Markets
“It’s time to just go to a meeting-by-meeting basis and not provide the kind of clear guidance that we had provided”. It were the final remarks of Fed Chair Powell at the July Fed meeting after which he went radio silent until today’s key note address at the Jackson Hole meeting. In absence of short term direction, markets swung from worrying over growth to worrying over inflation. Powell didn’t want to pin the central bank to a very strict rate path, after having to backtrack on promises in June and July.
Recall that the Fed after its May meeting sent out the message that similar 50 bps rate hikes would follow at next policy meetings, but accelerating monthly inflation prints eventually prompted back-to-back 75 bps rate hikes to the current level of 2.25%-2.50%. Since that July policy meeting, we’ve had a stellar payrolls report, strong ISM’s, a mixed bag of regional business gauges, better-than-feared retail sales, but also a (slight) deceleration in inflation dynamics (CPI: 8.5% Y/Y from 9.1% Y/Y). Individual Fed members over the past days added that, for now, there’s only one needle in the Fed compass: inflation.
Central banks all over the world hold the view that the long term benefits of anchored inflation expectations outweigh the short term economic pain stemming from aggressive tightening.
Despite the repositioning on rate markets, we still see room for hawkish surprises by Fed Chair Powell. We look for clues on three topics. First: guidance for the remainder of this year. US money markets currently discount a cumulative 125 bps additional rate hikes. Second: intentions for 2023. US money markets still hold on to the possibility of rate cuts in from H2 2023, a scenario which we deem very unlikely. Finally, and most importantly, hints on the neutral interest rate level.
Powell in July pointed out that the Fed reached that neutral level which neither fuels nor restrains growth if inflation were at 2%. The median projection in the June dot plot for this neutral level was indeed 2.5%. If inflation doesn’t return to target over the policy horizon, expectations about a neutral interest level could be increased. If so, it gives the Fed more leeway to tighten policy further before becoming really restrictive. For markets, we hold our medium-term views of higher core bonds yields, weakness on stock markets (which could be tonight’s main mechanism following Powell’s economic outlook) and a stronger dollar. Specifically for the US we target in first instance a return of the 10-yr yield towards the 3.5% YTD high. First targets in EUR/USD are around 0.97 which is the current bottom of the downward trend channel.
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In an interview with Bloomberg Reserve Bank of New Zealand governor Orr indicated that the RBNZ probably is coming closer to the point where aggressive tightening might slow. Another couple of rate hikes might nevertheless be needed. RBNZ policy is slowing consumption as needed. In this respect, Orr said that the Q2 decline in retail sales was no surprise, but’ “a good signal that monetary policy is biting and that we’re doing our job.” Still the RBNZ governor doesn’t expect a recession. Other factors than retail sales, including favourable terms of trade, a rebound in tourism and investment in construction are supporting New Zealand growth. The Kiwi dollar is ceding modest ground this morning trading near NZD/USD 0.62. Inflation in the Tokyo area this month rose at the faster than expected pace. Prices excluding fresh food rose from 2.3% Y/Y to 2.6% Y/Y. The August reading marks the fastest pace of increase since October 2014. However, the rise was again mainly driven by higher prices for energy and processed food. In this respect, the data probably won’t change the BoJ’s current stance to maintain an easy monetary policy. USD/JPY this morning gains a few ticks to trade at 136.8, but this meaning reflects the broader USD move.
