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Two Factors That Are Influencing Markets Today

Two Factors That Are Influencing Markets Today

FOMC

US and European stock futures are once again trading sharply lower as traders are still digesting the full message from the Fed. Last night, the Fed Chairman, Jerome Powell, made it apparent that the Federal Reserve will intervene if necessary to cool the fastest-rising inflation in nearly four decades, approving interest-rate hikes in March and paving the way for more frequent and probably greater hikes than previously expected. Chairman Jerome Powell also stated that the Fed may take an assertive stance. “I think there’s quite a bit of room to raise interest rates without threatening the labor market,”. This particular statement by the Fed chairman has broken the back of the recent rally that we saw in the equity markets. Investors are now thinking that the Fed, which was actually going to be only modestly hawkish could be downright aggressive in terms of their monetary policy approach.

The fact is that the Fed has its hands tied due to the soaring inflation and they have no choice left but to react in a way that can cool off the inflation number which are running at the hottest level in nearly 40 years. It is also true that the Fed monetary policy stance has been telegraphed well as the Fed members have been preparing the markets for an overly hawkish monetary policy stance. But traders are still in the state of shock to know that the Fed is actually thinking about lifting the interest rate by more than twenty basis points.

The Fed statement last night didn’t make it entirely clear that an interest rate hike will take place next month, thought indications are that it can take place as soon as their next meeting which is going to be next month. The exact statement by the Fed was “With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate,”. Given the fact that there is no Fed meeting in February, it is pretty much a given that the interest rate hike is likely to take place in March this year.

An additional factor which is also influencing the equity futures today is the fact that the Fed is now thinking of reducing the size of its balance sheet. The asset purchase programme which was put in place due to Covid will come to an end in March. It seems very clear that as the Fed starts increasing the interest rate, it will also begin the process of shrinking its balance sheet. Powell said “The balance sheet is substantially larger than it needs to be”. “There’s a substantial amount of shrinkage in the balance sheet to be done. That’s going to take some time. We want that process to be orderly and predictable.”

Geopolitical Tensions

If Russia strikes against Ukraine, European countries are debating what sanctions should be applied. Tougher sanctions, as well as any Russian reprisal, would affect Russia’s economy as well as its trading partners.

Examining the OECD’s TiVA and ICIO databases for 2018 to see which European economies and industries would be most vulnerable if the present sanctions, which were imposed in reaction to Russia’s invasion of Crimea in 2014, were tightened further.

Approximately 0.8 percent of EU economic activity is directly tied to Russian imports of intermediate and final products, which are mostly used to meet Russian demand. Economic sanctions against Russia would have an impact on this source of demand for European goods and services, especially in Eastern Europe. An additional 0.5 percent of EU output is reliant on Russian supplies, with Eastern Europe once again being particularly vulnerable. Commodities, energy, and basic manufactured products are the most common Russian inputs.

Europe’s vulnerability to Russia is, on the whole, manageable. However, the country’s overwhelming reliance on Russian energy sources poses a significant threat. Natural gas prices have already risen as a result of tensions between Russia and the West, affecting consumer purchasing power in Europe and putting a strain on the most energy-intensive sectors. It could get a lot worse. If Russia completely cuts off gas supply, the resulting disruption in electricity production might be even more damaging to the European economy.