Fed Hikes 25bp, BoE is Next to Decide

Yesterday’s Federal Reserve (Fed) decision was relatively hawkish.

The Fed raised the rates by 25bp, as broadly priced in, but Fed Chair Jerome Powell signaled that there would be another 25bp hike on the wire before this tightening cycle ends. That was hawkish.

The Fed confirmed that the Quantitative Tightening (QT) is up and running at the speed of $95bn per month.

The latest dot plot was unchanged with most members expecting the Fed rate to reach 5.10%. That would’ve been interpreted as being dovish if the meeting took place two weeks ago, before the Silicon Valley Bank (SVB) debacle – when Powell was still hinting that the Fed would speed up rate hikes to abate inflation.

Now, it’s not even sure that there would be another rate hike.

The Fed’s policy no longer depends on inflation only, it also depends on how the latest bank stress will impact credit availability. As Powell says, a decent ‘credit tightening from baking troubles’ in a way ‘substitutes for rate hikes’.

And uncertainty regarding a potential credit tightening brings confusion on the table regarding the Fed policy.

For equity traders, the combination of a 25bp hike, the hint of another 25bp, and the risk of credit tightening was too much to cheer. The S&P500 lost 1.65%.

But, on the bonds front, the perception of the latest Fed decision was different. The US 2-year yield fell despite Powell insisting that the tightening may not be over due to ‘inflation still running too hot’.

Moreover, the markets went on pricing a 100bp cut for the year end. The gap between the dot plot and market pricing widened, yet again, raising, one more time, the credibility issues that Powell is encountering right now.

And activity on Fed funds futures tells that the chance of another 25bp hike is no more than 35% in the wake of Powell’s comments.

In other words, bond traders don’t believe Powell. And Powell’s job has just gotten more complicated with financial stress joining the inflation headache.

The US dollar index fell after the FOMC decision yesterday, along with the yields.

US futures are in the positive at the time of writing. It is well possible that the post-FOMC equity selloff quickly reverses, at falling yields are supportive of equity valuations – if financial stress is contained and economic data is not too bad.

ECB, BoE expectations remain hawkish

The dollar’s sharp fall led to a strong rally in the EURUSD yesterday. The pair traded past the 1.0910 level as a couple of hours before the Fed decision and Powell’s speech, the European Central Bank (ECB) President Christine Lagarde repeated that the ECB will keep a ‘robust’ approach to respond to inflation risks, and that the 2% inflation target is non-negotiable.

Oh, how the tables turned

This year, we are faced with a decidedly hawkish ECB and a weakened Fed. And the sufficiently hawkish ECB and softening Fed expectations hint that the EURUSD has potential to extend gains above the 1.10 mark in the coming months. The 1.1275 is now a reasonable target for the bulls.

Across the Channel, Cable also rallied yesterday. It rallied because the latest inflation report from the UK was a shocker. The headline inflation unexpectedly ticked above the 10% mark, as food prices rose 18% last month. But core inflation, which doesn’t take into account food and energy prices, unexpectedly rose as well, and sat above the 6% level, again.

The latest set of CPI figures threw Mr. Bailey’s prediction of a ‘sharp fall’ in inflation under the bus.

And because inflation won’t ease by itself, it is almost certain that the Bank of England (BoE) will hike its own policy rate by 25bp when it meets today.

Cable is preparing to test the January highs as the softening Fed expectations due to bank stress and hawkish BoE expectations due to high inflation hint that the pair could continue its advance to 1.25 in the continuation of the actual positive trend.