Fed minutes balance risks going forward

Minutes from the July FOMC meeting, where the Fed hiked rates by 25bps, highlighted the balanced risks facing the Fed. The minutes explicitly noted the “risk of an inadvertent overtightening of policy against the cost of an insufficient tightening.” That tension seems to align with commentary from Fed officials since the meeting with some supporting more rate hikes while others saying rates are at a restrictive enough level for now. The minutes also confirmed the Fed would be driven by the near-term flow of data and wanted to monitor if the “disinflation process was continuing.” Markets are pricing in virtually no chance of an additional rate hike by the end of 2023 with rate cuts to come in H1 next year.

Inflation in the UK slowed in July, dropping by 0.4% m/m thanks to lower housing, household and communication costs. The drop in July was the first monthly decline since January but fell slightly short of market expectations of a 0.5% decline. On an annual basis, inflation slowed to 6.8% y/y in July from 7.9% a month earlier, coming in slightly hotter than market expectations. Core CPI was unchanged on an annual basis at 6.9% y/y as food costs were nearly unchanged last month. The inflation data follows on from record high wage growth reported earlier in the week which firms up our expectations that the Bank of England will need to hike rates again at their September 21 MPC meeting. We expect a 25bps hike to take the Bank Rate to 5.5%. Markets are pricing in a peak in UK rates at close to 6% in Q1 2024.

Today’s Economic Data and Events

• 16:30 US initial jobless claims Aug 12: forecast 240k

Fixed Income

• The minutes of the July FOMC didn’t provide any substantial new information that markets weren’t assuming anyway about how the Fed was monitoring data. Reaction in Treasury markets was fairly contained with a bearish tilt remaining in place. Yields on 2yr USTs rose 1bps to 4.9652% while the 10yr was about 4bps higher at 4.2504%.
• High yield and emerging market USD bonds had an otherwise positive day amid broad sell offs in the rest of the fixed income market.

FX

• Currency markets had a risk off day with the dollar rising against most peers overnight. The only exception was GBPUSD, which rallied 0.2% to 1.2732, as inflation remains elevated in the UK. EURUSD fell 0.2% to 1.0879 while USDJPY added 0.5% to 146.35.
• Commodity currencies were uniformly weaker with USDCAD up 0.3% at 1.3533, AUDUSD down 0.5% at 0.6424 and NZDUSD falling 0.2% to 0.5938.

Equities

• Equity markets turned negative overnight as risk sentiment dissipated. The Dow Jones index fell 0.5% while the S&P 500 gave up 0.8% and the NASDAQ closed lower by 1.2%. European markets were also weaker with the FTSE down 0.4% and the EuroStoxx 50 off by 0.1%.
• Asian markets have opened all in the red in early trading today with the Nikkei dropping 1% and the Hang Seng down by 1.5%.
• Regional markets were also weaker overnight with the Tadawul down 0.2%, the DFM falling 0.1% and the ADX lower by 0.3%.

Commodities

• Oil prices fell for a third day running overnight, their longest stretch of losses since the start of June. Brent fell 1.7% to USD 83.45/b while WTI was lower by 2% to USD 79.38/b. The EIA reported a draw in commercial US crude stocks of 5.7m bbl last week though there were much more modest draws across the rest of the barrel. Oil production rose 100k b/d to 12.7m b/d while product supplied added nearly 1m b/d last week.