Three game-changers in the week ahead

Get our take on how Monday's events could drive asset prices for the rest of this week. 

Last week was all about central banks, guess what, this week central banks are once again taking centre stage. This time the sole focus was on Fed chair Jerome Powell, who was speaking at the National Association of Business Economics on Monday and said that the US central bank was prepared to raise interest rates in half percentage point increments to deliberately slow down the economy and weaken inflation, if it became necessary to do so. This caused stocks to come under pressure and US sovereign bond yields to surge. After last week’s stellar rally for US stocks, which had their best week since 2020, today’s remarks from Fed chair Powell triggered a sell-off in US stocks, the S&P 500 slipped 0.04% and the Nasdaq fell 0.4%. Monday’s movement in stocks was a keen reminder that high commodity prices, rampant global inflation, a war in Eastern Europe and a hawkish Fed are not a good backdrop for equity market bulls, thus rallies may not be built to last. Below, we take a look at three factors that could drive markets this week.

1, The US Treasury market and the yield curve 

The US Treasury market is having its worst month since the election of Donald Trump in 2016, and the benchmark 10-year yield has surged nearly 50 basis points so far in March as the Fed sticks to its hawkish guns in the wake of the war in Ukraine. After touting the prospect of single 50 basis point hikes on Monday, Jerome Powell has caused yet another reassessment of where interest rates will go in the US in the coming weeks. The market is now expecting a 50-basis point hike from the Fed at its next meeting in May, according to the CME Fedwatch tool there is now a greater than 60% probability that US rates will rise to 75-100 basis points on May 4^th, up from 25-50 basis points today. The sharp rise in Treasury yields has caused the US yield curve to flatten sharply, as you can see in the chart below. The 2-10-year Treasury yield curve is at its flattest level since 2019, when the Fed was last considering tightening rates before the pandemic. If the yield curve inverts, this typically signals a recession is coming for the US economy. Thus, we could see more US yield curve inversion in the coming days and weeks, especially after Fed chair Powell’s speech on Monday, which touted the possibility of  more aggressive interest rate moves to tame inflation.  However, an inverted US yield curve can have a strange impact on the stock market. When the yield curve starts to flatten, this is when the bulk of a sell-off in stocks can happen, for example, the Nasdaq has fallen 14% since reaching a record high in November 2019. This has coincided with the period when the US yield curve started to flatten, as you can see below. Thus, the bulk of the selloff may have already happened for US stocks and it is worth noting that an inversion of the yield curve (when short-dated US Treasury yields rise above longer-dated yields), could be good news for tech stocks and the Nasdaq. This is because some of the younger, super-growth tech companies rely on longer dated bond yields to discount their future cash flows. When longer-dated yields are falling, this pushes up their future cash flows, which can attract buying interest for their shares. Thus, we will be watching the Nasdaq extremely closely in the coming days and weeks, to see if this index starts to make a bottom at the same time as the US yield curve finally inverts. 

Chart 1: US 2-10 yield curve (St Louis Fed)

2, Commodities 

The price action in commodity markets on Monday was another indicator that the risk premium for commodity prices has not yet been eradicated, and short, sharp spikes higher in commodity prices are to be expected. The price of brent crude surged by nearly 8% on Monday to $116 per barrel, after Russia and Ukraine’s latest round of peace talks stalled and the battles in Ukraine appeared to intensify. There was another factor also driving up oil prices at the start of this week, the lockdown in Shenzhen, a key industrial and technology hub in China, eased covid lockdowns and partially reopened at the end of last week, which has reduced fears that prolonged Chinese lockdowns could weigh on global growth and thus commodity demand. The EU is also considering joining the US and the UK in an embargo on Russian oil and the IEA have not helped matters by stoking more fears about tight supply and calling for emergency measures to reduce energy usage. This could include more working from home, reduced speed limits on the roads and a potential ban on business air travel. Metal prices were also higher, although the gold price was fairly stable as a hawkish Fed keeps demand for the yellow metal on ice for now. 

The issue with volatile commodity prices for traders is that it impacts all other markets. The bond and stock markets are impacted by inflationary concerns and FX markets are partly driven by interest rate differentials. In the FX space, an uber-hawkish Fed means more upside for the dollar in our view, and the dollar was the best performer in the G10 at the start of the week. We think that DXY could be back on track to target the psychologically important 100.00 level after failing to breach that resistance level last week. Essentially, if we continue to see elevated commodity prices, then the dollar should be supported on a broad basis in the coming weeks. 

3, Key data this week 

While there are overarching themes that are dominating markets and geopolitical risk remains critical for asset prices, economic data is also worth watching closely. There are two data points that we will be watching this week: firstly, UK inflation for February. It hit a fresh 30-year high in January, and prices are expected to have risen further last month, jumping to 5.9% from 5.5%. The fact that this week’s price data is likely to experience a significant jump higher even though the bulk of the price pressures that have built as a result of the Russian invasion of Ukraine won’t be felt until the March data is released, could also spook markets. While the UK and the US are facing similar problems, their central banks are dealing with them in different ways, with the BOE much more concerned about the impact high prices will have on growth. This is why a strong inflation reading for the UK this week could see more downward pressure build on the pound. GBP/USD is trading flat around the $1.3170 mark, after bouncing off support at $1.30 last week. This remains a key support zone, and if Chancellor Rishi Sunak does not deliver enough help for the UK consumer at this week’s Spring statement, then fears about UK growth could send GBP/USD back to test the strength of support at the $1.30 level. 

In Europe, all eyes will be on the March PMI data that is due for release on Thursday. These indices are expected to reveal a sharp drop in business sentiment as a result of events in Ukraine and the ensuing disruption to trade and the surge in energy and raw materials prices. The market expects a fall in the composite  Eurozone PMI from 55.5 in February to 53.8 in March, however the risk is that there could be a much larger drop, especially if sentiment wilts in Germany, which historically had extremely close links to Russia’s economy. If this happens then expect a selloff in European shares, with the Dax index being at risk if there is a collapse in PMI sentiment.