Because Russia is a giant commodity producer, its assault on Ukraine and the resulting sanctions sparked a rally in commodity markets that exacerbated already searing inflation. February’s consumer price index rose 7.9% and economists said rising gasoline prices could send it above 9% in March.

Gasoline at the pump jumped nearly 50 cents last week to $4.33 a gallon unleaded, according to AAA.

Market pros see soaring inflation as a catalyst that will keep the Fed on track to raise interest rates. However, the uncertainty surrounding the economic outlook could also mean that the central bank may not raise as much as the seven rate hikes that some economists predict for this year.

Cabana expects Fed officials to forecast five hikes for 2022 and four more next year. The Fed previously forecast three increases over the two years. Cabana said the Fed could cut its 2024 forecast to just one hike, down from the two in their latest outlook.

Any comments from the Fed on what it plans for its nearly $9 trillion balance sheet will also be important, as officials have said they would like to start trimming it this year after it began raising interest rates. . The Fed is replacing maturing Treasury bonds and mortgages as they run out, and that could slow that down in a process Wall Street has dubbed “quantitative tightening” or QT.

“The fact that they’re ready to flip the switch on QT in May is our base case scenario, but we recognize there are risks that this could be skewed later,” Cabana said. He said that if the Fed found it was unable to raise interest rates as much as it hoped, it could immediately delay reducing the balance sheet, which would make policy more soft.

Bond market liquidity

The 10-year Treasury yield rose above 2% at its highest level on Friday, after falling below 1.7% earlier this month, as investors sought safety in the bonds. Bond yields move opposite to prices.

“It’s inflation and inflation expectations. Treasuries behave in this environment a little differently than a flight to quality assets,” Cabana said. “It’s a different dynamic than what we’ve seen. You can see a flight to quality into Treasuries, but Treasuries are reflecting higher inflation expectations.

Cabana said markets were showing signs of concern over uncertainty in Ukraine. For example, the Treasury market is less liquid.

“We have seen that the Treasury market has become more volatile. We are seeing that the spreads between bid and ask have widened. Some of the less liquid parts of the market may have become less liquid, such as TIPS and 20 years. We also see the depth of the market thinning,” he said. “All of this is due to high uncertainty and a lack of willingness to take risks on the part of market participants, and I think that should worry the Fed.”

But Cabana said markets were not showing major stress.

“We don’t see any signs that the funding wheels are breaking down or that counterparty credit risks are very high. But there are a lot of signs that all is not well,” he said. .

“The other thing we continue to watch closely is the funding markets, and those funding markets are showing a real premium for dollars. People are paying a lot to get dollars in a way that they don’t. haven’t done since Covid,” he said.

Cabana said the market was looking for reassurance from the Fed that it was monitoring the conflict in Ukraine.

“I think it would disrupt the market if the Fed reflected a very high degree of confidence in one direction or another,” he said. “That seems highly unlikely.”

dollar strength

The dollar index was up 0.6% on the week and it rose during Russia’s attack on Ukraine. The index is the value of the dollar against a basket of currencies and is heavily weighted towards the euro.

Marc Chandler, chief market strategist at Bannockburn Global Forex, also points out that the dollar funding market is under some pressure but not tight.

“The dollar is today at its highest level in five years against the yen. This is not what one would expect in a risky environment,” he said. “It’s a testament to the strength of the dollar.”

Chandler said there is a chance the dollar could weaken over the coming week if it follows its usual playbook of higher interest rates.

“I think there could be a buy the rumour, sell the fact to the Fed,” he said. “It’s typical for the dollar to go up before the rate hike and then sell off.”

boiling oil

Oil turned wildly last week, hitting a high not seen since 2008, as the market feared there was not enough oil supply due to sanctions imposed on Russia. Buyers shunned Moscow oil for fear of breaching financial sanctions, and the United States said it would ban Russian oil purchases.

West Texas Intermediate crude futures jumped to $130.50 a barrel early in the week, but stabilized Friday at $109.33.

“I think the market bid at $130 was a bit premature,” said Helima Croft, head of global commodities strategy at RBC, noting the US ban on Russian oil. She said Monday’s price spike came as market participants believed there would be a wider embargo on Russian oil, including Europe, its biggest customer.

“Right now the market is too extreme either way. I think it’s justified at $110. I think it’s justified at over $100. I don’t think we’re headed for a ramp out, and I think we have room to go higher,” she said.

Calendar for the coming week

Monday

Earnings: Vail Resorts, Coupa Software

Tuesday

FOMC meeting begins

Earnings: volkswagen

8:30 PPI

8:30 a.m. Empire State making

4:00 p.m. ICT data

Wednesday

Earnings: Lands’ End, Shoe Carnival, DouYu, Lennar, PagerDuty

8:30 a.m. Retail

8:30 a.m. Import prices

8:30 a.m. Survey of business leaders

10:00 a.m. Business inventories

10:00 a.m. NAHB survey

2:00 p.m. Federal Reserve Interest Rate Decision and Economic Projections

2:30 p.m. Briefing by Federal Reserve Chairman Jerome Powell

Thursday

Earnings: FedEx, Accenture, Commercial Metals, Signet Jewelers, Dollar General. Designer Labels, Warby Parker

8:30 a.m. First unemployment registrations

8:30 a.m. Start of housing

8:30 a.m. Philadelphia Fed Manufacturing

9:15 a.m. Industrial production

Friday

10:00 a.m. Existing home sales

2:00 p.m. Chicago Fed President Charles Evans

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