After six days of losses European markets managed to break the cycle, closing the day higher, after the ECB said it was looking to speed up work on a crisis tool to deal with concerns about fragmentation in EU bond markets, and Italian bonds.
US markets also saw a strong session despite the Fed raising rates by 75bps, while retaining optionality on raising rates in July by either 50bps or 75bps. This refusal to confirm a 75bps move for July appears to have taken some of the steam out of yields and given stocks a boost.
The dot plot projections which FOMC members use to project interest rate expectations would appear to suggest rates coming back down again towards the end of 2023. The move rather counterintuitively prompted a rally in bond prices and a slide in yields, as a well as a sell-off in the US dollar.
It appears that the early week anonymous briefings by Fed officials during the blackout period to friendly journalists were on the money, as the Federal Reserve raised its key rate by 75bps in reaction to last week’s unexpectedly high CPI number.
While the move was largely expected, last night’s decision does raise the question as to why the Federal Reserve even bothers with forward guidance if one data point during a blackout period causes the central bank to rip up the guidance playbook.
While Powell tried to justify the move his reasons came across as weak.
What this about turn by the FOMC does tell us is that the Fed has become much more concerned about inflation than it was a few days ago, which seems strange when you look at some of the more recent economic data.
The Fed has consistently insisted it is data dependent, yet in the past few days we’ve seen data points that suggest the US economy is slowing. May PPI and retail sales and record low consumer confidence all jar against the Friday CPI number.
We did see one dissenting vote by Esther George of the Kansas City Fed President who wanted to stick to the original guidance tramlines and raise rates by 50bps. The Fed downgraded its 2022 GDP forecast to 1.7% from 2.8%, a number which still seems optimistic.
As far as inflation forecasts are concerned the Fed upgraded its 2022 inflation forecast from 4.3% to 5.2%, while downgrading its 2023 inflation forecast to 2.6% from 2.7%.
At his press conference Powell kept his options open on a 50bps or 75bps rate rise in July, while saying it remained data dependant, and that 75bps rate hikes wouldn’t become the norm.
In the aftermath of last nights Fed decision today’s European open looks set to be a positive one, after Asia markets also got a lift from last nights events.
Now we’ve seen the Fed decide at the very last minute to rip up its forward guidance playbook, last night’s decision increases the pressure on the Bank of England to follow suit later today with at least a 50bps hike in response.
The reality is given where the pound is now, and Governor Andrew Bailey’s own assertion that 80% of UK inflation is imported, the central bank needs to send a message that it is also serious about tackling its own inflation problem.
Last night the Fed laid down a marker that inflation was its primary concern. For too long the Bank of England has given the impression it doesn’t really care about its inflation target, and that needs to change.
While that may come across as harsh the evidence speaks for itself. Over the past decade the MPC has been very quick to cut rates and been glacial when it comes to raising them again.
While there are those who say it is foolish to hike into a slowdown because the economy can’t support it, you can also posit that the economy can’t support inflation at current or higher levels either, so it comes down to what is the lesser of two evils.
Inflation has a habit of becoming entrenched and embedded, and rate rises can be very effective in squeezing it out. A short sharp shock if you like is probably better than a prolonged income squeeze.
With the pound at current levels against the US dollar the central bank needs to look at the FX channel, and help keep a floor under the pound, which has been under pressure for weeks.
That means a 25bps today won’t be anywhere near sufficient, and that we need to see a minimum of 50bps later today with a firm commitment to tackle current levels of inflation, which the Bank of England tells us have yet to peak.
The UK is already heading towards stagflation and/or recession whatever the Bank of England does now, with another energy price cap rise coming in October. To pretend otherwise is wishful thinking, and with the pound down 15% over the last 12 months the MPC needs to send a clear message, and not the muddled guidance we’ve become used to.
EUR/USD – yesterday’s rally above 1.0500 proved short-lived, with the bias for a move towards parity remaining the underlying bias by way of the 2017 lows and support at 1.0340/50. This remains a key barrier for a move towards parity. Resistance now lies at 1.0630, as well as trend line resistance from the highs this year at 1.0720.
GBP/USD – the pound briefly slipped below the 1.2000 area to 1.1930 before rebounding earlier this week. This area remains a key support. A sustained break below 1.1950 opens up the prospect of the March 2020 lows. The 1.2160 area now becomes resistance, and above that at 1.2450.
EUR/GBP – fell back sharply from the 0.8720 area and April 2021 peaks. A move through 0.8730 targets the 0.9000 area. We currently have support at the 0.8580 area, with a break below that targeting the 0.8520 area.
USD/JPY – having failed at the 135.50 area we’ve since slipped back, and could fall further towards the 133.00 area. A sustained move above 135.50 targets a move towards the 137.20 area.
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