Market Strategist
Summary: The Fed meeting ended with a hawkish pause even as the case for a soft-landing outcome appeared to be weak from Chair Powell’s comments. Dollar has room to extend gains as Fed pivot appears to be delayed compared to the ECB, and a hawkish interpretation from the BOE meeting also remains difficult today. Decision from the Bank of Japan is due tomorrow, and hawkish hints could be seen after weeks of jawboning to limit the downside in yen, but sustained gains in yen may still remain unlikely until the Fed pivots.
The Fed decision was in-line with expectations with the rate left unchanged at 5.25-5.50%, but there were additional elements that made the overall message hawkish. The Fed has retained the 2023 Fed funds rate projection dot at 5.625% in order to keep the flexibility to hike rates again, especially given how the macro environment is currently being complicated by the rising energy prices. The bigger hawkish surprise came from 2024 dots which signalled that there will be less rate cuts next year that earlier thought. We saw the risk of 2024 dot moving higher to 4.8-4.9% from 4.6% June as noted in this article, but the dot plot showed that increased to 5.125% suggesting only two rate cuts in 2024 vs. four that were priced in by the markets going into the meeting.
Growth and inflation estimates also got a hawkish shift in Fed expectations with upwards revisions in both 2023 and 2024 real GDP. 2023 GDP growth was revised higher to 2.1% from 1% while it is up to 1.5% for 2024 from 1.1%. The unemployment rate has also been forecast lower to 3.8% at end-2023 from 4.1% while for next year it is 4.1% from 4.5%. Core PCE seen lower for 2023 at 3.7% from 3.9% but unchanged for 2024 at 2.6%. These forecasts might be indicative of a soft landing outcome, but Powell’s comments had little conviction. In his response to a press questions, he said that soft-landing was not a baseline forecast, but a “plausible” outcome.
We remain cautious of the growth trajectory for the US economy from here. While headline growth is still resilient, we have noted earlier that higher interest rates are starting to hurt the lower and middle income consumers and the small and medium enterprises. Rising credit card and auto loan delinquencies, erosion of pandemic-era savings, start of student loan repayments and tightening bank lending standards, all indicate that the economy is starting to get hurt due to the high borrowing costs beneath the headlines that have been largely been driven by Swiftonomics.
The Fed’s hawkish stance, however, is coming in clear contrast with ECB and what is likely to come from the Bank of England as well, which suggests there is still room for the dollar to remain supported until US economic data starts to show clear signs of weakness. The hawkish Fed stance could also mean risk-off as demand outlook deteriorates, and could weigh on commodity currencies such as AUD and NZD. Higher yield also continues to make the environment tougher for currencies where central bank stance remains divergent, such as the yen and the yuan.
BOJ Preview: Yen focus is getting louder and wider
As we said on our Monday Macro podcast, Bank of Japan’s Friday meeting has the most potential to surprise among a ton of central banks announcing policy decisions this week. A hawkish surprise by the BOJ remains a low probability, high risk event, with expectations remaining aligned to bring no changes to the policy and keeping the short-term interest rate target unchanged at -0.1% and that for the 10-year bond yield around 0% after the bank tweaked the settings of its yield-curve-control policy at the last meeting in July.
However, FX concerns are likely to be at the core of this week’s meeting especially with verbal intervention getting louder and wider in the past few weeks. Fed’s hawkish message last night has also meant that the pain on the yen may be sustained as US yields continue to rise, and US Treasury Secretary Yellen signalled this week that Japan has US support if they wanted to intervene in the FX markets. More importantly, that gives room to Governor Ueda to talk about the yen more directly, to the extent that he could raise the expectations of a policy pivot due to the volatility in the yen. Again, low probability but high-risk event.
Inflation dynamics also continue to get trickier with rising energy prices. Nationwide CPI print for August is due on Friday morning ahead of the BOJ decision, and headline CPI is expected to soften but stay above the target at 3.0% YoY (prev. 3.3%) while core is seen firm at 4.3% YoY. Plans for further government subsidies raise the risk of further inflation pressures, and may keep BOJ on action alert.
Also worth noting is that Ueda-san’s comments that the BOJ may have enough information by the end of the year on wage pressures had resulted in a significant forward adjustment in expectations that BOJ could end its negative interest rate policy to early 2024 form late 2024 earlier. However, if there is no follow up on those comments, markets will likely assume that those comments were only directed towards supporting the yen rather than signalling any real threat of policy normalization.
Having given some hints on policy direction and FX over the last few weeks, the BOJ has now exposed themselves going into this week’s meeting. No follow up on either could bring the yen bears back with a vengeance. A strong hawkish tilt such as hinting that raising rates or enduing YCC are real options for the foreseeable future could, however, bring 10-year Japanese government bond yields close to the 1% ceiling which will likely force the central bank to buy more bonds, a negative side-effect of the current YCC policy. This means Ueda is likely to face a tough challenge to sound neutral at Friday’s meeting, and any indications on policy normalization will remain subtle and modest at best, and unlikely to turn around the weakness of the Japanese yen. The carry strategy likely has more room to run with FX volatility remaining low.
There are a host of other central bank decisions due today before we get to the BOJ tomorrow. Especially important is the Bank of England decision that we previewed here, and highlighted the risk of a dovish re-pricing. Softer CPI print seen yesterday added to the case and we have seen the odds of a rate hike today move lower to sub-50% from ~80% earlier. Especially comforting was the drop in all-services inflation to 6.8% from 7.4% and below the MPC expectation for 7.2%. That signals that the vote spilt at the meeting today could tilt more dovish, with possibility of sustained services disinflation more likely now. Even if the BOE was to raise rates one more time today, any hawkish interpretations from the meeting remain unlikely.
Other G10 central banks that meet today, including the Swiss Bank, Norges Bank and Riksbank are all expected to raise rates by 25bps today. ECB’s Schnabel will also be on the wires today. She has been more balanced for now, but still more tilted towards inflation risks. If her comments suggest more comfort on the inflation outlook, or greater economic concerns, then that could bring more downside for the EUR.
Bond. Long Bond(s)
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Steen Jakobsen,
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Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
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With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
