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Summary

• As widely expected, the FOMC kept its target range for the federal funds rate unchanged at 5.25%-5.50% at today's policy meeting. The decision to keep rates unchanged was unanimously supported by all twelve voting members of the Committee.
• The statement noted that job gains remain strong, and it continued to characterize inflation as "elevated." The Committee also reiterated in the statement that "additional policy firming may be appropriate."
• The Summary of Economic Projections, which highlights the macroeconomic forecasts of the Committee members, was more optimistic than in June. Specifically, median forecasts of GDP growth for this year and 2024 were revised higher, while forecasts of the unemployment rate were revised lower.
• The so-called "dot plot" showed that 12 of the 19 Committee members believe that another 25 bps of rate hikes would be appropriate by the end of this year. Furthermore, the dot plot shows that only 50 bps of policy easing would be appropriate next year, considerably less than the 100 bps of rate cuts that were forecasted in June.

FOMC Remains on Hold but Continues to Think Further Policy Tightening May Be Appropriate

As universally expected, the Federal Open Market Committee (FOMC) decided at today's meeting to keep its target range for the federal funds rate unchanged at 5.25%-5.50%. All twelve voting members of the Committee supported today's decision to keep rates unchanged. In the statement that announced the decision, the FOMC said that "economic activity has been expanding at a solid pace." Although "job gains have slowed in recent months," they "remain strong." The Committee continued to characterize inflation as "elevated." Indeed, the year-over-year rate of core PCE inflation, which is the Fed's preferred measure of the underlying rate of consumer inflation, printed at 4.2% in July, although the 3-month annualized change slipped below 3% (Figure 1). Nevertheless, core PCE inflation remains above the FOMC's 2% target.

As has become standard boilerplate, the Committee said that it "will continue to assess additional information and its implications for monetary policy." In that regard, the FOMC retained a hawkish bias by re-iterating that "additional policy firming may be appropriate to return inflation to 2 percent over time." As we will discuss further below, this bias was represented in the so-called "dot plot."

Median Dot for 2024 Revised Higher

Following its usual quarterly procedure, the Committee released an update to its Summary of Economic Projections (SEP), in which each FOMC member outlines his or her macroeconomic forecasts. As we anticipated in our recent report that outlined our expectations for the FOMC meeting, the median GDP growth forecast for 2023 rose from 1.0% in the June SEP to 2.1% today. This revision reflects the run of stronger-than-expected economic data that have been released since the June 14 meeting. At the same, the median projection for the unemployment rate at the end of this year fell to 3.8% from 4.1% previously, reflecting the continued resilience of the labor market. The FOMC also seems to think that a "soft landing" for the economy is increasingly likely. The median forecast for real GDP growth in 2024 was revised up to 1.5% from 1.1% in the June SEP, while the forecast for the unemployment rate fell to 4.1% from 4.5%.

The median forecast for core PCE inflation at the end of this year edged down to 3.7% from 3.9% in the June SEP. Notably, all FOMC members forecast that PCE inflation, whether measured by the overall rate or by the core rate, will remain above 2% at the end of next year.

These macroeconomic forecasts undoubtedly influence the placement of the dots in the dot plot. The median dot for the end of 2023 remains at 5.625% (i.e., the midpoint of a 5.50%-5.75% target range), which is unchanged from the June SEP. In other words, 12 of the 19 members of the FOMC think it would be appropriate to hike rates by 25 bps at either the November 1 meeting or at the final meeting of the year on December 13. Furthermore, there was an important change for next year. In June, the median dot for 2024 stood at 4.625%, which indicated 100 bps of rate cuts next year would likely be appropriate. The median dot today stands at 5.125%. If the FOMC does indeed raise rates by 25 bps by the end of this year, then the Committee would cut rates by only 50 bps in 2024. Although the median dot for 2025 currently stands at 3.875%, there is a wide dispersion in the forecasts, which should be expected of a forecasted variable more than two years from now. In sum, the message from the FOMC today is higher for longer, in terms of interest rates (Figure 2).

