The Fed skipped a rate rise but its updated dot plot signaled that there may be two more to come this year with a first one most likely in July (dubbed a “live” meeting). 12 of the 18 MPC members pushed for the higher peak rate at 5.5-5.75% later this year. 7 MPC members have also lifted their estimate of the neutral rate beyond 2.5%. That’s up from four in March and three in December last year. Are we seeing the contours of a(n implicit) higher inflation target? Anyway, growth and core inflation was revised higher for this year (1% and 3.9% respectively) and remain more or less unchanged further out. Ongoing labour market strength forced the Fed to lower the expected unemployment rate to just 4.1% end 2023 and 4.5% in the two years ahead. Why, then, go for a pause and not just hike yesterday? The Fed wishes to go slowly and more gradual after an aggressive tightening campaign. It also offers theoretically the best chances for cooling the economy rather than outright break it. But going easy also implies rates need to be high for a long enough period to dampen activity sufficiently and bring inflation back to target. The Fed sees next year’s policy level at 4.5-4.75% and at 3.25-3.5% in 2025. US markets finished the day surprisingly stoic with equities closing in a range of -0.7% and +0.4%. After a sharp, dot plot driven intraday reversal at the front end of the curve (+18 bps in the 2-y), the US 2-y yield close the day 2.2 bps higher. In a further curve inversion, the 30-y even lost 3.75 bps. The dollar left the lows of the day but no more than that. DXY closed around 103 and EUR/USD still took out the 1.08 level. Markets currently don’t buy the 50 bps additional tightening but we think that’s only a matter of time. The burden of the proof has shifted: it suffices for economic data to just meet the consensus bar to move markets towards the updated rate projections.
The PBOC this morning as expected also cut its 1-y medium term lending facility rate by 10 bps to 2.65%. It followed the unexpected 7-day reverse repo rate cut earlier this week. The moves are aimed at jolting a stalling Chinese economy. That was once again obvious from this morning’s monthly batch of data. Industrial production, retail sales, property and fixed asset investments all flopped in May. China’s yuan gapped lower at the open but in the meantime recovered to USD/CNY 7.15. Other markets, including US bonds (yields +2.3-4.9 bps) are affected by a stellar Australian jobs report (see below).
Next up is the ECB. A 25 bps rate hike to 3.5% is all but certain. We expect the central bank to hint at another move in July, as currently discounted by money markets, but to take a more neutral, data-dependent approach beyond that. There are a few events that warrant monitoring before committing to anything from September on. One is the full stop on the APP reinvestments from the second half of the year on. Another is the repayment of a big chunk of TLTROs at the end of this month. Yet another is the evolution of core inflation. There’s a good chance the “easing” in April and May may not continue, reverse even, over the summer months. Given what is priced in, the euro and yields could experience some profit-taking after the meeting. But being committed to kill off inflation, we believe they still have the backing of the ECB, which limits the downside potential.
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The Australian Bureau of Statistics (ABS) published May employment data this morning. The Australian economy added 75.9k jobs (vs 17.5k expected) with the lion share of that amount being full time occupations (+61.7k). The increase in employment in May saw the number of employed people in Australia reach 14 million for the first time (almost 13 million pre-pandemic). The Australian participation rate hit a new high, rising from 66.7% to 66.9% with the unemployment rate dipping from 3.7% to 3.6%. The ABS head of labour statistics said that the whole range of indicators – strong growth in hours worked, the elevated employment-to-population ratio and participation rate, along with the low unemployment and underemployment rates – all point to a continuing tight labour market. Australian money markets further scaled up RBA tightening bets with a cumulative 50 bps of rate hikes now discounted by the October meeting. Risks are probably tilted to achieving that even earlier. AUD swap yields rise over 10 bps at the front end and 4 bps at the very long end. AUD/USD tries to take out the April and May tops around 0.68 which serve as resistance levels.