Overnight Headlines

*Asian stocks fall on threat of war, inflation; China markets slumps  

*ECB to turn off money taps on Ukraine “watershed” moment

*Dollar hits five-year high versus yen, euro pressured by growth risks

*US inflation hits 40-year high, inviting aggressive Fed tightening

US equities ended in the red as risk aversion remains elevated. Talks between Russia and Ukraine didn’t yield any positive breakthrough. All three major indices closed lower after the best session in months on Wednesday. Banks and big tech got hit while Amazon surged following a stock split and buyback plan. Asian markets have extended the global slump. Chinese stocks are especially concerned by potential regulatory issues on US-listed mainland firms. Futures are mildly positive.

USD clawed back some of its losses and pushed off 98 support on the DXY. EUR initially saw a high of 1.1120 after the ECB decision. But it soon retreated and dipped below 1.10 before stabilising. Gains in EUR/GBP and EUR/CHF also reversed. GBP gave up nearly all the prior session’s gains closing below 1.31. USD/JPY is pushing higher today above resistance at 116.35. Commodity currencies were modestly higher with AUD moving above its 200-day SMA at 0.7312.

Market Thoughts – ECB hawks win the argument

The ECB opted to be far more hawkish than expected. It chose to reduce its asset purchases earlier than expected which we mentioned yesterday was a possibility. The bank did this despite the severe tightening in financial conditions driven by events in Ukraine.

The ECB’s credibility as an inflation-fighter is restored. Indeed, some central bank watchers are saying this could be a regime shift at the ECB to the way it has conducted policy over the last few years. President Lagarde said geopolitical events posed “a substantial upside risk” to inflation. We wait to see how the growth picture lays out. But only a major escalation or deep recession may stop them.

As the first major central bank to meet post the Russian conflict, there will now be increased pressure on the Fed to stick to its hawkish guns next week. That also goes for other policymakers, with the BoE also meeting next Thursday. Much of the move in rate expectations that were lowered after the war have now been reversed.

Chart of the Day – USD/JPY breaks out

US inflation came in as expected yesterday, rising to 7.9% y/y, driven by energy prices. The core print, which excludes food and energy costs, also remained brisk at 6.4% y/y. Of course, these figures do not even take into account the most recent spike in commodity and energy prices. Estimates are for above 9% readings going forward.

The US economy has strong momentum and looks resilient. This has pushed up Treasury yields to their highest in a few weeks and close to 2% on the 10-year.

In turn, this has seen USD/JPY, which is highly correlated with these yields, breakout out to five-year highs. The major had been forming an ascending triangle pattern over recent months. The November top at 115.52 was initial resistance, then the previous cycle high at 116.35. The measured move target is near 118, though there is a long-term trendline to beat first around 117.