A relief was what I expected after the Federal Reserve’s (Fed) fully priced decision to hike the rates by 75bp yesterday, but a rally is what happened.
Nasdaq jumped 2.5% and the S&P500 recovered 1.5%.
The reason for the post-Fed rally is perhaps not that the market was happy to hear that Powell doesn’t think that 75bp hikes would become ‘common’ in the near future – as we may see at least one more 75bp hike this summer, but it was the fact that the market had gone well ahead of itself in terms of hawkish pricing, and a part of the hawkish bets were cut after the announcement.
And the announcement was all but dovish. The dot plot showed that the Fed officials mostly think that the rates would reach 3.4% late this year, up from 1.9% plotted in March.
US yields eased as the Fed hawks scaled back their expectations to a softer reality, and the US dollar index came down from a fresh two-decade high. The futures are in the positive at the time of writing, but the optimism may not last long, as the economic picture and the Fed news are, in fact, less than ideal.
Yesterday’s retail sales data printed an unexpected negative number in May, hinting that inflation may be taking a toll. Jerome Powell said he sees ‘no signs’ of a broader slowdown in the economy. But, he was also saying that inflation would be transitory last year.
What now?
We will likely continue seeing choppy market conditions.
One good news is the softening oil prices, as investors price a higher chance of recession, which would curb oil demand and ease prices. The barrel of US crude is down to $115 level this morning, even after the weekly data showed that the US inventories grew slower than expected.
But the price pullbacks will likely attract fresh long positions, as recovery in Chinese demand, the global pickup in travel, and the tight crude supplies should support the bullish market in the medium run.
Alors, Christine?
The aggressive hawkish shift in Fed policy, the rising US rates and the soaring US dollar are not a gift for the other central banks.
The European Central Bank had an emergency meeting yesterday, to discuss how to slow the soaring bond yields after they announced the end of the asset purchases program last week, but more importantly how to prevent the peripheral yields from soaring faster than the core yields.
Now that the Fed steps on gas to raise rates faster, the ECB and the other central banks need to catch up with the Fed. Otherwise, the stronger US dollar would make the other countries’ imports, especially the energy and commodity imports, way more expensive than they already are. And that would lead to higher inflationary pressures and hawkish central bank policies.
We know Christine Lagarde doesn’t want to conduct a catch-up policy with the Fed, and that Mario Draghi thinks that raising the interest rates in Europe is a terrible idea as the European inflation comes from high energy prices, and not from high demand.
But the European inflation is boosted by the soaring dollar as energy purchases happen in USD.
Therefore, the ECB must make sure that the highly indebted peripheral countries will be able to withstand a tighter ECB policy, to avoid throwing a renewed debt crisis on top of the pandemic, war and soaring inflation. As a result, the ECB will apparently invent another instrument, an anti-fragmentation instrument, to buy the most fragile countries’ debt, hoping to reduce the differential between the core and the periphery yields.
Good luck making the Germans buy the idea.
BoE & SNB: No fireworks expected
We watch two other monetary policy meetings today, the Bank of England (BoE) and the Swiss National Bank (SNB).
The BoE is set to raise the bank rate for the 5th straight meeting, but the pound will hardly gain on that decision unless we see a bigger hike.
Some expect the SNB to move in tandem with the ECB to tame inflation. But the truth is, the SNB has little incentive to tighten hurriedly as long as the franc helps tame inflation. The SNB is also expected to say goodbye to the negative policy rates in the coming quarters. We shall see the negative rates vanish by the end of the Q1 of next year. But there is probably no hurry from the SNB to tighten quickly. The longer the Swiss could keep the rates at supportive levels, the better it is for their economy!
