• Inflation worries intensify, lifting yields ahead of Fed rate hike
• Stock markets under fire, especially tech sector and China plays
• Yen gets blasted, gold and oil retreat ahead of more peace talks

Equities sink ahead of Fed liftoff

Global markets are under an incredible amount of stress as the Fed prepares to pull the trigger on higher rates. The war in Ukraine and the latest lockdowns in China have set off a domino effect, with investors betting that the inflationary flames won’t be extinguished anytime soon even though the Fed will try its hardest to do so.

Various measures of inflation expectations have stormed higher this week and refuse to retreat despite the dramatic reversal in energy prices. Therefore, traders are betting the Fed will be forced to raise rates faster to combat spiraling prices, which is pushing US Treasury yields higher.

Beyond inflation concerns, there’s also a growing risk of a credit episode. With central banks closing the liquidity gates and fears that defaults from Russian-exposed entities could snowball, credit investors are rushing for the exits, propelling yields on junk bonds much higher. The real risk is, what happens if you have a global recession while inflation is so high?

Nobody wants to find out, hence why money managers are slashing their risk exposure. The tech-loaded Nasdaq fell 2% yesterday and futures point to another bloody nose today. That’s a serious drawdown but it pales in comparison to the turmoil in China. The Hang Seng index fell almost 6% today amid a fire sale in tech stocks, with the latest lockdowns compounding worries over internet regulation.

War trade reversal

In the broader market, the war trade continues to retrace. Crude oil and gold prices are in full retreat, surrendering almost all of their war-related gains as the prospect of a cease-fire has left traders no choice but to take profits on their long bets.

Ukrainian and Russian negotiators will meet again today and even though there hasn’t been any clear sense of progress so far this week, the fact that the talks continue on a daily basis is seen as an encouraging sign in itself.

With safe-haven demand fading and global bond yields racing higher, one of the biggest casualties has been the Japanese yen. The world’s third-largest economy has barely escaped deflation and the spike in energy prices will likely curtail the spending power of consumers, so the Bank of Japan is not expected to telegraph an exit from decades of easy money policies this week.

Euro and sterling get some relief

Staying in the FX arena, the optimism for a resolution in the Ukraine conflict and the pullback in oil prices has translated into some relief for the battered euro. The single currency is outperforming early on Tuesday, defying the gloomy mood in equity markets.

Since the euro and the dollar are essentially opposite sides of the same coin, the greenback is on the retreat. Many players are likely positioning and hedging ahead of tomorrow’s crucial Fed meeting.

Finally, the weakness in the British pound has been a real puzzle lately. Sterling has underperformed even the euro since Russian forces rolled into Ukraine, even though the Eurozone is much more reliant on Russian energy than the United Kingdom is. This begs the question - is it just Russian assets in the UK being liquidated?

As for today, there isn’t anything huge on the economic calendar. Markets will keep their eyes on the peace negotiations, marking time until tomorrow’s FOMC decision.