Fed and China Risks Move Sharply Higher

Macro-Pressures Building Quickly

In the past 24 hours, we have heard from the Federal Reserve Chairman, Jerome Powell, that rates are very strenuously going much higher than the market had thought, and that China has made very firm, and in fact its most aggressive official comments seen so far, against the USA.

When it comes to equity market risks, they do not get much bigger than aggressive Fed hikes still to come, and fast rising geo-political risks.

Market have immediately begun to price in a far more realistic picture of the likely trajectory of the Fed Funds Rate than they had previously. Markets have been badly mis-taken to think that there would be a ‘pivot’, or even an early pause in rate hikes.

The mantra of the Fed has been largely consistent in regard to rates going higher for longer than the market expects.

What was new, in the Chairman’s address to Congress, was the dropping of some of the gentle window dressing that had been erected recently.

Chairman Powell has attempted to massage the message, so that it was firm, but not too alarming. Alluding to the possibility of a soft economic landing and slowing to 25 point hikes too early, have only encouraged the markets mis-guided beliefs of it will all soon be behind us.

The stretch between sentiment and reality in regard to rate expectations needed to be resolved, and the Chairman has now done this.

While markets adjusted on the day, accepting the likely reality of much higher rates, that adjustment, or pricing in of this information has very probably only just begun. Stocks do indeed remain vulnerable to further downside risks over coming days, and perhaps months.

As if this was not enough to digest, markets have also been hit with a far more assertive stance diplomatically by China toward the USA. China frustrations seem to have reached a tipping point. Therefore, some pointed comments by President Xi Jinping, and then extremely significantly in diplomatic terms, the new Foreign Minister gave a speech in which he aggressively laid down that the US needed to stop going down the containment of China path. If not, the possibility of escalation, and even conflict would certainly grow.

These are strong words indeed, especially coming from the former Ambassador to the US, who would be all too aware of just how such remarks would be received in Washington.

US equities, currency and bond markets had only just begun to price in the prospect of a significantly higher terminal Fed Funds Rate. They have not yet had a chance to consider this latest stepping up against the USA by China.

China again made it very clear that Taiwan is its territory, and there should be no crossing of that line by Washington. That China’s patience has run out, seemed to be the central theme of the Foreign Ministers speech.

While it is hoped that no actual China US clash will occur, there is no doubt that the risk of such a development just rose markedly. Markets may need to adjust for this heightened risks outlook.

Australian markets could be vulnerable here. If there were a US China military clash, of any kind or degree, how would the Australian equity market and currency be priced?

Clifford BennettACY Securities Chief Economist

The view expressed within this document are solely that of Clifford Bennett’s and do not represent the views of ACY Securities.

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