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Fed set to raise rates for the first time since 2018

Fed chairman Jay Powell

European markets managed to recover off their lows yesterday, helped by a decline in oil prices which helped diminish concerns that an energy price spiral might trigger an economic slowdown.

US markets finished the session strongly higher, with the S&P 500 finishing up for the first time since last Wednesday, with the decline in oil prices and yesterday’s producer price index (PPI) report offering hope that inflation pressure might well be close to subsiding, after core PPI came in softer than expected.

As a result of yesterday’s strong finish, European markets look set to open higher this morning, however any rally is likely to find itself pushing against the headwinds of headlines out of Ukraine, as well as the prospect that Russia might default on a bond payment later today. A $117m interest payment is due today on a US dollar bond. Russia has said it will pay in roubles which would start the clock ticking on a potential default.

It’s also set to be a big day for the US economy, with the latest US retail sales report for February, ahead of the latest interest-rate decision for the Federal Reserve Open Market Committee (FOMC). US retail sales recorded a big rebound in January after a large decline of -1.9% in December. January retail sales showed that, despite weak consumer confidence, spending rebounded at its fastest rate in 10 months, rising by 3.8%, well above expectations of 2%. The biggest gains were in online sales, as well as furniture, autos and building materials, as US consumers spent money on improving their homes and upgrading their cars, without too much in the way of concern about rising energy prices and a higher cost of living. US consumers are coming at the looming wages squeeze from a slightly better place financially due to the various stimulus packages of the last 18 months, however in the longer term these savings are likely to decline, as input prices continued to rise. Expectations are for US retail sales to rise by 0.4% in February.

In essence today’s Federal Reserve rate decision is probably the easiest one it will have to make this year. With US headline inflation at 7.9%, and likely to go higher, it’s pretty much certain that we will see an interest-rate rise later today of 0.25%, pushing the Fed Funds rate range off zero and up to 0.25% to 0.50%. There are some on the FOMC who are probably in the camp that want to see a 50bps rate rise, however considering the Russian invasion of Ukraine and the resultant volatility in global commodity prices, we could see a bit of caution.

The most recent payrolls numbers showed that wages growth slowed from 5.5% to 5.1% in February, which while still quite strong doesn’t suggest that wages are about to explode higher yet. The Fed’s bigger problem is how it manages its messaging for future rate rises against a backdrop of surging input prices, which are likely to slow the US economy over the course of the rest of the year.

St Louis Fed president James Bullard has been particularly vocal about the need for a 1% rise in interest rates by 1 July, and with the Fed’s unemployment mandate more or less met, the main focus is set to be on inflation and the prospect that we could see headline CPI hit 10% by the middle of the summer. This week’s growth and inflation forecasts are likely to be significant in that context as markets look to price the prospect of how aggressively the Fed might tighten monetary policy over the next few months.

Before Russia's invasion of Ukraine, some market pricing was suggesting we might see seven rate rises this year, and while some are suggesting that might not happen now, there is an argument that it might be the lesser of two evils. The transitory playbook seems 'so last year' now, with the Fed having to balance the risks of tightening too quickly and tipping the economy into recession or allowing inflation to do it for them by letting it rip.     

EUR/USD – had a quick peek above the 1.1000 area yesterday but failed to follow through. The main resistance remains at last week’s high 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 – has found support at the 1.3000 area but needs to get back above 1.3200 to minimise the risk of a move towards 1.2800, on a break below 1.2980.   

EUR/GBP – slid back from the 0.8455 area yesterday but needs 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 – continues to look well supported closing in on the December 2016 peaks at 118.65. A move through here targets 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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