- War in Ukraine: optimism over peace talks continually led to pessimism and disappointment last week – will it be another such scenario this week?
- Fed to begin hiking cycle with a 25 basis point rise on Wednesday
- BoE set to tighten policy again amid surging inflation
Stock index futures rose as trading got under way on Monday, while gold and crude oil slipped, as once again, there was hope that the Ukraine conflict could end after officials from both sides gave their most upbeat assessments yet on Sunday about the progress in peace talks. Apparently, there could be positive results within days. You can understand why the markets have reacted positively to the headlines given the fact that developments in the Ukraine have been the primary driver of risk appetite. But so far, every bit of optimism has led to pessimism and disappointment, with Russian forces continuing their military operations regardless. Will this prove to be another such scenario?
If last week was anything to go by, I wouldn’t hold my breath.
Indeed, last week was yet another eventful week, with headlines from Russia and Ukraine causing wild moves in asset prices, keeping traders on their toes. On Friday alone, we saw risk assets being tossed in all sorts of directions, before the bears came out on top. Initially, Putin was quoted as saying that there are “certain positive shifts in talks with Ukraine,” which caused stocks and the euro to rise. However, this was later countered by Ukraine’s Kuleba, who said that “zero progress was made in talks with Russia,” and that talks don’t seem to impact Moscow’s behaviour on the ground.
Let’s hope we don’t get that sort of conflicting headlines as we look ahead to the new week.
The main macro event will be the Fed’s much anticipated rate decision on Wednesday, with Jay Powell and his colleagues at the FOMC expected to hike rates by 25 basis points. But there is no doubt in mind that the focus for the majority of market participants will be on the going conflict between Russia and Ukraine, and the implications this has on many markets, not least commodities.
War in Ukraine
Russia’s ongoing invasion of Ukraine is once again going to dominate the news and markets. It is all a question of whether a peace agreement will be reached or whether there will be further possible sanctions on Moscow. So, apart from this week’s Fed meeting on Wednesday, and possibly the BoE’s rate decision on Thursday, nothing else is going to matter. The focus will be fixated on the Ukrainian situation and unless something changes dramatically, I am expecting investors to remain cautiously optimistic, which should limit risk taking. So, any rebound we might see in the stock markets should be taken with a pinch of salt, while there is no resolution in the conflict.
FOMC rate decision (Wednesday)
Among the non-geopolitical events, the FOMC’s rate decision on Wednesday and Powell’s press conference will be the highlights. Will the Fed surprise the market with a 50 basis point hike? I doubt it. Although inflation has continued to soar, a 25 basis point hike is a good way, the Fed would feel, to get the hiking cycle started without scaring the markets.
This will be the first hike since December 2018, when a 25 basis point increase lifted interest rates to a target range of 2.25% -2.50%. But then Covid struck at the end of 2021, and by March 2020, rates were slashed to 0% to 0.25%, where they have stayed since.
But thanks in part to the Fed’s vast QE programme and zero interest rates, the big surge in energy and commodity prices, and lifting of lockdowns, inflation has surged significantly – certainly significantly more than the Fed had expected. The headline CPI measure of inflation has risen to 7.9%, which is the highest level in 40 years. Clearly, it is time for the tightening to begin.
Worrying for the Fed, the University of Michigan’s 1-year inflation expectations shot up to 5.4%, up sharply from 4.9% and the highest print since Dec 1981.
Against a backdrop of rapidly rising inflationary pressures around the world, you would expect the Fed to be more aggressive in hiking. Earlier this month, Powell said he would prefer a 25 basis point hike but would not be opposed to a 0.50% hike in the future meetings, should inflation accelerate.
It will be interesting to find out how the Fed’s dot plots will look like. In December, they saw the Fed funds rate moving to 0.75 to 1.00 percent, meaning they expected 3 rate hikes in 2022. But now, expect to see a sharp revision, with 6-7 hikes not out of the question.
Bank of England (Thursday)
The BoE meets on Thursday and another 0.25 basis point hike is expected, which would lift rates from 0.5% to 0.75%, to the highest level since before the pandemic. If expectations are met, this would be the third hike in a row, after the BoE kicked off the rate hiking cycle with a 50 basis point hike. The only surprise would be if the BoE hikes more than expected, which is an outside possibility given that UK inflation is at the highest level for 30 years.