Stocks rallied, the dollar fell to a new low, and gold jumped as US front end rates tumbled after the Federal Reserve appeared to give a more cautiously optimistic outlook. The S&P 500 rallied more than 1 per cent, the Nasdaq jumped 2 per cent and the 2yr Treasury note yield fell to a two-week low.
European stocks rose in early trade following the decision but with the European Central Bank and Bank of England later there is no let up.
The Fed hiked 25bp as expected, with chair Jay Powell saying “it would be… very premature to declare victory” on inflation but that “the disinflationary process has started”.
Truth be told there were mixed signals from the Fed statement. It kept the “ongoing increases” language, added inflation “has eased somewhat”, and changed “pace” of future increases to “extent”, as it transitions from rate of hikes to duration. Powell also mentioned “a couple more rate hikes”, which gave a bit more detail around the end point – question is whether this is in fact the end point and how long it stays there.
Powell said that since December they’d covered a lot of ground and financial conditions have tightened “very significantly over the last year”… but still said a lot of work to do. I find the lack of push back on financial conditions odd. The easing in recent months has been clear and in December the Fed seemed keener to push back. Perhaps it’s not that bothered as long as it keeps seeing core inflation come down, but it was odd that journalists in the press conference did not take him to task on those comments.
Bank of England: do the doves change tune?
Inflation is not coming down fast enough, and the Bank of England will likely respond with a 50bps hike. In December the Bank hinted at slowing to 25bps, but wage pressures are elevated and inflation is sticky.
Another split vote is likely as we continue to see genuine disagreement between members of the Monetary Policy Committee. My sense is that the Bank will be able to sound a little more optimistic on the economy given the decline in energy prices and the market pricing for rate hikes; whatever the IMF thinks. But more optimism on the economy doesn’t tame inflation – this goes to the heart of the conundrum facing central banks right now. As soon as they lift their foot off the brake pedal the inflation engine runs away from them.
As per the ECB, a lot of the market moves we will see will be less about the front end and the immediate hiking cycle, but whether the BoE starts to shift its medium-term inflation outlook on rising wages and more persistent price pressures. That might signal a more hawkish BoE stance longer term.
If forecasts for constant rate inflation are close to 2 per cent, then the Bank is close to the peak – maybe one more 25bps hike in March. This would take the Bank rate (assuming 50bps today) to 4.25 per cent. Governor Bailey has said that market pricing for the terminal rate around 4.4 per cent was correct. What is less well understood is the extent to which structural labour market tightness pushes up longer-term forecasts for inflation, which would force the Bank into a more hawkish pose.
Hiking not done for ECB
A 50bps hike seems like a done deal. The question is whether Christine Lagarde guides for another 50bps in March, and what the market thinks the upcoming staff forecasts – also due March – will mean for the future path of rates. Data out Tuesday merely confirmed 50bps is a certainty as French inflation rose to 6.0 per cent from 5.9 per cent in December. The harmonized index which the ECB looks at rose to 7 per cent from 6.7 per cent.
- Base case: with no staff forecasts, I’d anticipate no changes to growth/inflation outlooks, a 50bps hike + indication very likely to do similar in March. QT nod with APP ending this year.
- Hawkish: Lagarde could warn on inflation persistence, sticking firmly to 50bps in March and hinting at more hikes required beyond then.
- Dovish: inflation slowing/growth contracting more than thought, 50bps but not committed to another, could slow to 25bps in March and stop.
Neil Wilson is the Chief Market Analyst at Finalto
