European markets which had managed to rebound modestly in the lead up to last night’s Fed decision, saw a little bit of a pullback in yesterday’s session, mainly out of an abundance of caution in the event the Fed delivered a hawkish surprise.
As expected, the Federal Reserve did raise rates by 75bps, with the statement leaning into a narrative that the central bank was aware that lags in monetary policy might require a slower pace of hikes going forward. Once the press conference got under way any expectation that slight change of tone would turn into a dovish pivot hit the wall quite hard.
While Powell acknowledged that a slowdown in the size of rate rises was likely, it didn’t alter the fact that rates would probably still need to go much higher in order to get inflation back to target of 2% over time.
This would seem to suggest that while we can expect to see a 50bps move at the December meeting, the eventual terminal rate could well be much higher than 4.5% and could be as high as 5%. This admission that rates might need to rise by more than expected saw the US dollar, and yields which had initially slipped back, reverse course sharply, rallying to the highs of the day, while stock markets fell sharply, closing the day just above the lows of the day.
So, while the market got what it wanted in the context of expectations of smaller rate rises, they probably weren’t expecting that rates might need to go quite a lot higher, thus removing any prospect of an imminent pause, or even a rate cut much before the end of 2024.
It would seem that the Fed is still working on the premise of erring on the side of doing too much than too little, and if that means stock markets go down so be it. Of course, that doesn’t mean that expectations won’t change as more economic data is released with US payrolls tomorrow and the October CPI report next week.
With US markets finishing the day lower, today’s European open looks set to be a similarly weak one, as we look ahead to today’s Bank of England rate decision, where rates are also expected to go up.
If the Bank of England was hoping for the US central bank to makes its life easier, it’s clear that Powell didn’t get the memo.
The sharp rise in the US dollar in the wake of last night’s press conference once again has put pressure on the pound and means any flexibility the Bank of England might have had in going for a 50bps move today may have gone.
Recent sterling weakness certainly hasn’t helped when it comes to the inflation narrative for the Bank of England, along with the recent political turmoil, which has served to push up import costs, but has also increased borrowing costs, in turn prompting a rise in mortgage rates.
With the Bank of England getting its quantitative tightening program under way earlier this week, the bigger question today is whether we get a 50bps rate rise, or a 75bps move, with the odds now favouring a slightly more aggressive 75bps move after last night’s Fed decision.
The only certainty today is that it is likely to be a split decision, as it was in September. Then it was three policymakers favouring a 75bps move, five a 50bps, and Swati Dhingra who voted for 25bps.
With fiscal policy now set to be a lot tighter despite warnings about raising tax rates into a slowdown, the scope for the Bank of England to be more aggressive is expected to be more limited in the longer term, due to concerns about the impact on demand.
This seems a little late in the given the wretched retail sales numbers seen in August and September, and which are likely to worsen, given that the actions of the government in raising taxes is likely to mean any recession is now likely to be much more prolonged, which in turn could mean that the pound stays under pressure for longer.
Today’s consensus remains marginally for a 75bps move today, but there are downside risks for a smaller move, given that it took 25 years to get to the point of a 50bps move from the more customary 25bps.
The decision is unlikely to be unanimous if September is any guide, however what comes after that could well see a significant step down, with the Bank of England likely to adjust its growth forecasts lower and its inflation forecasts higher. Let’s hope they are more accurate than they have been so far, this year.
EUR/USD – has continued to slip back towards the 0.9750 area and trend line support from the recent lows. While above this line we could still see a return to the parity area. Resistance currently at the 0.9970 area.
GBP/USD – closing in on the 50-day SMA and trend line support from the recent lows. A move below 1.1350 opens a retest of the 1.1100 area.
EUR/GBP – finding support just above the 0.8570 area. A move below the 0.8570 area could well see further weakness towards the 200-day SMA and the 0.8500 area. Resistance currently at 0.8670.
USD/JPY – dipped back towards the lows last week 145.10, rebounding strongly from 145.67, in the wake of last nights Fed decision. A move through the 149.20 area retargets the 150.00 area.