Morning Bid: Reserve judgment

A look at the day ahead in U.S. and global markets from Mike Dolan.

The U.S. Federal Reserve’s toughest task on Wednesday would be to convince markets it won’t be cutting interest rates again next year. Ebbing inflation questions whether it will bother.

Wary of Fed pushback, buoyant stock and bond markets on Tuesday quickly tempered their initial enthusiasm on news of a second straight month of surprisingly soft U.S. consumer price inflation (CPI) in November.

The edgy volatility owes something to short term options plays, with wild swings over two days in the VIX index (.VIX). Although Wall St still ended comfortably higher by the close, stock futures hunkered down again on Wednesday awaiting the Fed decision, forecasts and chair Jerome Powell’s guidance.

A downshift in the Fed rate rise campaign to half-point clips, after four straight 75 basis point hikes, is now baked into expectations. What happens next year is really the issue.

Fed funds futures prices now imply a better-than-even chance the Fed will follow this week’s half point rise with a smaller 25-basis point (bp) hike at its first two meetings of 2023 – and stopping shy of 5% by March.

Morgan Stanley for one sees only one more 25 bp rise after today, at the Fed’s February meeting, and sees the peak funds rate there at 4.625%.

Perhaps more significantly, futures still see a half point cut in rates between then and year-end and are again toying with the idea Fed rates will be lower at the end of next year than at the end of this one.

The Fed in recent months has frequently protested against the idea it will be in easing mode again next year. Markets now wonder if it will be as vociferous this time around – with ‘dot plot’ rate forecasts, economic projections and a news conference to convey its feelings.

Ten-year U.S. Treasury yields backed up a tad to 3.46% first thing, but the 3-month-to-10-year yield curve inverted further beyond 90 bps to its most negative in 40 years.

Asia stocks were slightly higher, European bourses lower. The dollar stayed close to 6-month lows hit after the CPI on Tuesday.

The euro and sterling led the dollar lower, with some expectations that the expected half point rate rises from the European Central Bank and Bank of England on Thursday will be accompanied by more hawkish rhetoric than the Fed.

Wary of rising wage inflation and waves of UK labour strikes, UK government bond yields significantly bucked the trend towards lower sovereign borrowing rates on Tuesday, and both 10 and 30-year gilt yields hit their highest in over a month.

News on Wednesday of a bigger-than-expected retreat in British inflation last month did little to rein in that move as annual consumer price rises remain in double digits.

Elsewhere, the ongoing crypto quake continued to grab headlines.

After reports on Tuesday that Binance saw withdrawals of $1.9 billion in 24 hours, the largest such outflow since June, the crypto exchange’s chief on Wednesday said deposits were returning.

FTX founder Sam Bankman-Fried’s failure to secure release on bail in the Bahamas, meantime, increases the likelihood he will consent to extradition to the United States to face fraud charges, legal experts said.

Some of the banks that lent Elon Musk $13 billion to buy Twitter are preparing to book losses on the loans this quarter, but they are likely to do so in a way that it does not become a major drag on their earnings, according to three sources with direct knowledge of the situation.

Stock movers in Europe included a jump in Zara owner Inditex (ITX.MC), which posted a 24% increase in net profit as price rises helped offset weakening global demand for clothing.

On Wall St on Tuesday, Moderna Inc (MRNA.O) surged 19.63% after the biotechnology firm’s experimental vaccine in combination with Merck & Co Inc’s (MRK.N) blockbuster drug Keytruda showed promising results in a skin cancer study.

Key developments that may provide direction to U.S. markets later on Wednesday:

  • U.S. Federal Reserve’s Federal Open Market Committee policy decision and press conference
  • U.S. Nov import and export prices
  • U.S. corporate earnings: Lennar, Nordson
  • G20 Finance and Central Bank Deputies meeting in Bengaluru