Fed upgrades economic forecasts and rate projections

• The Fed kept policy rates at 0.25% at the upper bound and asset purchases at USD 120bn/month at its June FOMC meeting, unchanged on previous policy. In the Fed’s new economic projections, however, it raised its forecast for real GDP growth in 2021 to 7% from 6.5% previously and its expectation for PCE inflation up to 3.4% from 2.4% previously. Expectations for 2022 and beyond were relatively unchanged, confirming that the Fed continues to see inflationary pressures as transitory.
• Most notably the FOMC also brought forward its expectation for rate hikes with a majority of members now expecting to see rates increase in 2023. The dispersion for where rates will be is wide, ranging from a mid-range level of 0.625% up to 1.625%.  In our view this reflects a more optimistic outlook by FOMC members on the speed of the US’s economic recovery than was the case in March.  While the FOMC started talking about tapering asset purchases, Fed Chairman Jerome Powell made it clear in the post-meeting interview that the economy has not made sufficient progress for this support to be imminently withdrawn. The timing of tapering will depend on the data in the coming months.  
• The expectation that the Fed will now move faster on rates than expected—even if some market participants believe it is still behind the curve—will reinvigorate short positions on US Treasuries and could pose a risk for emerging markets in the near term.US Treasuries have sold off in response to the expectation of rates moving higher earlier than expected with the 10yr UST yield adding nearly 5bps to push up to near 1.53% after having drifted lower in response to the 5% May inflation print reported last week.
• UK inflation came in much higher than expected at 0.6% m/m and 2.1% y/y in May (Bloomberg consensus was for a 0.3% m/m gain).  Headline CPI is now above the Core CPI also rose sharply to 2.0% y/y from 1.3% y/y in April.  Headline CPI is now above the Bank of England’s 2% target for the first time since mid-2019, but this is largely due to transitory re-opening adjustments (including restaurants, hotels, clothing and package holidays), as well as higher fuel prices. Chancellor Sunak noted in an interview that higher inflation and interest rates would have an impact on the UK’s debt, but that he expected inflation to remain anchored around 2% in the medium term.     
• China retail sales rose by a smaller than expected 12.4% y/y in May while industrial production was also weaker than forecast at 8.8% y/y. Both indicators showed slower growth than in April, suggesting that the recovery is cooling from Q1 2021. The unemployment rate eased to 5.0% in May, the lowest since the pandemic began. 

Today’s Economic Data and Events

• 13:00 Eurozone CPI (May) forecast 2.0% y/y
• 16:30 US initial jobless claims (June 12) forecast 360k

Fixed Income

• The Fed revised its dot plot at the June FOMC meeting and now a majority of policy makers expect rates to move higher in 2023. Fed chair Jerome Powell also indicated in his press conference that the Fed was preparing to discuss how to bring an end to its quantitative easing programme. All told we would describe the Fed’s stance as positive if not necessarily hawkish in the sense that it is trying to head off inflation.
• US Treasuries sank rapidly on the Fed’s projections with yields on the middle of the curve moving up sharply. The 2yr UST yield jumped 4bps to over 0.2%, its highest level since before the Covid-19 pandemic began. The 5yr and 7yr USTs added around 11bps to their yield each while the 10yr jumped to 1.57% at the end of trading, up 8bps.
• European bond markets will take time to react to the Fed’s stance in trading today as yields had actually moved lower across the board overnight. There has been a repricing in some Asian markets early today with Australian and New Zealand yields up 9bps and 13bps respectively on the 10yr.
• Emerging market bonds weren’t trading during the Fed commentary but we would anticipate a move downward thanks to the projection of higher US rates. Combined with elevated oil prices, emerging market local currency bonds may be running out of road, threatening the near-term economic outlook for many markets..

FX

• The dollar shined as the Fed outlined a view for a stronger US economy this year and rate hikes as early as 2023. The broad DXY index moved up to over 91, a gain of 0.65% on the day as investors reposition for higher US rates.
• EURUSD showed considerable downside, falling more than 1% to 1.995, aided lower by dovish commentary from ECB officials who noted that they didn’t want to move higher on rates before the Fed. USDJPY gained almost 0.6% to 110.71 while GBPUSD slumped below the 1.40 level, falling almost 0.7% to 1.3988.
• Commodity currencies were among the bigger movers with USDCAD rising 0.8% and declines of around 1% each in AUD and NZD.

Equities

• US equity markets slumped following the Fed’s projection of higher interest rates in 2023. The S&P 500 fell nearly 0.5% while the NASDAQ was off by 0.2%. Both markets did show a sharper sell-off in their initial response to the FOMC before recovering some poise to moderate their losses.
• Elsewhere European markets had a positive day earlier in the session with the FTSE and CAC both recording gains around 0.2%.

• Asian markets are mixed in early trade today. The Nikkei is off by more than 1% while the Hang Seng is treading water and the Shenzhen Composite is actually up by almost 0.7%.

Commodities

• Oil prices managed to record another gain overnight despite the move higher in the US dollar and projections of higher rates. However, the market appears to be digesting the implications in early trade this morning with Brent and WTI both down by around 1% at USD 73.61/b and USD 71.43/b respectively.
• The EIA reported a drop in crude stocks of 7.4m bbl last week while there were builds in gasoline and jet stockpiles. Production ticked upward to 11.2m b/d while there was a strong recovery in total product supplied, up almost 3m b/d last week with strong gains in distillates, jet and gasoline demand.
• The Saudi energy minister, prince Abdulaziz bin Salman, told an energy event that the oil market was “not out of the woods” and that being “excessively cautious” was “paying off.” That would suggest that Saudi Arabia is in no rush to add OPEC+ volumes in the second half of the year, helping to keep oil markets tight amid a demand recovery.

• Gold prices sold off sharply in response to the Fed, falling more than 2.5% to USD 1,811/troy oz, their lowest level since the start of May. The move was mirrored in the silver market, down 2.5% to below USD 27/troy oz while platinum and palladium split the difference by falling and gaining respectively.

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