Fed hikes rates by 75bps

• The FOMC hiked rates by 75bps yesterday, the first time it has made such a large move upwards since 1994. This takes the upper bound to 1.75%, and the door was left open for another potential move of that magnitude at the next meeting. Chairman Jerome Powell did say that he did ‘not expect moves of this size to be common’, and a 50bps hike is still an option at the meeting, but inflation will likely remain high over the next several months and the focus is squarely on price growth now after the upside surprise to the CPI print last week. The statement said that ‘the committee is highly attentive to inflation risks’, even while this risks derailing economic growth and the labour market. The Fed now expects unemployment to rise to 4.1% by 2024 from the present 3.6% what Powell termed a ‘softish’ landing, but the risks to the outlook are mounting. The dot plot sees rates rising to 3.4% by year-end and 3.8% at end-2023 and core inflation is forecast at 4.3% this year and 2.7% next year.
• US retail sales declined by -0.3% m/m in May, down from the (downwardly revised) 0.7% growth seen in April and missing expectations of modest growth of 0.1%. Stripping out auto sales and petrol there was positive growth of 0.1% as car sales fell -3.5% m/m, but even this was the slowest pace of growth in five months, reflecting how higher inflation is starting to bite on the US consumer. Of the 13 categories of goods, six saw lower sales in the month.
• Following an emergency meeting yesterday following turmoil in the European bond market, the ECB promised to hasten work on a new policy tool that would help temper the rise in borrowing costs in some of the peripheral countries. Spreads between the core such as Germany and some of the southern states such as Italy have been widening so the bank will accelerate plans for its new ‘anti-fragmentation instrument’. There was little detail on the planned mechanism but the ad hoc meeting shows the level of concern around the risk of a new Eurozone crisis as monetary policy in the single currency bloc starts to tighten.

• Eurozone industrial production expanded 0.4% m/m in April. This offset some of the -1.4% contraction seen in March but was shy of consensus projections of 0.5% growth and leaves output down -2.0% y/y still. Germany saw m/m growth of 1.3% but this compares with a -4.5% contraction the previous month, highlighting the pressures the economy has come under from the conflict in Ukraine and persistent supply chain issues emanating from China.

Key economic data and events today

15:00 Bank of England bank rate. Forecast: 1.25%

16:30 US initial jobless claims, week to June 11. Forecast: 218,000

Fixed Income

• US Treasury markets seemed to focus on the next run of FOMC meetings rather than the June meeting where the Fed hiked the Fed funds rate by 75bps. Treasuries rallied following the press conference as Fed chair Jerome Powell said the large hikes would be rare and that the next meeting would be a hike of either 50bps of 75bps. Yields on the 2yr UST dropped more than 23bps to 3.1908%, though they have started to push higher in trade today. With plans for the balance sheet rundown remaining intact there was no immediate pressure on the 10yr yield either. The 10yr UST rallied with yields down by almost 19bps to 3.2839%.
• Markets eased back on their expectations of a 75bps hike at the July meeting, expecting about halfway between 50bps and 75bps. Given that inflation is unlikely to have improved by the Fed’s standards in June, the top end of that range may again be delivered.
• European bond markets also rallied overnight with the 10yr bund yield down 11bps to 1.634%. An emergency ECB meeting sought to address the blowout in spreads for peripheral Eurozone bonds with yields on Italian 10yr bonds down more than 36bps overnight to 3.799% while Spanish bond yields fell 23bps to 2.874%.

FX

• Currency markets swung against the dollar in response to the Fed even as the FOMC outlined a steady path of hikes for this year and next. The broad DXY dollar index dropped by 0.3%, though it remains at year-to-date highs. EURUSD added around 0.3% overnight to 1.0444, not getting much of a boost from the emergency ECB meeting while USDJPY dropped by 1.2% to a still elevated 133.84. GBPUSD was up by 1.5% to 1.218 with the Bank of England in focus for markets today.
• Commodity currencies all managed to rally against the USD. USDCAD fell by 0.46% to 1.2891 while AUDUSD gained 1.9% to 0.7003 and NZDUSD added 1.16% to 0.6288.

Equities

• US equity markets rallied yesterday after Jerome Powell did not confirm that there would be a further 75bps hike at the next meeting, despite it remaining a strong possibility. The NASDAQ, which has been especially sensitive to tightening prospects, rose 2.5%, while the Dow Jones added 1.0% and the S&P 500 1.5%.
• There were positive moves in Europe earlier in the day also, as the FTSE 100 gained 1.2% while the DAX and the CAC both moved 1.4% higher.
• Locally, the ADX gained 0.4% and the DFM 1.2%. The Tadawul closed -0.4% lower. The upcoming IPO of business park operator TECOM in Dubai is expected to raise as much as USD 454mn.

Commodities

• Oil markets fell overnight, down by 2.2% in the Brent market to USD 118.51/b and by 3% in WTI to US 115.31/b as the prospect of much tighter US monetary policy risks a sharp slowdown in the US economy. Data from the EIA showed a 100k b/d increase in US oil production last week to 12m b/d, its highest level since 2020. Commercial crude inventories rose by almost 2m bbl last week while SPR stocks fell by more than 7.7m bbl.
• The IEA outlined its projections for oil markets in 2023 for the first time in its Monthly Oil Market Report. According to the IEA, oil demand will move above pre-pandemic levels in 2023, rising to 101.6m b/d thanks to a strong recovery in non-OECD demand, particularly from China. However, supply conditions will be more constrained as spare capacity in OPEC is run down and the outlook for Russian oil supply remains subject to considerable uncertainty. The IEA baseline projections show a considerable deficit developing in 2023.

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