- Eyes on the Fed's interest rate decision tonight
- Is the action priced in?
- Crude oil rallies on EU sanctions
It’s all about the Fed meeting today. The Fed is about to attempt to untie the Gordian knot of inflation with a sledgehammer. Fed funds futures indicate 95 per cent of 125bps of hikes over the next two meetings, so we are likely to see 75bps at either May or June meetings if the market has read the Fed correctly... incredible pricing really that underlines just how far the Fed has pivoted in the last couple of months. Consensus for today is very much for 50bps, priced at 100 per cent likelihood, with a 91 per cent chance of 75bps coming in June.
Overall market pricing indicates ten 25bps of hikes this year and today’s interest lies not in whether it’s 75 or 50, but what the likely path is for the rest of the year. I think the Fed will reiterate that the only thing it is looking at right now is getting inflation back under control and Powell will in all likelihood leave 75bps-100bps type moves on the table, though the consensus remains for 50bps at this meeting. The risk is very much skewed to the upside and 75bps is entirely plausible. To give you an idea of just how much ground the Fed needs to make up, the Taylor rule would put fed funds rates at more than 10 per cent. This, I think, means we see the Fed act swiftly and front-load the hiking over this summer: the mantra is to go hard and fast. Meanwhile the terminal rate now seen around 3 per cent, about 70bps higher than before and the Fed is seen reaching this earlier than previously thought. Market participants anticipate the Fed to commit to an aggressive balance sheet run-off, too.
Anyway, if the market has priced this, is there room to rally? Paul Tudor Jones yesterday made the case that this is a ‘70s environment and it’s a horrible time to be investing in stocks or bonds... “You can’t think of a worse environment than where we are right now for financial assets,” he said Tuesday on CNBC. “Clearly you don’t want to own bonds and stocks.” BofA last week said much the same: “...good news on EPS, war, China COVID, Fed finally hiking properly can aid sentiment near-term, but... still think 1973/74 analogy worthy, inflation means Fed must tighten until it breaks the economy or the market; until it does asset prices must reset lower.” After the Q1 contraction in the US economy, we’re already looking as to what Q2 might look like. Atlanta Fed calls for +1.9 per cent, which is low enough to suggest a recession is on the cards since the GDPNow data is always some way out. The initial estimate of first-quarter real GDP growth released by the US Bureau of Economic Analysis on April 28th was -1.4 percent, 1.8 percentage points below the final GDPNow model nowcast released on April 27th. Jolts all-time high yesterday at 11.5m... factory orders up big... suggests employers can continue to raise wages.
Stock markets in Europe were broadly lower in early trade on Wednesday after Wall Street notched its second straight day of gains. The Hang Seng fell 1.5 per cent overnight as sentiment around tech stocks was hit by news Didi (DIDI) is being investigated by the SEC over its $4.4bn US IPO. Meanwhile US 10 year rates were back under 3 per cent, gold holds the break under $1877 but is off its lows this morning.
Crude oil rose as the EU said it would phase out Russian oil by the end of the year. WTI rallied over 2 per cent and continues to chop around through the April range at $105. Obviously it’s going to be tricky to remove all Russian fossil fuels as not all members are equally in favour of the plan, but it’s showing the direction of travel. EIA crude oil inventories are later today, seen at -0.7m. API figures showed inventories fell by 3.5 million barrels for the week ended April 28th. Russian oil is one thing, but what about natural gas? That’s a much harder habit to shake.
The dollar rose handsomely through April but by the end was touching multi-year tops, levels above 103 that have previously been the top and catalysed a move lower again. Friday last week finally saw some profit taking and a pullback. Looking perhaps for the first Fib level around 100.50 to be retested. Question is whether this looks like a topping pattern or a consolidation pattern before resumption of the uptrend?
As commented on last week, we might have already seen max CB divergence – that is, the point in time when markets are pricing for the most extreme divergence between the Fed and other developed central banks. We find out more whether that’s the case with the Bank of England tomorrow – does the MPC want to kick inflation or is it worried about the economy? My view is that inflation is an evil that is worth defeating come what may. Meanwhile there are signs that the European Central Bank is finding the Fed’s aggressive actions hard to ignore. "Talking is no longer enough, we need to act... a rate increase in July is possible in my view,” says the ECB’s Schnabel.
Neil Wilson is the Chief Market Analyst at markets.com
