Fed raises rates by 75 bps, dollar cools off, stocks bounce
Bank of England could disappoint market expectations today
SNB surprises with 50bps rate hike, BoJ set to keep powder dry
Fed goes big
The Federal Reserve raised interest rates by 75 basis points, in line with market pricing. Chairman Powell attributed the powerful move to the latest sizzling inflation reading and concerns that inflation expectations were starting to drift beyond the 2% target, which forced the Committee to roll out the big guns.
Interest rate projections were recalibrated higher to almost hug market pricing. The median Fed official sees rates at 3.38% by December, slightly below what money markets envision. Powell argued that a recession can still be avoided, especially if there’s any help from geopolitical events, but was adamant that the Fed will keep its foot on the brakes until inflation abates.
There was a sense of relief in the markets after the Fed chief stressed that 75 bps moves are unlikely to be the norm moving forward. That remark took the shine off the dollar and helped equities bounce back as some of the uncertainty faded, although both moves have already retraced.
All told, the Fed is trying to frontload as much tightening as possible while the sun is shining. The issue is that the Atlanta Fed GDPNow model revised growth for Q2 down to zero yesterday after data showed retail sales aren’t even keeping pace with inflation. If this is validated by official data, it would imply the US economy is on the verge of recession following the contraction in Q1, opening up another can of worms for Fed officials.
Traders overestimating BoE?
The central bank baton will pass to the Bank of England today. Markets are certain a rate increase is on the menu but are split on the size, assigning equal chances to 25 bps and 50 bps moves. Admittedly, the most likely outcome is a 25bps rate increase coupled with cautious commentary around the economy.
BoE officials were already on red alert about recession risks at their last meeting back in May. Some policymakers even supported a ‘pause’ in rate hikes moving forward despite high inflation, and since then incoming data have confirmed their concerns with PMI business surveys signaling a sharp slowdown in growth while the unemployment rate moved higher.
The BoE has not raised rates by 50 basis points so far in this cycle while the British economy was humming along - why would it do so now that storm clouds are on the horizon? This spells downside risks for sterling, especially if the central bank opens the door for a pause during the summer, forcing market pricing to adjust.
SNB surprises, BoJ also in focus
The Swiss National Bank took markets by storm today after it raised interest rates by 50bps, overcoming even the most aggressive forecasts. It dropped the phrase that the franc is ‘highly valued’, foreshadowing less intervention in currency markets going forward and propelling the franc higher in the process.
Turning to the ECB, the special meeting yesterday turned out to be a dud. It was more a statement of intent that the ECB is serious about addressing fragmentation risks, without much substance. But it worked, with the spread between Italian and German yields narrowing in the aftermath as many speculators were flushed out of the fragmentation trade.
Early on Friday, the spotlight will turn to the Bank of Japan. A parade of BoJ officials made it clear lately that no policy shifts are coming, preventing market participants from even speculating about any changes. A reaffirmation that the BoJ remains committed to yield curve control would likely spell more pain for the yen, which has been slaughtered by rising yields abroad and a terms of trade shock stemming from energy prices.