Investors Contemplate Rates Reaching 6%

Commodity currencies have retreated as the prospects of a U.S. recession grow, with the Australian dollar sinking 2% on Tuesday. The Bloomberg Dollar Spot Index climbed to the highest since early January on Wednesday after rallying 1% the previous day. The yen is once again closing in on the 140 level against the greenback.

“Before Powell last night, we were more inclined to try shorting USD/JPY around the 137-138 level — think we would probably hold off on that, with Fed terminal rates very possibly heading to 6%,” said John Bromhead, a currency strategist at Australia & New Zealand Banking Group Ltd.

Credit markets are similarly bracing for the fallout from the repricing of U.S. rates.

“It’s not our base case, but a 6% Fed Funds rate would likely result in a stronger dollar, weaker global growth and ultimately downside for risk asset valuations,” said Mark Reade, head of fixed-income desk research at Mizuho Securities Asia. “While China’s reopening and a relative scarcity of new supply would likely cushion the blow for Chinese USD bond spreads, it is unlikely those spreads emerge unscathed.”

Emerging Markets

The Fed rhetoric risks worsening the outlook for emerging-market assets, after Beijing’s modest economic growth target earlier this week dashed hopes of a resumption of the reopening rally that buoyed global markets earlier. The South Korean won, a proxy for risk sentiment in Asia, sank 1.8% on Wednesday.

“Higher-for-longer is becoming the base-case scenario, and if that scenario materializes, EM can suffer,” said Brendan McKenna, emerging markets strategist at Wells Fargo in New York. “Markets were really hoping for an early Fed pause and cuts this year, so far that scenario is not unfolding.”

Still, some investors see buying opportunities in the stock market.

“We would expect the more cyclical and cheaper markets of North Asia to be favored and rotation away from South Asia to continue,” said Sat Duhra, fund manager at Janus Henderson Investors. “Finally the higher quality tech names in North Asia, in particular semiconductors, are beginning to appear attractive on valuation and is a sector that should fully participate in any recovery in earnings.”

–With assistance from Liz Capo McCormick, Ishika Mookerjee, Georgina Mckay, Matthew Burgess and Wei Zhou.

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