Tug-of-War Continues over Interest Rate Expectations

With Waller pouring cold water on expectations for the rate of monetary policy easing in 2024, bond yields and the USD found renewed vigour. The yield on the 10-year note strode several points back above the psychological 4% level, which upset the confidence of equity markets. Meanwhile the USD continued its reversal of fortune to start 2024, with the Dollar Index(DXY) marching back above the 103 level. The latest move higher by the USD is perhaps a reminder that rumours of the greenback’s demise at the back end of2023 were greatly exaggerated. Particularly if bond yields continue to edge higher on reshaped interest rate expectations.

The reinvigoration of the USD and bond yields pulled the rug out from under the gold price to some degree. The precious metal lost 1% in value, with the spot price hovering around the $2028 level during Asian trading hours on Wednesday. Though with geopolitical tensions escalating rather than receding, safe haven buying flows could well provide a floor for the gold price. However, if macroeconomic data or Fed-speak sparks a further hawkish shift in the interest rate outlook, the gold price could be staring down the barrel of a move below the $2k level. In other words, the short-term fate of the gold price is probably in the hands of the bond market.

The geopolitical environment is continuing to have ramifications for the oil price. The shipping outlook is far from certain due to conflicts in and around the Red Sea, though despite this there appears to be very little in the way of risk-premium being built into the oil price. If shipping routes are disrupted to a greater extent this could impact not only the oil market but broader pricing for the global economy. As such, goings on in the vicinity of the Red Sea right now have the potential to cause flare-ups for both oil and global inflation. The WTI contract has been spending much of January trading in the $71-$74 range, but there is scope for a move higher given the ongoing conflict in the Middle East.

Looking ahead, US Retail Sales data will be one to watch when it gets released (Wednesday US time), as any potential ‘hotness’ in the numbers could cause a rethink as to the odds of a March rate cut from the FOMC. Financial markets are trying their best to look on the bright side when it comes to hopes from the Fed and when the rate cuts could commence. While last week’s PPI numbers were soft, one only has to look back to the higher CPI print and the strong payrolls figures a few weeks back to see that Fed member Waller’s circumspect remarks on the rate outlook are not entirely without justification.