Markets
The Fed kept policy rates and the pace of its bond buying programme unchanged yesterday. However, given progress of vaccinations and strong policy support, it turned again more optimistic about the economy going forward. Growth in 2021 is seen higher at 7% (+0.5ppt), 3.3% in 2022 (unch) and 2.4% (+0.2ppt) in 2023. Unemployment was broadly left unchanged. Core PCE inflation is expected sharply higher this year at 3% (+0.8ppt) before slowing to 2.1% (+0.1ppt) and 2.1% (unch) in the years thereafter. Powell reiterated higher prices are mainly temporary, linked to the reopening and doesn’t expect them to feed into expectations. He does admit higher inflation could go on for longer. A majority of the FOMC certainly seems to think so too. They brought forward en masse their rate hike expectations: the median dots suggest two (!) hikes in 2023 and 7 out of 18 members already expect one next year. Powell downplayed the dots’ predictive power, saying it only meant that some believed economic conditions will be met sooner than anticipated. Following the Fed’s preferred normalization sequence, that means tapering in theory is not so distant. Powell noted they are still “ways away” from the substantial progress needed to do so, adding however this was the “talking about talking” meeting. This is consistent with our view the Fed will start tapering by the end of the summer (September at the latest). The central bank did address the money market, where the liquidity glut turned rates negative from time to time: it raised the IOER rate to 0.15% and the rate it pays on its reverse repo facility (RRP) to 0.05%. Powell is not worried about the RRP record volumes, saying it is doing what it’s supposed todo. Some say this is “backdoor tapering” (allowing liquidity to return to the Fed), preceding the actual scaling down.
While the start of the taper debate didn’t come as a big surprise for markets, the dot plot sure did. It served as a wake-up call that easy policy isn’t going to last forever and that even the Fed may be forced to act sooner rather than later. Wall Street fell up to 0.77% (DJI) -” though losses were bigger earlier in the session. US yields skyrocketed across the curve, with changes varying from 4.4 bps (2y) over 11.5 bps (5y) to 8.5 bps (10y) on the account of real yields. The dollar benefitted. EUR/USD fell more than a big fig to 1.20. The trade-weighted DXY captured the 91 lever. Because of today’s rather empty calendar, we’ll have a clear view on further market repositioning in the wake of the hawkish Fed shift. From a technical point of view, nothing has changed for (long) US yields yet. The 10y visited the upper bound of the downward trend channel without really threatening it but that could change today with more market repositioning. The dollar has more backing from the charts after EUR/USD fell sub 1.205. The 1.20 area marks the next support zone and looks fragile during early European trading hours. A break lower would improve the technical dollar charts further. We wouldn’t row against the current tide.
News Headlines
Australian May employment grew by a net 115.5 k while a rise of only 30 k was expected, bringing it above the pre-pandemic level. The participation rate rose from 65.9% to 66.2%. The unemployment rate nosedived from 5.5% to 5.1%, bringing it back to the levels from before the pandemic. The report questions the RBA’s assessment that it still can take years for the labour market to be tight enough to cause sustained wage growth. The Aussie dollar regained only a small part from yesterday’s USD-driven decline (currently AUD/USD 0.7625). The Australian 10-y yield jumps 9 bp to 1.64% currently.
The central bank of Brazil as expected raised the Selic policy rate for the third consecutive time by 0.75% to 4.25%.However, the MPC signaled that further policy normalization will be appropriate. “For the next meeting, the Committee foresees the continuation of the monetary normalization process with another adjustment of the same magnitude. However, a deterioration of inflation expectations for the relevant horizon may require a quicker reduction of the monetary stimulus’’. Yearly inflation was 8.06% in May, well above the Bank’s 3.75% target for this year and also above the upper limit of 5.25%. The 2022 inflation target stands at 3.5%. USD/BRL tested the 5.0 barrier yesterday but rebounded after the Fed policy announcement (close 5.0559).
