The Fed maintains a soft bias

Markets

Yesterday, markets finally entered calmer waters as they awaited the outcome of the Fed policy meeting. The Fed as expected left the target range for the Fed fund rate unchanged at 0.0%/0.25%. In the statement, the Fed acknowledged that ‘indicators of economic activity and employment continue to strengthen. The sectors most adversely affected by the pandemic have shown improvement, but have not fully recovered’. Inflation has risen, but the Fed maintains the view that price rises are mostly transitory in nature. The economy has made progress toward the Fed’s goals of maximum employment and price stability. However, especially on employment, Fed chair Powell pointed out that there is still some ways to go for it to be substantial enough to start tapering asset purchases. The Fed will continue to monitor this process ‘in the coming meetings’. So, the wait-and-see era might continue for some time to come. A concrete roadmap for tapering at Jackson Hole or even at the September meeting maybe is too early. On the ‘transitory’ nature of inflation, the Fed Chair clarified that current inflation is not broadly based but mostly in specific categories that face bottlenecks in the wake of the pandemic. He also specified that one-off prices rises, even if they are not reversed, are no sustained inflation. On the composition of asset purchases once tapering will start, Powell said there is little support to start MBS tapering earlier than Treasuries. However, scaling back MBS buying faster is a topic of debate. The Fed also established two permanent repurchase-agreement facilities, a domestic one and another for foreign counterparties, that will provide a backstop for money markets. The market reaction was guarded, but investors clearly understood that the Fed maintains a soft bias. Yields declined only marginally (0.8 bp 10y, 1.3 bp 30-y), but this masks a further decline in real yields (-4.7 bp), for an important part compensated by a rise in inflation expectations. The 10-y US real yield hit a new all-time low at -1.18%!!. The combination of lower real yields and higher inflation expectations logically translated in some, albeit modest USD loss. The trade-weighted DXY closed at 92.32, EUR/USD at 1.1845. USD/JPY was an exception to the rule (109.91 vs 109.78). Equities finished mixed. The S&P 500 (-0.02%) and the Dow (-0.36%). The Nasdaq outperformed (+0.70%).

This morning, Asian/Chinese equites are rebounding as Chinese authorities tried to comfort investors and as the PBOC provided additional liquidity. US yields are little changed. The dollar is ceding some further ground with EUR/USD changing hands near 1.1850. The yuan also rebounds (USD/CNY 6.4735). Commodity related currencies (AUD-NZD-CAD) maintain (Aussie dollar at AUD/USD 0.7375) or extend (loonie USD/CAD 1.2490) post-Fed gains.

Later today the calendar is well filled. The first estimate of US Q2 GDP growth is expected at 8.5 Q/Qa. The Core PCE price deflator is expected to increase from 2.5% to about 6.0%. US jobless claims might resume their downtrend after last week’s uptick. In Germany (and some other EMU countries) July HCPI will be published. German inflation is expected at 0.4% M/M and 2.9% M/M (from 2.1% in June). German labour market data are also worth to keeping an eye on. The US Treasury will sell 7-y bonds. Of late, markets often were more sensitive to negative news rather than to better than expected data. Quite some caution should already be discounted. However, yesterday’s message from the Fed doesn’t provide much of a trigger for ST sharp rebound in yields. 1.12%/1.20% remains first short-term support in 10-y US yield which don’t expect to give away easily. For the German 10-y yield the -0.47% support is nearby. Easing market tensions and low real yields might cause some further USD profit taking with EUR/USD 1.1881/1.1895 still first technical reference. Regaining USD 1.1975 would call off the downside alert in EUR/USD.

News headlines

A vote 67-32 in the US Senate yesterday was a first step for potential further approval of a $ 1 trillion bipartisan infrastructure bill. The agreement includes money for roads, for power grid spending, for railways, for action to expand broadband access, for clean drinking water, for environmental resiliency, public transit and airports. The bill still needs formal approval by to Senate an by the House of Representatives before President Biden can make it law.

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