Why a Fed pivot on rates could push markets into risk-on mode

A pause in rate hikes at the regulator's upcoming meeting could result in the US dollar trading sideways through to the start of summer

The New York Stock Exchange. Markets appear to be positioning towards a change in policy by the US Federal Reserve. Reuters
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The US dollar continues to struggle through April. Following a 2.25 per cent drop in March, the US Dollar Index, a measure of the value of the greenback against a weighted basket of major currencies, is currently 0.77 per cent lower at the time of writing.

The index now finds itself preparing for another test of those one-year lows at 100.80, where it previously found strong support in March.

Since my last column, markets seem to be positioning more towards a Federal Reserve pivot, or a shift in policy.

While much of the rhetoric through to the end of 2022 and early 2023 was focused on how a hawkish Fed would drive rates to control inflation, the overall market sentiment now is that a pivot is even more entrenched.

Of course, last time around, we had the news of the Silicon Valley Bank collapse, which was a cause for concern in the recent Federal Open Market Committee minutes but inflation data from the US has showed signs of a slowdown.

The consumer price index dropped to an annualised 5 per cent in March, down from 6 per cent previously — the lowest level since May 2021.

Meanwhile, core CPI year on year ticked higher to 5.6 per cent versus a previous reading of 5.5 per cent.

This was the first time since 2020 that the core print came in higher than the overall reading.

Recall that the core CPI is stripped of energy and food prices. So the fact that this reading was higher means that the overall CPI may not hint at such a slowing of US prices.

At last glance, markets are currently pricing in an 86.7 per cent chance that the Fed will raise interest rates to either 5 per cent or 5.25 per cent — this is up from a 65.2 per cent probability a week ago.

While markets are pricing in a 25 basis point hike in May — this is on the back of more than 400 bps of hikes over the past year — they seem increasingly optimistic of pauses in rate rises in subsequent meetings.

Ultimately, this will yield a more risk-on mode in markets, with more anaemic conditions for dollar-long positions and the greenback expected to trade sideways with a bearish bias into the start of the summer.

Also adding to the risk-on mood has been a strong start to first-quarter earnings.

The big banks were the first to report earnings last week, with heavyweights Wells Fargo, Citi and JP Morgan Chase all reporting stronger-than-expected earnings.

Keep an eye out for more earning reports this week, with stronger results expected to continue adding weight to US indices.

The US500, better known as the S&P 500 index, has been on its own mini renaissance since mid-March, a period in which it gained more than 7.8 per cent.

Fundamentally, momentum will continue to be driven by Fed action and earnings, while technically the index looks good to test 4,300 levels before June.

One of the other key talking points has been the performance of gold.

The precious metal has been on an absolute tear in April — smashing through $2,000 to print a high of $2,048.

Watch: US Federal Reserve chief warns of 'pain' in reducing inflation

US Federal Reserve chief warns of 'pain' in reducing inflation

FILE PHOTO: Federal Reserve Chair Jerome Powell attends the Federal Reserve Bank of Kansas City's annual Jackson Hole Economic Policy Symposium in Jackson Hole, Wyoming August 28, 2015.  REUTERS / Jonathan Crosby / File Photo / File Photo

That’s the highest level in 13 months and just 1.3 per cent off its all-time intraday high of $2,075 experienced in August 2020.

The movement in gold has been particularly intriguing. Traditionally, the precious metal is seen as a hedge against inflation.

With inflation showing signs of slowing over the past two months, we would expect more anaemic gold prices.

However, it is the risk-on mood that has resulted in a breakout from the channel of $1,900.

At the time of writing, the precious metal was holding above $2,000.

While it could not sustain more than $2,030 for very long, I expect choppy trading, with the metal to bounce around in the channel between $1,980 and $2,050 in the weeks ahead.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers

Updated: April 19, 2023, 4:00 AM