Powell's hawkish tune gets equities going as bonds take a back seat

Washington

INVESTORS responded to the US Federal Reserve's intent to tackle inflation with a clear risk-on pivot, as stocks climbed while Treasuries retreated.

Equity strategists highlighted the usually positive outlook for stocks in the early stages of a tightening cycle, even as bond and currency analysts suggested more volatility was likely in their markets into 2022.

Market watchers expect the US dollar's weakness to be short-lived and see its rally resuming.

"Equity prices turned from red to green, likely because the uncertainty had been lifted and Fed chair Jerome Powell didn't sound as hawkish as many had feared," said Sam Stovall, chief investment strategist at CFRA Research.

"History says, but does not guarantee, that prior Fed tightenings resulted in minor price increases for the equity market over the ensuing year."

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Stovall noted that the S&P 500 Index rose initially during a majority of the Fed's 17 post-World War II tightening cycles, highlighting a median gain of about 3.5 per cent for the periods between the first hike and the third.

Traders are pricing for the first US rate increase to come next June, while the Fed indicated there could be 3 hikes in 2022.

In an abrupt policy pivot, the Fed sped up the drawdown of its asset-purchase programme and laid out a road map for 8 interest-rate increases through to 2024.

Powell also raised the possibility that the central bank might begin to withdraw liquidity before too long by reducing its massive balance sheet.

While equity investors welcomed the combination of Fed certainty and a confident outlook, there were also signs of caution as strategists outlined the risks that either policy aggression or the impact of omicron could undercut the expansion.

"The Fed is likely going to continue to tread lightly as they walk the fine line of attempting to cool inflation without slowing the economy too dramatically," said Charlie Ripley, senior investment strategist for Allianz Investment Management.

"The reality is uncertainty surrounding Fed policy is high and will likely remain that way as Powell attempts to unwind the largest monetary stimulus package in history without disruption."

Nomura Securities in Tokyo saw the outcome as broadly positive for global stocks, with extra potential that it could set up Japanese equities for some outperformance - and not only because the yen weakened noticeably after the meeting.

"Buying in US equities was concentrated in names or sectors where high growth can be anticipated even under a rate-hike cycle," said Takashi Ito, an equity market strategist at Nomura.

"It wouldn't be strange to see the discount on Japanese equities narrow following the FOMC, with market interest centred around electronics, machinery, automakers and marine transportation stocks."

Currency strategists expect the US dollar's strength to reassert itself, despite the overnight surge for commodity currencies such as the Australian and New Zealand dollars.

The National Australia Bank (NAB) sees the Fed potentially hiking 4 times next year, provided the pandemic does not substantially disrupt the economy.

"Our 2022 base case is for the dollar to stay strong at least through mid-2022," said Rodrigo Catril, a NAB currency strategist. "The euro and the pound are at risk of further under-performance, amid energy struggles, a dovish European Central Bank, plus politics."

Vishnu Varathan, Mizuho Bank's head of economics and strategy, also sees a firmer dollar in the first half, especially against the euro and the yen. Even commodity currencies look vulnerable because of the potential for weaker raw materials prices, he said.

The lack of a strong reaction in bond yields was also seen as only temporary, with most strategists expecting a fresh climb that would start with shorter-dated maturities and extend.

"US 10-year yields could test 2 per cent in 2022," Varathan said. "Whether that will be exceeded could at a later stage be a function of the expiry of flexible average inflation targeting. Or in other words a reversion to an outright inflation target."

While the US yield curve initially flattened, the bets unwound by the end of the trading day, with longer-end yields rebounding. BLOOMBERG