The tug-of-war between Fed officials and broader financial markets over the outlook for interest rates continues. While the market expects the Fed to cut interest rates at all costs during 2024, Fed officials have been cautious in their rhetoric. Christopher Waller is the latest Fed member to postpone the pace of easing expected by the market. Waller said interest rates should be lowered “methodically and cautiously”.
Bond yields and the dollar have regained their vitality as Waller’s expectations of the pace of monetary policy easing in 2024 have poured cold water on them. The yield on the 10-year Treasury note has risen back above the psychological level of 4% several times, disrupting investors’ confidence in the stock market. At the same time, the dollar continued to reverse its trend at the start of 2024, with the US Dollar Index (DXY) returning above the 103 mark. The dollar’s recent rally may be a reminder that rumors of the dollar’s demise in the second half of 2023 have been greatly exaggerated. Especially if bond yields continue to move higher as interest rate expectations reshape.
The recovery in the US dollar and bond yields weighed on gold prices to some extent. Precious metals prices fell 1% during Wednesday’s Asian session, with spot prices hovering near $2,028. Although as geopolitical tensions escalate rather than subside, safe-haven buying inflows are likely to provide support to gold prices. However, if macroeconomic data or the Fed’s speech trigger a further hawkish shift in the interest rate outlook, then gold could fall below the $2,000 level. In other words, the short-term fate of gold prices is likely to be in the hands of the bond market.
The geopolitical environment continues to have an impact on oil prices. The outlook for shipping is far from clear due to the conflict in and around the Red Sea, but the risk premium in oil prices does not appear to be high. If shipping routes are disrupted more severely, this will not only affect the oil market, but also have a broader impact on prices in the global economy. Therefore, the current developments near the Red Sea have the potential to lead to an explosion of oil and global inflation. The West Texas Intermediate (WTI) crude oil contract has been trading in a range of $71 to $74 for most of January, but there is still room for the contract to move higher given the ongoing conflict in the Middle East.
Looking ahead, the release of US retail sales data (Wednesday US time) will be worth watching, as any potential “overheating” in the data could lead to a reconsideration of the possibility of a rate cut by the Federal Open Market Committee (FOMC) in March. When it comes to Fed hopes and when to start cutting interest rates, financial markets are trying to think on the bright side. While last week’s producer price index (PPI) data was weak, one need only look back at the higher consumer price index (CPI) and strong wage data a few weeks ago to see that Fed official Waller’s cautious rhetoric about the outlook for interest rates was not unreasonable.