Below trend growth to continue
Fed delivers 75bps rate rise, sees 50 or 75 most likely at next meeting
Knee-jerk market reaction to the FOMC is in the vein of a ‘dovish 75bp hike , though it’s worth a reminder that the market’s initial take on the May FOMC was that it was interpreted as a ‘dovish’ 50 point hike, with Powell at that time ruling out consideration of a 75bps hike either that day or in the future, only for the market to reverse course and see the Fed as hawkish less than 24 hours later ( good/correct call!). Today, it was the comment from Fed chair Powell that he doesn’t expect moves of this (75bps) size to be common and that either 50bps or 75bps was most likely at the next meeting, that elicited much of the knee jerk market reaction: bond yields lower, equities up and the USD down, moves which has been significantly extended into the New York close.
Elsewhere, we have seen sharp compression in Eurozone peripheral bond market spreads (Italy in by 25bps over Germany, Greece 35bps) after the ECB’s emergency meeting ended with the Governing Council being charged with coming up with a new ‘anti-fragmentation instrument’, and in the meantime availing themselves of the existing PEPP to skew the way it reinvestments the proceeds of bonds maturing on its balance sheet, towards peripheral debt if needs be.
Back to the Fed, and whether we should believe its new ‘dot plot’ and revised forecasts any more than past iterations is debatable. The new Funds Rate projections show the median dot for end-2022 lifted from 1.75-2.0% to 3.25-3.5% , meaning that versus the new 1.50-1.75% rate, the Fed’s collective best guess is for another 175bps of tightening over the remaining four FOMC meetings this year, implying on one possible iteration that three of the remining four meetings would need to deliver 50-point hikes. In 2023, the median dot is raised from 2.75% to 3.75%, while for 2024 the Fed is now willing to predict the start of an easing cycle with a 3.25-3.50% median dot. Mr Market already had the Fed easing in H2 2023 ahead of this meeting.
As for the economic forecast, GDP growth estimates are cut from 2.8% to 1.7% for 2022, from 2.2% to 1.7% in 2023 and from 2.0% to 1.9% in 2024. The unemployment rate is now seen at 3.7% (3.5%) in 2022, 3.9% (3.5%) in 2023 an up to 4.1% in 2024 from 3.6% back in March. All the stiff of a soft landings. Since when did a central bank ever predict anything different?
On inflation , the Core PCE deflator is seen at 4.3% this year (from 4.1%), 2.7% in 2023 (2.6%) and an unchanged 2.3% in 2024. Of note in the Powell presser, he played up the significance of the rise in the University of Michigan consumer inflation expectations reading published last Friday (which lifted to 3.3% from 3.0%) and also noted the importance of headline inflation from an expectations perspective. Here here.
In data news , US retail sales disappointed by falling 0.3% in May against expectations of a small rise. Auto sales slumped 3.5%. But various core measures also undershot expectations. These nominal sales look even weaker when adjusted for still strong inflation. The soft results saw the Atlanta Fed’s GDPNow Q2 estimate cut from 0.9% to flat. The (New York) Empire State survey rose to -1.2 from -11.6, a smaller lift than expected (2.3). US import prices rose by 0.6%, much less than the 1.1% expected. Perhaps the stronger US dollar is starting to make its presence felt here?
In other overnight news, the EU, as foreshadowed on Tuesday evening, has initiated two legal proceedings against the UK in response to the proposed t passed) UK government legislation that would tear up parts of the Brexit withdrawal agreement related to the N. Ireland protocol. This will include, we presume, seeking a ruling on the legality of the proposed legislation (which the UK of course claims is the case). In any event, our view that it is questionable whether the bill will ever get passed through the UK parliament, at least not for long time. GBP was weaker on this on Tuesday but hasn’t extended losses overnight – in fact it is the second best performing G10 currency of the past 24 hours. The Brexit issue nevertheless remains one of the numerous factors likely to be weighing on sentiment towards all things GBP in the weeks and months ahead.
Market have come into the New close with US Treasury yields down 19bps at 10 years and 23bps at 2 years (the latter effectively taking out one quarter point rate rise it had priced in pre-Fed). Equities extended the initial positive Fed reaction to be 1.5% higher for the S&P500 by the close with the NASDAQ +2.5%, though both are back a bit from their best intra-day post-Fed levels.
In FX it is the of late highly risk sensitive AUD that has fared best overnight, building on pre-Fed gains to rise by 1.9% and now back just above 0.7000. After GBP, the JPY and NZD both show gains of more than 1%, the former in front of what in now going to be an important BoJ meeting tomorrow and the latter in front of this morning’s Q1 GDP figures. The DXY USD index is 0.6% at the New York close, and the broader Bloomberg BBDXY index 0.9% weaker.
AUD outperformance comes despite hat has been a generally poor night for commodities, where iron ore futures are off 1.6% and oil down between $2.40 (Brent) and $3.20 (WTI).
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