We tend to side with the seven FOMC members who believe that no further rate hikes are needed this year, although we acknowledge the risk that the Committee could indeed hike one more time. As we outlined in our most recent U.S. Economic Outlook, monetary policy will tighten passively in coming months (Figure 3). That is, even with the FOMC on hold, the real fed funds rate will creep higher in coming months if, as we forecast, inflation continues to recede. This rise in real interest rates will exert stronger headwinds on the economy, which we believe will lead to a modest contraction in economy activity next year (Figure 4). We then look for the FOMC to cut rates by more than the market (and most Committee members) currently expect. Not only will lower rates be appropriate if the economy weakens, but the FOMC will need to cut rates just to prevent an upward creep in the real fed funds rate.

• Fed kept rates steady; target range remained at 5.25%-5.50% (as expected)
• Dot plots showed 12 of 19 expected policymakers (12 also called for one more hike in June)
• Fed projections saw rate cut bets halved from June’s 5.10% to 4.60%

US stocks dropped and king dollar returned after the Fed kept rates unchanged and signaled one more rate hike will happen this year. The US economy is too strong and this rate hiking cycle will last a lot longer than Wall Street wants.

It is clear that higher-for-longer will be the Fed’s theme for a while given the summary of economic projections (SEP) revisions. The slowing economy will happen, but the growth and unemployment targets that the Fed is setting is concerning. The FOMC statement noted that “Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.”

If we continue to see an extended period of time that the economy performs well, the growth/inflation mix will lead to a harder hitting lag from their rate hiking cycle.

The Fed still believes the soft landing will happen, but a few more stickier inflation reports and that will make those 2024 rate cut bets disappear. Higher rates are not going away as it seems US economic resiliency is here to stay. The 2-year Treasury yield initially surged on the release of the statement and SEP, rising 4bps to over 5.14%.

Fed Chair Powell’s opening emphasized a long list of reasons on why they will need to keep up the hawkish rhetoric: The economy has been expanding faster than expected this year. Consumer spending has been “particularly robust.” Housing has “picked up somewhat.”

The path of policy will adjust meeting by meeting, but it seems the incoming data might support additional tightening by year-end. Powell’s comment that the Fed is in a position to proceed carefully on firming rates took away some of their hawkishness.

Powell wants convincing evidence that inflation is under control and that won’t be happening anytime soon given the gas price trajectory and the current state of the labor market.

Dollar firmer post Powell (EUR/USD 5-minute chart):

• Gold rising inside minor impulse wave 1
• Likely to reach resistance at 1985.00

Gold continues to rise inside the minor impulse wave 1, which reversed earlier from the upper trendline of the recently broken down channel from May.

The active impulse wave 1 belongs to the intermediate impulse wave (1) from the end of August.

Given the strong daily uptrend, Gold can be expected to break the next resistance at 1950.00 and to rise further toward the next resistance level 1985.00.

• USDJPY broke the resistance level 147,40
• Likely to riseW to resistance level 147.70

USDJPY currency pair recently broke the resistance level 147,40 (which has been reversing the price from the start of September).

The breakout of the resistance level 147,40 accelerated the active impulse wave 5 of the intermediate impulse wave (3) from the middle of July.

Given the clear daily uptrend, USDJPY currency pair can be expected to rise further toward the next resistance level 147.70.

Fed keeps federal funds rate unchanged at 5.25-5.50% as widely expected, by unanimous vote. Tightening bias is maintained as "The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals".

In the new dot plot, 12 of 19 policymakers penciled in one more 25bps rate hike this year to 5.50-5.75%. By

In the new median projections,

• 2023 GDP growth is revised up to 2.1% (from 1.0%).
• 2024 GDP growth is revised up to 1.5% (from 1.1%).
• 2025 GDP growth is unchanged at 1.8%.

• 2023 unemployment rate is revised down to 3.8% (from 4.1%).
• 2024 unemployment rate is revised down to 4.1% (from 4.4%).
• 2025 unemployment rate is revised down to 4.1% (from 4.5%).

• 2023 PCE inflation is revised up to 2.2% (from 3.2%).
• 2024 PCE inflation is unchanged at 2.5%.
• 2025 PCE inflation is revised up to 2.2% (from 2.1%).

• 2023 core PCE is revised down to 3.7% (from 3.9%).
• 2024 core PCE is unchanged at 2.6%.
• 2025 PCE is revised up to 2.3% (from 2.2%).

