The Fed statement is an exact copy of end July

Markets

Russian President Putin’s announcement of a partial mobilization raised concerns on the next episode in the war in Ukraine. It triggered a European risk off with higher European gas and oil prices, a temporary decline in German/EMU yields and further equity losses. The (TW-DXY) dollar already touched a minor new cycle top. Still, the news didn’t change markets’ assessment on inflation or on the ECB reaction function. At the end of the European session, short term bund and European swap yields still closed higher(German 2-y 1.76%, + 4.6 bps; EMU 2-y swap 2.77%, +9.2 bps) in a flattening move. From there the focus turned to the Fed decision.

In advance, markets were divided whether the Fed would hike by 0.75% or 1.0%. In fact, it delivered a ‘hawkish’ 75 bps hike, raising the target for the Fed Fund rate to 3.00/3.25%. The Fed statement was an exact copy of end July. Ongoing increases in the policy rate will be appropriate as inflation remains elevated, reflecting supply and demand imbalances, higher food and energy prices and broader price pressures. The SEP (dots) confirm the case for further tightening. Despite the rate hikes already put at work before yesterday, Fed governors still raised projections for PCE inflation to 5.4% this year (from 5.2%); 2.8% in 2023 (from 2.6%) and 2.3% in 2024 (from 2.2) with inflation only returning to target in 2025. Fed governors see the Fed fund rate at 4.4% end this year (3.4% June), at 4.6% end 2023 (from 3.8%) with a moderate easing not seen before 2024 (3.9%) and 2025 (2.9%). Restrictive policy will have a price in terms of growth with 2022 growth at 0.2% (from 1.7%), 2023 at 1.2% (from 1.7%) and 2024 at 1.7%, all below trend growth (1.8%). Unemployment is forecast to rise from 3.8% end this year to 4.4% in 2024. At the press conference, Chair Powell reiterated the Fed has to move policy well into restrictive territory to bring supply and demand back in balance and cool an extremely tight labour market. Policy currently only entered the early stages of restrictive territory. Cooling down inflation needs a period below-trend growth and for that to happen policy will have to stay restrictive for quite some time (no rate cuts soon). Markets reacted volatile after the Fed announcement and during the press conference. However, at the end of the day screens showed a further hawkish repositioning. The US yields curve flattened with the 2-y gaining 8.6 bps. The 30-y lost 6.85 bps. Markets now discount a peak policy rate between 4.50%/4.75%. The trade-weighted dollar got is break higher. DXY trades near 111.55 (highest since 2002). EUR/USD dropped below the 0.9864 YTD low (currently 0.9831).

The BOJ remains ‘last man standing’, maintaining its ultra-easy policy (Cfr infra). Later today, the Bank of England, the Swiss national bank and the Norges bank decide on policy. Especially for the BoE it will be interesting to see whether they join the ’75 bps’ club. This morning, US yields stay upwardly oriented post-Fed and so does the dollar. Asian markets continue trading in risk-off modus.

News headlines

The Brazilian central bank kept its policy rate unchanged at 13.75%, ending/pausing a tightening cycle which dates back to March 2021 and covered a cumulative 1175 bps of rate hikes. 2 of the 9 governors’ still voted in favour of a 25 bps rate hike. The BCB remains vigilant, vowing to hold rate at a high level for a sufficiently long period and not ruling out potential extra hikes. The central bank downgraded this year’s inflation forecast from 6.8% to 5.8% while keeping levels for 2023 and 2024 broadly stable at 4.6% and 2.8%. Risks to the outlook are balanced. The Brazilian real loses out against a strong dollar but at USD/BRL 5.17 holds decent compared to other EM FX.

The Bank of Japan stuck to its ultra-easy monetary policy, keeping the policy rate unchanged at -0.1% and continuing to defend a yield cap for the 10-yr government bond yield (0.25%). The BoJ kept its forward guidance on keeping rates low or lower and repeated its commitment not to hesitate to add easing if needed. A Covid-related aid program will be phased out instead of ending it abruptly. The Japanese yen spiked lower on the outcome with USD/JPY temporary above 145 for the first time since 1998, keeping the intervention threat more than alive. It’s hard to see them being effective though given the gigantic split between a hawkish Fed and a dovish BoJ.

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