Sample Category Title

• The Fed hiked rates by 25bp to 5.25 - 5.50% as widely anticipated. We make no changes to our Fed call, and still think this was the final hike of the cycle.
• Powell's tone was balanced, as he gave few new signals on the future rate outlook. Markets interpreted this slightly dovishly, as the latest 'dots' from June were still clearly in favour of one more hike beyond July.
• The decision provided moderate support to US Treasuries, and lifted EUR/USD close to 1.11. We still see the cross at 1.06/1.03 on the 6M/12M horizon.

The Fed delivered the widely anticipated 25bp hike in the July meeting while keeping the door open for further hikes. That said, Powell carefully refrained from pre-committing to any future policy actions.

The focus remains on incoming data, with two more CPI prints and Jobs Reports still to go before the September meeting. Powell highlighted that the June CPI had been a modest positive surprise, and underscored that the combination of easing labour demand and recovering labour force participation has loosened labour market conditions as well.

On the other hand, he acknowledged that stronger-than-expected economic activity as well as the recent easing in financial conditions (weaker USD, stronger equities) could contribute to prolonging inflation pressures.

Responding to a question on the lags of policy transmission, Powell hinted that the upcoming Q2 Senior Loan Officer Opinion Survey (due for release 31st July) will signal further tightening in credit conditions. The Fed staff is no longer forecasting a recession for the US economy, but a clear slowdown remains the most likely scenario.

Powell emphasized that the Fed's policy stance is now clearly restrictive, as real yields have risen sharply over the past year. We discussed this in our Fed preview, 20 July, and this week, the Conference Board's consumer survey showed further signs of declining inflation expectations, despite overall positive development in the sentiment.

Powell also noted that the Fed could continue QT even when cutting rates in the future. We agree, as over the summer, even the increased T-bill issuance following the debt ceiling raise has had little impact on USD liquidity conditions. So far, money market funds have absorbed the issuance by reallocating funds from the Fed's ON RRP facility, while bank reserves remain steady at a healthy level. This means the Fed can continue QT well into 2024, while as our base case, we forecast the first rate cuts in Q1 next year.

Overall, with few new policy signals, we make no changes to our Fed call, and still think today marked the end of the rate hiking cycle. We expect the upcoming inflation releases to continue signalling cooling underlying inflation, and track the July Core CPI close to the June print around 0.2% m/m. With excess savings soon depleted and credit conditions still tightening, the balance of risks for the economic outlook remains tilted to the downside despite the most recent encouraging data.

Markets: Slightly dovish, no changes to longer-term views

Today's message from the FOMC provided moderate support to treasuries, with the 10Y UST yield down by about 4bp since the rate announcement. Money markets are still pricing in a decent probability (just below 50%) for a final 25bp hike by the November meeting. Nonetheless, we expect the market pricing to align with our view of no further hikes as signs of softening labour market conditions and inflation show up in the data. This should make better room for duration plays, as the end of the hiking cycle will draw market focus towards the timing and pace of future rate cuts. Weakening US macro data should have a stronger impact on FOMC pricing in that environment. With the 2s10s UST curve rather extremely inverted at currently -98bp, the conclusion of the hiking cycle should also pave the way for a more resilient bull steepening of the curve going forward.

EUR/USD moved slightly higher just below 1.11, as the market interpretation was a bit to the dovish side. Overall, however, there were no surprises from the Fed, and hence it does not give us reason to change our FX view. We maintain our strategic case for a lower EUR/USD. We expect the relative strength of the US economy to weigh on the EUR/USD in the coming months, and we continue to forecast the cross at 1.06/1.03 in 6/12M. Tomorrow, we expect a relatively muted market reaction on the back of the ECB meeting. If anything, EUR/USD could move lower if the ECB does not deliver any firm signs of a September hike.

Summary

• The FOMC raised its target range for the fed funds rate by 25 bps today. The move was widely expected by financial markets and economists. The Committee has hiked its policy rate by 525 bps since March 2022.
• The post-meeting statement was little changed from the previous statement released in June. The Committee characterized the ongoing expansion in economic activity as "moderate," a small upgrade from "modest" in the June statement. The Committee continued to describe unemployment as low and inflation as elevated.
• This meeting did not include an update to the Committee's Summary of Economic Projections, which includes the dot plot. The median dot in the June projections was for a federal funds rate of 5.625% at year-end, which implies one more rate hike between now and the end of 2023.
• In his press conference, Chair Powell stated that it was "possible" the Committee could hike again at its September meeting, but he quickly followed that statement by noting that it was also "possible" the FOMC would be on hold come the next meeting. Data dependency was a key theme that emerged during his post-meeting presser.
• Our base case remains that today's rate hike will be the FOMC's last of this tightening cycle. That said, we would not be shocked if the FOMC squeezed in one more rate hike between now and the end of the year. Regardless, quantitative tightening should continue for the foreseeable future.

FOMC Hikes Rates by 25 bps. Will It Be the Last?

