Fed hikes by 50bps

• The Federal Reserve raised the Federal Funds rate by 50bps to 1% on the upper bound, the second rate hike this year, delivering on market expectations of a large hike. The Fed will also start to run down its balance sheet from June 1st, a few weeks later than had been expected and at an initial monthly pace of USD 47.5bn before ramping up to a monthly pace of USD 95bn after three months have elapsed. The decision was unanimous and the statement indicated that the Fed would be “highly attentive to inflation risks” which may be taken as a signal of more hawkish policy to come. In the press conference after the rate change announcement, Fed chair Jerome Powell said that 50bps hikes would likely be in play for the next two FOMC meetings but didn’t appear to endorse plans for a larger 75bps hike.
• With the rate change coming in largely in line with market expectations, initial price reaction was relatively limited. US Treasuries actually rallied in the immediate aftermath as the messaging from the Fed was not as aggressively hawkish as had been expected while equities recovered and the dollar came off somewhat.
• Central banks across the GCC have followed the Fed in hiking rates with the Central Bank of the UAE raising the base rate by 50bps along with similar moves in Saudi Arabia, Bahrain and Qatar. Kuwait’s central bank hiked rates by 25bps.
• The European Union has proposed to completely ban imports of Russian crude oil and products by the end of the year and is also considering sanctions on the Russia’s largest bank. The proposal, which requires unanimous assent from EU members, would add further negative pressure onto Russia’s economy and would also contribute to further tightening in global energy markets as Russia loses access to one of its critical export markets for oil and refined products.
• The Reserve Bank of India hiked its repurchase rate by 40bps to 4.4% in an unscheduled policy meeting. Inflation has been near the top end of the RBI’s target range of 4% +/- 2% and RBI governor Shaktikanta Das noted that inflation needed to “be tamed” to keep the Indian economy on sustained growth. The bank also raised reserve requirements and said it would soak up INR 870bn from the domestic banking system to further tighten monetary conditions.
• Labour conditions in the US continue to remain strong even as the prospect of higher costs, wages and interest rates dampen the outlook for the economy. Total job openings in March rose to 11.5m, up from 11.3m in February and ahead of market expectations. Meanwhile the quits rate rose to 4.5m in March, the highest on record in data stretching back to 2000. The non-farm payrolls report for April will be published at the end of the week with market expectations for 390k jobs to have been added last month.
• Saudi Arabia’s economy grew 9.6% y/y in Q1 2022 according to preliminary (flash) estimates. The oil and gas sector was the main driver of growth, up 20.4% y/y off the low base of Q1 2021. The private non-oil sector grew 3.7% y/y, a slower rate of growth than in Q4 2021.  We expect non-oil GDP to slow this year to 4.1% from 4.9% in 2021, while oil and gas GDP is forecast to grow 13.0% this year. We expect headline GDP growth of 7.7% in the kingdom in 2022.
• Near-term indicators are showing the impact of China’s zero-Covid policy with the composite Caixin PMI coming in at 37.2 in April, down from an already contractionary 43.9 in March. The services component fell to 36.2 down from 42 while manufacturing held up relatively better, falling to just 46 from 48.1 a month earlier. With the risk of more countries enduring strict lockdown measures the odds are rising for a prolonged slowdown in China’s economy.

Today’s Economic Data and Events

• 10:00 GE Factory orders March y/y: forecast -0.7%
• 11:00 TU CPI y/y April: forecast 67.8%
• 15:00 UK Bank of England Bank Rate: forecast 1%
• 16:30 US Continuing claims April 23: forecast 1.4m

Fixed Income

• Treasury markets rallied in the wake of the May FOMC as the Federal Reserve was less hawkish than had been feared, particularly with chair Jerome Powell effectively ruling out, for now, a 75bps hike. Yields on the front end of the curve dropped sharply, down 14bps on the 2yr UST to close out at 2.6421% while the 10yr yield fell around 4bps to 2.9344%. With the Fed laying out two more 50bps hikes ahead of normal moves later in the year, markets will have some more certainty about where rates will end the year with swaps markets pricing in rates at around 2.75% in December.
• European bond markets were generally softer as rhetoric between the EU and Russia heats up. Yields on the 10yr bund rose by less than 1bp to 0.968% while the 10yr gilt yield added 1bp to 1.964%

FX

• The dollar fell overnight as the Federal Reserve provided no surprises even as it hiked rates by 50bps. The greenback was weaker against all peer currencies with EURUSD adding 0.96% to settle at 1.0622 while USDJPY fell 0.81% to 129.09. Sterling jumped by more than 1% to 1.2631 in anticipation of today’s Bank of England meeting.
• In commodity currencies AUDUSD was the outperformer, jumping more than 2.3% to 0.7260 while NZDUSD added almost 1.7% to 0.6544. USDCAD fell 0.7% to 1.2747 as the loonie was helped by a less aggressive than feared Fed and a jump in oil prices.

Equities

• US equity markets surged as the Fed’s 50bps hike came in largely as expected. The Dow added 1.8% while the S&P and NASDAQ jumped either side of 3%. Should inflation begin to normalize in response to the Fed’s moves then equity markets may be able to discount higher rates ahead.
• In Europe, however, escalating geopolitical rhetoric is weighing on the outlook. The Dax closed lower by around 0.5% while the Cac fell 1.2% and the FTSE was off by 0.9%.

Commodities

• Oil prices rose around 5% each in response to the EU proposal to ban imports of Russian oil and products and ahead of today’s OPEC+ meeting. Brent futures settled at USD 110.14/b and WTI closed at USD 107.81/b.
• OPEC+ will likely stick to their plan for modest production increases for June, particularly as strict Covid controls in China threaten the oil demand narrative for the rest of the year.

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