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Real Money Is Ready for Biggest Fed Hike Since 2000: Trader Talk
By Vassilis Karamanis
(Bloomberg) — It’s been months since my inbox has been so busy dealing with market color. It’s not down to Friday’s chunky month-end flows, but mostly because the Federal Reserve’s hawkish shift caught a few investors sidelined, if not wrong footed. Hedge funds rarely second-guess a move when the narrative changes, yet what stood out was real money stepping up its game, getting involved in the market through high volume spot flows and options plays. The direction of their trades suggests that a move by the Fed not seen for two decades would support their conviction.
Almost three weeks ago, when the dollar was on a 2.5% slide, and just a day before it entered rebound mode to erase those losses, I wrote that the main problem for the bulls was the perception that the Fed was behind the curve. And I wondered what could restore market confidence in policy makers’ ability to keep things in check: “Whether it will be four hikes this year with a 50 basis-point increase at one of the meetings, the upcoming balance sheet adjustments or the back-end of the curve eventually reflecting the Fed’s dot plot, that’s anyone’s call.”
At the time, the market was pricing in 89 basis points of interest rate increases by year-end. Now, almost five hikes are priced in, with a further 30 basis points added by money market traders. The question is whether we could see a rare 50 basis-point move in March, the first since 2000. For Raphael Bostic, president of the Fed’s Atlanta branch, it’s something the central bank could go for if a more aggressive approach to taming inflation is needed. The key point: whether higher wages are meaningfully boosting prices.
As the week kicks off, Fed fund futures show 31 basis points of tightening for the March meeting. The tighter the hiking cycle gets, the stronger the dollar will become, because the close correlation between yields and the currency has resumed. For the time being, it’s hard to bet against the greenback on front-end rate differentials versus its major peers and especially the low yielders. As long as it’s sympathy — or wishful thinking — that sends euro area bonds lower, it’s hard to see an imminent rebound for the euro. What seems to be in play is a modest shift lower in its range from $1.12-$1.15 to $1.11-$1.14.
Talk won’t do the trick for dollar bears any more. The European Central Bank will have to take action if inflation turns out to be more persistent than currently expected, according to Veronika Grimm, a member of the German government’s Council of Economic Experts. We know the doves in the Governing Council are under pressure, but that has been the case since January last year when inflation picked up dramatically. Real money is betting that this week won’t see a change of tune by president Christine Lagarde.
With volumes running at 150% of recent averages since the latest Fed decision, institutional investors were among the main desks buying the dollar against the yen, the Aussie and the euro. The break of $1.12 saw a pick up in interest for strikes below $1.10 on one- to three-month trades, according to traders based in London, Frankfurt and Dubai. Against the pound, real money also went on the offer, but in lower volumes. They do expect the Bank of England to tighten further in the months ahead, although there is a case to be made that officials may disappoint those looking for a 120 basis-point change by year end.
Macro desks and fast money are also going with the long-dollar story, yet I wouldn’t be surprised if they trimmed exposure as the next ECB and BOE meetings approach and ahead of Friday’s U.S. payrolls report. But real money doesn’t talk, it screams. There’s no sense in trying to go against such powerful flows. You can challenge the trade, but will unlikely be on the winning side when the dust has settled. For now, the winds may be blowing a little too powerfully.