• 2023 federal funds rate unchanged at 5.6%.
• 2024 federal funds rate raised to 5.1% (from 4.6%).
• 2025 federal funds rate raised to 3.9% (from 3.4%).

Full FOMC statement here.

Full Summary of Economic Projections here.

Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have slowed in recent months but remain strong, and the unemployment rate has remained low. Inflation remains elevated.

The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Adriana D. Kugler; Lorie K. Logan; and Christopher J. Waller.

• Investors see rate cuts by the ECB, despite post-meeting hawkish rhetoric
• Eurozone prel. PMIs the next piece of information that could shake those bets
• Euro could slide if the PMIs disappoint when released on Friday, at 08:00 GMT

After ECB meeting, the market sees rate cuts for next year

Last week, the ECB decided to raise interest rates by 25bps, taking the deposit facility rate to a record high of 4%. However, with the latest data pointing to a severely wounded economy, officials cut their economic growth forecasts, and despite raising those for inflation, they hinted that this could be the last rate increase in this tightening cycle.

The euro tumbled and market participants began pricing a series of rate reductions for next year, allowing only a small probability for another hike by December. Even after several policymakers, including President Lagarde, pushed back on rate cut bets the following days, and noted that further increases cannot be ruled out, investors were not convinced. They are still assigning only a nearly 30% probability for another quarter-point increment and they are seeing rates being 60bps below current levels by the end of next year.

Attention now falls on Friday’s preliminary PMIs

This suggests that market participants are placing more trust in economic data than just remarks, and that they are more concerned about economic performance than high inflation. With that in mind, Friday’s preliminary PMIs for September may attract special attention. The manufacturing PMI is forecast to have slightly increased but to remain well below the boom-or-bust zone of 50 that separates expansion from contraction. What’s more, both the services and composite indices are expected to have slid further into the contractionary territory, ringing the recession alarm bells even louder.

Should this be the case, the euro is likely to come under renewed selling pressure, even if the price subindices point to some acceleration due to the latest rally in oil prices. For traders to start buying euros again, upcoming data may need to start pointing to some economic recovery, or at least a stabilization, something for which there is no evidence yet.

US and Eurozone growth dynamics drive euro/dollar

In contrast to the Eurozone data, US economic indicators have been pointing to a resilient economy, not justifying expectations of around 80bps worth of rate reductions by the Fed for 2024. Taking that into consideration, the risks surrounding the US dollar from the outcome of the FOMC decision on Wednesday may be tilted to the upside, as there may be a decent chance for the new dot plot to point to a higher rate path than the one currently implied by the market.

Ergo, a hawkish Fed combined with further softness in the Eurozone PMIs may be a toxic cocktail for euro/dollar. The pair has been in a recovery mode due to the relatively hawkish comments by several ECB policymakers after last Thursday’s decision, but that recovery may stay limited and short-lived below the 1.0765 resistance level, marked by the highs of September 12 and 13. Another round of declines would likely take the price back below the key territory of 1.0665 and perhaps confirm a bearish trend reversal on the daily chart. The next important support may be the 1.0530 zone, which stopped the pair from moving lower back in February and March.

For the outlook of euro/dollar to brighten again, the bulls must sweat a lot. They may have to drive the action all the way above the 1.1070 territory, which provided strong resistance on several occasions this year.

• Amidst a very busy week, the BoJ holds its sixth rate-setting meeting
• Market is not expecting fireworks; there is increasing commentary about negative rates
• The decision will come on Friday 03.00 GMT, press conference shortly afterwards

The week is expected to close on a high note

The Bank of Japan is holding its sixth meeting for 2023 on Friday, two days after the key Fed meeting. Despite the yen’s underperformance making new headlines, the BoJ is not expected to announce a change in its main interest rate. However, the market is curious whether the BoJ is ready to proceed to another amendment of its monetary policy toolkit, especially if the Fed opts for another rate hike on Wednesday.