After pausing in June, the FOMC resumed its rate hike campaign at its July meeting, increasing the target range for the federal funds rate by 25 bps. The range now stands at 5.25%-5.50% and has increased by 525 bps since March 2022 (Figure 1). The decision to raise rates was supported by all 11 members who were eligible to vote at this meeting. The FOMC also reaffirmed the current pace of quantitative tightening. That is, the Federal Reserve will allow up to $60 billion of Treasury securities and up to $35 billion of mortgage-backed securities to roll off its balance sheet every month.

Since the FOMC last met on June 13-14, the economy has continued to weather the headwinds stemming from tighter monetary policy better than expected. In recent weeks, the Bloomberg Economic Surprise Index, which measures the degree to which economic data come in stronger or weaker than consensus expectations, has come off its recent peak but remains near a two-and-a-half year high (Figure 2). The post-meeting statement changed slightly to reflect this reality. The Committee upgraded its assessment of economic activity by characterizing the pace of expansion as "moderate" instead of "modest". The statement still characterized recent job gains as "robust" and the unemployment rate as "low."

Otherwise, there were essentially no other changes to the post-meeting statement. This meeting did not include an update to the Committee's Summary of Economic Projections, which includes the dot plot. The median dot in the June projections was for a federal funds rate of 5.625% at year-end, which implies one more rate hike between now and the end of 2023 (Figure 3). The statement language reaffirmed that the FOMC wants to keep its options open in regard to future tightening: "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 his press conference, Chair Powell highlighted the progress that has been made in bringing down inflation thus far, but he cautioned that the "process of getting inflation back down to 2% has a long way to go." The Chair stated that it was "possible" the Committee could hike at the September meeting, but that it was also "possible" the FOMC could be on hold. The importance of future economic data and its role in future monetary policy decisions came up numerous times during the presser, and Chair Powell explicitly stated that this is "not an environment where we want to provide a lot of forward guidance." Generally speaking, the Chair's comments seemed to reiterate that the FOMC wants to preserve maximum flexibility as it awaits future data that will help determine whether monetary policy is sufficiently restrictive to bring inflation down to a more tolerable level.

Our base case remains that today's rate hike will be the FOMC's last of this tightening cycle. For much of this tightening cycle, the FOMC has been playing catch up amid sky-high inflation and a federal funds rate that was at the zero lower bound just 16 months ago. Today, with the fed funds rate comfortably north of 5%, the Fed's balance sheet steadily shrinking and core inflation trending down (Figure 4), the case for additional tightening is more tenuous. That said, we would not be shocked if the FOMC squeezed in one more rate hike between now and the end of the year. Regardless, quantitative tightening should continue for the foreseeable future. The FOMC will get two more employment reports and two additional CPI readings between now and its next meeting on September 19-20. The annual Jackson Hole Economic Symposium, to be held August 24-26, affords Chair Powell another opportunity to offer his assessment of the U.S. economic outlook.

• GBPUSD reversed from support zone
• Likely to rise to resistance level 1.3000

GBPUSD recently reversed up from the support area set between the key support level 1.2850 (former monthly high from June), lower daily Bollinger Band and the 50% Fibonacci correction of the upward impulse from June.

The upward reversal from this support area started the active short-term correction b.

Given the strong daily uptrend, GBPUSD can be expected to rise further toward the next round resistance level 1.3000 (target price for the completion of the active wave b).

• EURAUD reversed from support zone
• Likely to rise to resistance level 1.6540

EURAUD currency pair recently reversed up from the support zone lying between the key support level 1.6300 (which has been reversing the price from June), lower daily Bollinger Band and the 38.2% Fibonacci correction of the upward impulse from June.

The upward reversal from this support area is likely to form the daily candlesticks reversal pattern Bullish Engulfing.

EURAUD can be expected to rise further toward the next resistance level 1.6540 (which stopped the previous waves A, B and (C)).

FOMC raises federal funds rate by 25bps to 5.25-5.50% as widely expected, by unanimous vote. The accompanying statement is like a carbon copy for the June's one. The one exception is:

"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 raise the target range for the federal funds rate to 5-1/4 to 5-1/2 percent."

Fed will continue to "continue to assess additional information and its implications for monetary policy."

Full statement below:

Recent indicators suggest that economic activity has been expanding at a moderate pace. Job gains have been robust in recent months, 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 raise the target range for the federal funds rate to 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; Lorie K. Logan; and Christopher J. Waller.

Recent indicators suggest that economic activity has been expanding at a moderate pace. Job gains have been robust in recent months, 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 raise the target range for the federal funds rate to 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; Lorie K. Logan; and Christopher J. Waller.

After pausing at the last meeting, the Fed will announce its rate decision today with a widely expected 25-point hike to a range of 5.25%-5.50%. This event is 97% priced into interest rate futures, according to the FedWatch tool, and the main intrigue lies in the clues as to the Fed’s next moves. And there is plenty of room for speculation.

