Positive cross asset price action reflects more benign front-end rates pricing

A rally in duration-sensitive assets, with tech equities outperforming, implies a dovish pivot from the FOMC in its decision to hike the Fed funds by 75bp. That interpretation is a big stretch, but a shift away from forward guidance after Chair Powell signalled monetary policy is now in neutral territory represents a significant change. In other words, monetary policy is no longer on auto-pilot and will be data-dependent. Still, further hikes will be restrictive with the policy rate at neutral.

Positive cross-asset price action following the FOMC reflects more benign front-end rates pricing. There is ~100bp priced for the year’s remaining three meetings, broadly implying +50bp in September and +25bp at each of the November and December meetings, ahead of ~50bp of cuts priced for 2023. That backdrop suggests a growth slowdown that pulls inflation down.

With an increasingly data-dependent Fed, the volatility of central bank decisions increases, requiring a higher risk premium. Hence CPI releases have become ten folds more critical. Slow-to-decline CPI inflation would suggest market pricing is not aggressive enough.

For now, though, lower US real yields are positive for duration-sensitive equities, gold and crypto and a headwind for the USD. The JPY is the biggest beneficiary in G10 FX (+1% vs. the USD), gold and crypto and a headwind for the USD. The JPY is the biggest beneficiary in G10 FX.

Fed Chair Powell noted the importance of the Q2 Employment Cost Index (ECI) due Friday since slower wage growth is essential to get inflation down to its 2% target. Note that the knee-jerk rally in risk assets - like the past few times - could turn out to be a false dawn.