European and US markets carried over a strong session from Asia yesterday, although some of the gains were underpinned by hopes of a ceasefire and a peace plan between Russia and Ukraine.
As with everything the devil will be in the detail on any agreement, and while the fact that both parties are talking is a good thing, one can’t help thinking as far as Russia is concerned, they are going through the motions, while Ukraine will insist on cast-iron security guarantees of the type Russia might find difficult to live with.
Markets appear content to look past these inconsistencies and new Russian atrocities, as have oil markets, and we also didn’t get any surprises from the US Federal Reserve, which has set us up for a positive European open later this morning, with Asia markets also having another strong session, after yesterday’s China-inspired surge.
As expected, the Federal Reserve raised rates by 25bps, by an 8-1 margin, with St Louis Fed president James Bullard dissenting by pushing for a 50bps hike. This was in line with market expectations, as was the expectation that most Fed officials saw the prospect of 7 rate increases this year. The FOMC also upgraded its inflation forecast for 2022 to 4.3% from 2.6%, and in 2023 to 2.7% from 2.3%, while downgrading GDP to 2.8% in 2022 and 2.3% in 2023. The upward adjustment to the inflation forecast, while significant, is still well below the current level of 6.1%.
Nonetheless the nature of yesterday’s press conference suggests we will see a 50bps hike at some point, maybe as soon as May, while there was no mention of balance sheet reduction. There was some scepticism that with all the adjustments to growth and inflation forecasts, the Fed appeared convinced that unemployment would remain steady at around 3.5%, even as they tighten policy.
Bond market reaction certainly appears to indicate some scepticism about whether a recession can be avoided, with the 5- and 10-year yields converging. Powell’s argument on unemployment not increasing as the Fed tightens appears to hinge on the labour market being a tight one, and while there is a case for questioning this reasoning, based on previous experience, the fact remains the US economy still has over 10m unfilled vacancies.
You can certainly make an argument that the US economy is probably not as strong as Powell and the US central bank think it is, but how do you make an argument for an increase in the unemployment rate against a backdrop of 10m vacancies?
With the Federal Reserve decision in the rear-view mirror, US markets finished the session higher, after initially slipping back post rate decision, as Powell’s optimistic tone during the press conference lifted the overall mood.
Looking towards today the Bank of England looks set to follow suit with another 25bps move later today, and their third rate hike in as many meetings. In some respects, despite its muddled guidance over the last few months, the Bank of England has been ahead of the game when it comes to rate rises. Two rate rises since December has put base rates back to 0.5%, still below the levels they were pre-pandemic.
With unemployment still low, and average wages still subdued the central bank must be looking with some concern over how much further this run high in inflation is likely to go. With CPI already at 5.5%, and RPI even higher the Bank of England is already expecting prices to rise further with a target of 7.25% by April.
In light of recent events and the surge we’ve seen in commodity prices, both energy and agricultural this level is likely to get surpassed in the coming months with the very real prospect we could see a move closer to double figures and above 10% by the summer.
Like the Federal Reserve this will present the Bank of England with very real problems when it comes to meeting its inflation mandate. In short, it has to balance the risks of tightening too quickly and risking tipping the economy into recession or allowing inflation to do it for them by letting it rip.
A weaker pound is unlikely to help either, which means the Bank of England will probably have to hike many more times by the time the year is out. This is likely to have significant consequences for the UK economy, and more specifically for the housing market, and those not currently on fixed rates mortgages.
As we look ahead to today’s decision it’s hard to see how the Bank of England can avoid raising rates again by 0.25% to 0.75% and put the base rate back to where it was pre-pandemic, and that’s how we need to look at today’s possible decision to raise rates. We’re still at very historically low levels of interest rates. The last time inflation was this high, base rates were over 6%.
EUR/USD – has finally moved through the 1.1020 area and looks set for a retest of the highs last week just above 1.1100. While below the risk remains for a move back to trend line support from the 2017 lows, at 1.0800. Below 1.0780 opens the risk of a move towards 1.0600.
GBP/USD – having found support at the 1.3000 area, we now need to get back above 1.3200 to minimise the risk of a move towards 1.2800, on a break below 1.2980. Above 1.3220 targets the 1.3400 area.
EUR/GBP – has been unable to move back above the highs this week at 0.8455 but need s to break below the 0.8370 area to minimise the risk of further gains towards the 200 day MA, and 0.8480 area. Below 0.8370 targets 0.8320.
USD/JPY – pushed above the 119.00 area yesterday and looks set for a move towards the 120.00 area. Only a move back below 116.20 undermines this scenario and argues for a move back to 115.40.
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