At the last meeting in late July, the BoJ widened the boundary of its yield curve control (YCC) framework. This was seen as a shy first step towards the eventual normalization of monetary policy, as bond yields were finally allowed to increase a tad. The post-meeting BoJ members’ comments didn’t diverge from the usual commentary, closing the door to the buildup of hawkish expectations. However, the overall sentiment appears to have changed somewhat after Governor Ueda’s September 10 comment.

His “quiet exit” remark reignited market rumours that the BoJ is finally preparing to abandon its ultra-loose monetary policy stance. Further adjusting the YCC framework seems to be the easy next option for the BoJ, but the market is focusing on negative rates. The BoJ’s target rate has remained at -0.1% since February 2016. Interestingly, BoJ’s Tamura has already been on the airwaves downplaying the importance of a possible return to positive rates, by stating that the abandonment of negative rates is not the same as monetary policy tightening. Therefore, the BoJ policy board has probably already discussed this move and it is expected to be part of the discussion again this week.

Data releases failing to surprise on the upside lately

The basis for any BoJ move is the economic outlook. The strongly positive GDP figures for the second quarter of 2023 have been followed by mixed data. Similar to other countries, the housing sector remains under pressure with the July housing starts dropping very close to an 8-year low, and labour cash earnings showed a considerable slowdown in July. On the flip side, the PMI surveys remain optimistic, especially when compared to the euro area figures.

However, the BoJ’s focus falls squarely on the inflation data and wages. The August Tokyo inflation print surprised on the downside. If this tendency is confirmed by the national data, on Friday we could see the headline CPI dropping below 3% for the first time since July 2022. Various BoJ members have stated that inflation is expected to gradually re-accelerate after a period of slowdown. Therefore, a possible downside surprise could affect market sentiment, but it will probably not change BoJ’s strategy going forward.

Wages have emerged as the key input in BoJ’s analysis

What is affecting the BoJ members’ attitude are the developments in wages. Since the record-breaking wage agreements in April 2023, retail sales have been registering strong annual increases. For this trend to continue, firms need to continue with their aggressive wage hikes, further fueling spending and helping the public overcome the deflation mentality of the past decades. Importantly, Ueda stated that by year-end the BoJ could have enough on the 2024 wage negotiations. This could mean that a rate hike could be firmly on the agenda at the December 19 meeting.

The yen needs help, especially if the Fed hikes on Wednesday

The yen continues to suffer against most currencies with the US dollar-yen pair making a new 2023 high and reaching its highest level since November 4, 2022. With the Japanese authorities limiting their reaction so far to verbal interventions, the burden falls on the BoJ to provide some support to the ailing yen. If the BoJ maintains its current stance on Friday, the US dollar-yen pair could set sail for the October 21, 2022 high at 151.94.

On the flip side, should the BoJ manage to surprise on Friday, we could see yen bulls staging a pullback similar to the mid-July correction with the main target being the 144.99 area. However, such a move could prove excessive and premature if the economic data don’t start to improve significantly over the next few trading days.

UK consumer inflation slowed from 6.8% to 6.7% y/y, contrary to the expected acceleration to 7.0%. Core inflation, excluding food and energy, saw an even more significant slowdown of 6.2% from 6.9% y/y, well below the average forecast of 6.8%.

The weaker-than-expected data sparked a brief sell-off in GBPUSD, with the exchange rate dropping nearly 0.5% within minutes to 1.2330, a level last seen in May.

The UK’s annual price growth rate is still higher than other developed economies, outpacing several major emerging ones. The latest data has fuelled speculation that the Bank of England will pause on rate hikes or even end the hiking cycle that began almost two years ago.

But the dovish rhetoric looks premature in our view. These 9.1% y/y retail price increases are unacceptable for a developed country, and core inflation has been “too high for too long”, entrenching inflation expectations. A strong labour market increases the risk of secondary inflationary effects, exacerbated by the recent rise in commodity and energy prices.

Producer input prices rose by 0.4% in August. Producer output prices have risen by 0.2% over the past two months, signalling the end of the deflationary impact on final inflation.

For over two months now, the Pound has been gently retreating against the Dollar because of contrasting economic data from these countries, with the UK being the weaker side. However, it would be a mistake to assume that the Bank of England will quickly turn its monetary policy towards easing, as this could increase pressure on Sterling and reinforce pro-inflationary factors.