European markets had a predominantly negative tone yesterday, driven by rising concern that the uncertainty over reduced Russian gas flows is likely to lead to a European recession as we head into year end.
US markets also underwent a negative session after US retailer Walmart issued a profits warning, and US July consumer confidence fell to its lowest levels since February last year.
To cap it all off the latest earnings numbers from Google owner Alphabet and Microsoft both came in below expectations. Microsoft blamed a strong US dollar and a slowing PC market, although it should be noted that Q4 revenues were still a record $51.87bn, and 12% up over the same period a year ago.
As for Alphabet, advertising revenues were also good, but again below expectations. YouTube revenue came in at $7.34bn, below $7.52bn, while advertising revenues rose 12% to $56.3bn.
As we look ahead to today’s European open the main focus will be on this evening’s Fed meeting.
It’s certain that the Federal Reserve will be hiking rates again today by another 75bps, with the only question being what comes next, and whether we see 50bps or another 75bps in September. Two weeks ago, there was some speculation that we might see a 100bps move today, however that seems much less likely now.
An aggressive 100bps is by no means off the table, but it has become less probable after two of the most hawkish Fed members, Christopher Waller and St. Louis Fed President James Bullard pushed back, saying that 75bps remained their favoured option, which prompted a modest retreat in the US dollar, which hit a 20 year earlier this month.
Since the Federal Reserve went into the blackout period, a lot of recent US economic data has shown signs of fraying around the edges, prompting bond markets to reprice the timeline and scope of future rate increases. This repricing has come about despite a headline CPI rate that hit a new 40 year high in June of 9.1%, although almost half of this rise has come about because of sharp increases in the price of food and energy, which the Fed can’t do much about.
Nonetheless all of this hasn’t stopped the central bank from being accused of being woefully behind the curve when it comes to where rates are, and where they should be.
This is why today’s press conference from Fed chairman Jay Powell is probably more important than the decision to raise rates. Anyone thinking that in light of recent data that the Fed is likely to soften its tone is probably going to be disappointed, although we might see Kansas City Fed President Esther George dissent and vote for a smaller hike, like she did at the June meeting.
In any case, the last thing the Fed wants to do now is to allow the market to think it’s about to embark on a dovish pivot, despite increasing evidence that the economy is slowing.
Powell will want to keep his options open for September, knowing full well that he has the Jackson Hole August Symposium coming up, as well as two CPI reports, and two payrolls report before that September date.
For now, it should be expected that the Fed will lean into the narrative that they need to get inflation under control, even if it pushes headline unemployment quite a bit higher. There appears to be a determination on the part of many board members that they need to squeeze inflation until the pips squeak and if that means unemployment starts to rise so be it. The Fed already expects unemployment to move above 4% next year in any case.
There is already compelling evidence that inflation may well have peaked, core PCE has been on a downward track since March, however that isn’t any comfort to consumers, and while longer term inflation expectations have slipped to their lowest levels in over a year, the Fed will be reluctant to entertain the idea of a dovish pivot at this point.
As far as their economic projections go, the Fed already expects unemployment to rise above 4% next year, so it’s likely they will take the view that further hawkishness is probably the way to go, even as 5-year inflation expectations slide to their lowest levels in over a year.
In the words of San Francisco Fed President Mary Daly, in comments made on July 15th, the Fed isn’t concerned about overcooking things, although that’s easy for her to say as she isn’t a voting member this year. Nonetheless her remarks do offer an insight into the mindset of other Fed members. Monetary policy is still accommodative and the Fed isn’t talking about hiking rates to an “extreme range” but to “something more like in the 3% range.”
Daly went on to note that the lower inflation expectations data from the University of Michigan was a good thing, but went on to insist current policy was still very accommodative.
With the Fed funds rate currently at 1.5% to 1.75%, there is still plenty of room for the rate to go higher with 75bps today, and to be over 3% by year end.
EUR/USD – has continued to come under pressure while below the peaks last week at the 1.0275 area. The risk remains for a move back towards parity, and the previous lows at 0.9950. A move below 0.9950, towards 0.9660.
GBP/USD – made another marginal new high yesterday, as we look to move towards the 50-day SMA, and down trend from the February highs. Support remains at the 1.1870 area, with the bias remaining towards the downside while below the 50-day SMA.
EUR/GBP – drifting back towards the 0.8400 area with the risk of further losses towards 0.8300. While 0.8400 holds the risk of a rebound is all too real and a move back to the 0.8480 area.
USD/JPY – edging back to the 138.00 area, despite the retreat from the 139.40 level last week. We have support at the 135.50 area. A break of 140.00 targets the 145.00 area. Major support sits at 134.80 level and the July lows.