Last night’s Fed meeting saw the central bank accelerate its tapering program to $30bn a month, from January as expected, while adopting a slightly more hawkish outlook when it comes to tackling the risks of rising inflation.
Fed officials also brought forward their expectations of rate hikes to three in 2022 and three in 2023, however the tone of the statement, as well as the press conference suggested that they still believed that current levels of inflation were likely to be transitory, even if the word wasn’t used in the statement.
The reference to supply and demand imbalances and the reopening of the economy was just a roundabout way of saying the same thing. Nonetheless the change of tone does suggest that the Fed is alive to the risk of higher prices and will act if they deem it necessary.
As a result, the initial spike in 2 and 5 year yields along with the US dollar, gave way to a fading of the move, while US stocks rallied to their highs of the day.
As such today’s European market session looks set to be a strong one, and with the Fed meeting now in the rear-view mirror, all attention now turns to today’s Bank of England and ECB decisions, where the inflation problem is just as real, especially for the Bank of England after yesterday’s big jump in headline CPI in November.
The US is facing similar Omicron challenges to the UK, yet the Fed was able to deliver a message that was clear and concise, something the Bank of England has consistently struggled with.
This week’s UK economic data, under any other normal metric, would normally have been the trigger for a modest rate rise given recent comments from Governor Andrew Bailey that he wanted to see more evidence of lower unemployment before making a move on rates. We have now seen that. If today’s decision was based on the data alone which ultimately it should be, a rate rise wouldn’t even be open to debate, we would probably see it being delivered.
Of course, those comments from Bailey came against a different economic backdrop six weeks ago, when the Monetary Policy Committee bottled the decision to raise rates by 0.15%, a move which would have been easy for the market to absorb, and which would have meant that the central bank could have comfortably sat on its hands today.
That indecision came back to haunt it yesterday, after headline CPI jumped to 5.1%, well above Bank of England forecasts for this year, while RPI hit a new 30-year peak of 7.1%.
The fall in unemployment to 4.2% was also welcome, however against a backdrop of new restrictions and a slowdown in economic activity due to Omicron, for the central bank to move today would send a very odd message when compared to how things looked at the beginning of November.
Ultimately the bank may decide it has little choice but to adopt a strategy of hold and hope, despite evidence of more persistent price pressures in the data, and the risk we could see a move towards 6% in the months ahead. Interest rate markets are still pricing an outside chance the MPC might move today, especially given comments from Bailey earlier this week that he felt that Omicron didn’t present a financial risk to markets. Nonetheless, given the Omicron backdrop this feels like a stretch given the central banks reputation for timidity when it comes to tightening policy.
The arithmetic of today’s decision will still be an interesting one after November’s 7-2 split on rates.
Will external MPC member Michael Saunders reverse his decision to hike given his comments earlier this month, expressing reservations about a move today due to concerns about Omicron. He did also go on to acknowledge that delaying a rise also had risks in potentially exacerbating an inflation shock further out now that workers are pushing for higher wages. What will Dave Ramsden do after he also voted to raise rates in November as well.
The central bank has found itself in a rather large hole of its own making and will need to be extremely adroit in terms of their guidance. If they hold rates today, how do they square a 7-2 decision to hold in November, with a vote 9-0 to hold today when unemployment is lower, and inflation is higher. It would be yet another example of muddied messaging.
The MPC needs to get back on track on delivering a message to markets that is clear and consistent. Omicron does pose a risk, but it could well be temporary, and today’s decision needs to reflect that, while keeping the prospect of a February hike very much in play. A 9-0 decision won’t send that sort of message, which suggests we could see another split decision.
Soon after the Bank of England announces its policy decision we get to hear from the European Central Bank and Christine Lagarde, where inflation levels are also uncomfortably high, although core CPI is much lower.
This gives the ECB much more flexibility when it comes to being accommodative, and recent comments from President Lagarde suggest that it's highly unlikely that rates are going anywhere next year, as far as she is concerned. Whether she can convince the rest of the Governing Council remains to be seen.
The sharp rise in prices is starting to become a huge credibility issue for the ECB, with President Christine Lagarde insistent that current inflation levels are transitory. That sort of thinking seems completely at odds to what is happening in supply chains in Spain, Italy and Germany where factory gate prices are rising at over 20% on an annualised basis.
The ECB is still expected to end its PEPP program at the end of March next year, while its other program the APP of €20bn a month looks set to continue.
EUR/USD – still range trading below resistance at the 1.1385 area. The risk of a retest of the 1.1185 November lows remains the line of least resistance. We also have support at the 1.1160 level. A move through 1.1420 argues for a move back to the 1.1520 level.
GBP/USD – still appears to have solid support above the 1.3160 area, and while we do so we can move back towards the 1.3400 area. A break of 1.3160 opens up the 1.3000 level. We need to recover back above the 1.3300 level to stabilise and move towards the 1.3500 level.
EUR/GBP – found support at the 0.8480 area yesterday. A break below this level reopens a move to the downside. Resistance comes in at the 200-day MA at 0.8560.
USD/JPY – moved through the 114.00 level, with the potential to head towards the 115.00 area. The 112.50 level still looks fairly solid for now. A move below the 112.50 level targets the 111.80 area.
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