Risk aversion flows - the market giving up on a year-end rally

١٥ ديسمبر ٢٠٢٢

US500 -2.8%, NAS100 -3.3%
GER40 -3.3%, EUStoxx -3.5%
VIX +2.3 vols at 23.45%
DXY +0.8%
AUDUSD -2.4% (the weakest link in G10 FX), GBPUSD -1.9%
XAUUSD -1.6%, XAGUSD -3.5%

The markets saw yesterday’s Fed meeting as hawkish, but there was enough in Powell’s press conference to keep us believing they will move to an even slower pace of hikes and risk was subsequently supported – well, the ECB made traders re-focus on the hawkish angle with an outcome that was designed purely and simply to let the markets know they still have a lot of work to do and it was the outcome that possibly couldn’t have been more hawkish/negative for risk. The BoE hiked by 50bp, and the dovish angle came from the dissenters, two of whom were calling for rates to be on hold – however, the Bank removed a line that previously suggested the BoE would be unable to reach the peak/terminal rate priced by markets.

We’ve had enough time to dissect the Fed's stance and ultimately while they made it clear they’re ever-more data-dependent, the market sees a bank who on balance are not as persuaded by the fall in inflation as the market would like. Step up the ECB – Christine Lagarde made it clear the market’s terminal pricing of the future ECB rate setting - at 2.8% - was grossly mispriced and detailed an intention to go hard on hikes until sufficiently restrictive – she was as clear as she could be that a step down to 50bp (from 75bp) was not a pivot – by saying they still have to “still have to rise significantly” it suggests that a 50bp hike at the 2 Feb meeting is all but assured and the policy rate to head above 3%.

QT starts in March, where the Bank will be allowing maturing bonds to roll off the balance sheet at an average pace of E15b pm – this is perhaps more definition than some had expected, and it leads us to feel the pace will step up to E30b by mid-year. Another G7 central bank that will be hiking and removing liquidity concurrently – while some will argue this is priced in, I am not so sure that is the case.

The wash-up is German real rates have gained 17bp, the 10yr BTP – German bund yield spread has widened 16bp and while EURUSD initially spiked to 1.0735 on the hawkish ECB outcome, it's been all USD buyers as the session wore on and EURUSD is back to 1.0600. The EUR has been supported, however vs the crosses, where long EURAUD has been a solid trade. Sizeable AUD weakness on risk aversion flows has helped there. EU equity has been smacked, with GER40 and EU Stoxx -3%+

We knew it was a defining week – the market has looked at the Fed, BoE and ECB and seen an almost homogeneous response that the battle on inflation is far from over – the market wanted a metaphorical hug that everything will be ok, but central banks have pushed real rates higher and made us refocus that these institutions are not there to support recession risk at this point and inflation is the evil that must be targeted – I have no doubt that will change in 2023 and the market will take its pound of flesh – perhaps we’re seeing it now, but judging by moves in the USD, real rates, and the technical breakdown in the US500 and XAUUSD, for now, active managers are shutting up shop and the prospect of a Santa rally slips through our fingers.