Fed remains on track despite faltering inflationary pressures
As broadly expected the Federal Reserve lifted borrowing costs by 25bps following a two-day meeting. The decision was already priced in by market participants. However, the Committee created a stir with a surprisingly hawkish statement and press conference from Janet Yellen despite the recent publication of lacklustre economic data.
Indeed, the last CPI and retail sales reports came on the soft side and triggered a USD sell-off, just a couple of hours before the announcement of FOMC’s decision. The consumer price index extended only 1.9%y/y in May versus 2.0% expected and down from 2.2% in the previous month amid sustainable downside pressure on crude oil prices. In addition, the core measure, which excludes the most volatiles components such as food and energy prices, slid to 1.7%y/y, down from a previous reading and median forecast of 1.9%. Finally, retail sales printed in negative territory and contracted 0.3%m/m in May, well below market’s expectations of a flat reading, signalling that US consumers preferred to remain cautious against the backdrop of political jitters in the US and an uncertain economic outlook.
Committee’s members seemed committed to hold the line and keep steady the tightening pace as announced at the preceding meetings. Moreover the Fed remains highly confident the recent set-back in inflation developments is only temporary and expects to increase by another notch the federal funds target before the end of the year.
In our opinion, the fact that the Fed is not really concerned about the disappointing inflation readings suggests that the institution may have started to reconsider the ground for reaching at all cost the 2% inflation target. Indeed, overall the US economy is not in such a bad state as it is not in recession anymore and the economic growth is the envy of many countries.
Finally, the Committee discussed further about balance sheet unwinding as it drafted carefully a plan for policy normalisation; and it is expected to be implement before the end of the year. However, the Fed remained extremely cautious by stating that “the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee’s target for the federal funds rate”.
The USD was broadly higher this morning and erased partially the losses triggered by the release of the CPI and retail sales report. EUR/USD is back below 1.12 and currently trading with a negative bias.
Switzerland: SNB holds rates unchanged
Loose monetary policy is to continue for some more time. The EURCHF pair is back above 1.0900. This morning Swiss policymakers have decide to hold rates unchanged at -0.75% repeating that the Swiss franc is largely overvalued and that this is a threat for the Swiss economy. The Swiss franc is trading at a level around 30 times higher than levels before the financial crisis. Such high levels are definitely boosting deflationary pressures.
The plan is definitely staying the same for the central bank. Defending the Swiss Franc at all costs. The FX reserves keep on growing towards very massive levels. It now represents CHF 700 billion. As long as the Swiss central bank considers the currency is overvalued, the FX reserves are going to keep climbing.
In Swiss political news, Didier Burkhalter, head of the Federal Department of Home Affairs, will leave the Federal Council on October 31st. He was mostly criticised for his pro-Europe views. Monitoring relations with the EU is very important, as one key driver for the CHF depends on its giant neighbour.
For the time being, we can see that political uncertainties have reduced since the French elections. Nonetheless, other political uncertainties seem to arise with Hungary, Czech Republic or Poland seeming to refuse to welcome any more migrants and they will likely be sanctioned by the European Commission.