In their speeches, FOMC officials keep reminding us that the fight against inflation is not over and will be a long one. Translated into the language of interest rates, this means the prospect of (at least) one more hike and a long (up to a year) plateau period.

Markets see the situation differently, assuming there will be no further hikes and that the first cut will come before a year.

Managing these expectations is a major challenge for the Fed. But does the US central bank have to? If so, it could disappoint markets and give the dollar a boost.

In addition to core and headline inflation, the Fed also looks at the labour market. The near multi-year low in the unemployment rate promises to keep upward pressure on prices, suggesting room for further tightening. Separately, house prices are rising for the third month in a row, despite multi-year highs in mortgage rates. Rental prices are rising even faster, reducing the backlog from previous years but acting as a critical pro-inflationary factor.

The Fed’s hawkish tone later on Wednesday could trigger a broad correction in equities and provide a longer-term boost to the dollar, taking the DXY index into the 103.0-103.7 range. This could lead to widespread profit-taking in equities, taking the Nasdaq100 below 15000 and the S&P500 to 4400.

A softening of the Fed’s stance would pave the way for a quick return of the DXY below 100 and set the stage for further gains in equities, with the potential to update multi-month highs in the coming weeks.

The Bank of Japan will announce its latest policy decision on Friday after concluding its two-day meeting. Speculation has been intensifying in the run up to the meeting about what the central bank will decide, as higher inflation has raised the possibility of another tweak to its yield curve control policy. Officials have tried to play down the prospect of a policy shift, but the Bank of Japan has a long track record of shocking the markets and so traders have good cause to be wary. This has provided some respite for the yen, even if it turns out to be temporary.

Inflation finally rears its ugly head

After decades of non-existent price pressures, inflation in Japan is finally headed in the right direction. The consumer price index rose at the fastest pace since the early 1990s back in January, hitting 4.3%. That is quite significant when considering that all the previous spikes in inflation over the last 30 years have been entirely down to increases in the sales tax. But the Bank of Japan isn’t celebrating quite yet. As other central banks fret about sticky inflation, the BoJ isn’t convinced that high inflation is here to stay in Japan. This need for caution is somewhat supported by the data.

Headline CPI appears to have peaked as it’s eased a little since January to just above 3.0%. Core CPI, which excludes fresh food prices and is the measure targeted by the BoJ to achieve 2% inflation, has also settled slightly above 3.0%.

However, when stripping out both food and energy prices from the CPI index, the annual rate of inflation stood at 4.2% in June and has yet to peak. When adding to the equation the effects of a weaker currency – the Japanese yen has depreciated by about 7% versus the US dollar this year – there is a reasonable argument to assume that inflation is set to stay above the BoJ’s 2% target for some time to come.

It’s all about sustained wage growth

Yet, like his predecessor, new governor, Kazuo Ueda, wants to see more evidence that inflationary pressures won’t dissipate once the pandemic and energy shocks have faded, and for that to happen, there has to be a domestically driven demand backdrop. Hence, all the focus on wage growth.

Some progress has been made; wage increases accelerated at the end of 2022 before falling back earlier this year. But there are positive signs that average cash earnings are starting to pick up again as they rose by 2.9% year-on-year in May.

The big question now is whether or not these tentative signals that high inflation is becoming more embedded in the Japanese economy, and more importantly, in the Japanese people’s mindset, warrant another recalibration of the Bank’s yield curve control (YCC) policy. YCC was last adjusted in December when the target band on the 10-year JGB yield was widened by 25 basis points to 0.50% above and below zero percent.

The case for a BoJ shock

If the BoJ were to opt for another tweak, an increase in the band from ±0.50% to ±1.00% would be the likely scenario. The main case for the BoJ to act pre-emptively and catch markets by surprise is to avoid a situation where speculators push up the 10-year yield to the upper limit of the target band, forcing the Bank to make emergency bond purchases. The risk of a prolonged or intense pressure on the yield cap is that it could lead to a disorderly exit from yield curve control policy – something that would be hugely embarrassing for the BoJ as well as potentially costly.

A tweak now would keep speculators at bay well into 2024, buying policymakers some valuable time to properly assess the country’s changing inflation landscape. But most importantly, the Bank would in fact be prolonging the lifespan of YCC, enabling it to maintain an ultra-accommodative policy stance even as it allows the 10-year yield to climb to multi-year highs.

A boost for the yen? Maybe.

For the yen, a widening of the target band would come as welcome relief and the immediate reaction would be a spike higher. Dollar/yen could dip towards its ascending trendline before sellers target the 200-day moving average at 136.78 and the 133.00 congested region.

However, further gains would likely depend more on what the US Federal Reserve signals about its tightening plans and how the dollar responds to that. In the months ahead, if expectations about Fed rate cuts, or even a long pause, don’t materialize, a tweak in YCC policy might not be enough to prevent the yen from revisiting its 2023 and 2022 lows of 145.07 and 151.94 per dollar, respectively.