Fed hikes 75bps, at least 150bps more hikes projected in 2022. But not as hawkish as it might have been. ECB emergency meeting promises new instrument

Lots of action in markets overnight, before and after this morning’s FOMC update. The net result sees rates lower and equities are higher. The S&P500 up more than 1% as we go to print. In currencies, the USD is weaker and commodity currencies higher as broader risk appetite improves. AUD has surged nearly 2%, up to 0.70. NZD is up more than 1% approaching 0.63. USD/JPY has fallen back below 134. Conditions remain volatile post this morning’s Fed announcement.

The FOMC lifted the Fed Funds rate by 75bps to a range of 1.50-1.75%. While market polls were for a 50bp move, expectations had moved post last week’s strong US CPI reading and media commentary such that a 75bp move was fully anticipated on the day. Kansas Fed President George dissented, arguing for a 50bp hike at this meeting. This was one of a few signals that gave an impression of a statement that was not as hawkish as it might have been.

The accompanying statement noted the Fed is ‘highly attentive to inflation risks’ and ‘strongly committed to returning inflation to its 2% objective’. The Fed anticipates that ongoing increases in the Fed Funds rate will be appropriate.

The FOMC’s median projection for the Fed Funds sits at 3.375% by the end 2022, implying at least 150bps more hikes over the remaining four meetings this year. This may well include a follow up 75bp in July, but it is not a given with Chair Powell in the press conference noting that ‘we don’t expect moves of this size to be common’ with reference to today’s move. Again, not as hawkish as might have been.

The median projection shows the Fed Funds at 3.75% by end of 2023, before easing to 3.375% by end of 2024 (albeit within a wide range of views from 2.125% to 4.125%). The median long run dot has edged up to 2.5% from 2.375%. So the plot reveals a desire from the Fed to get a move on with rate hikes – as if it wasn’t obvious from today’s chunky 75bp hike. But progress will be data dependent.

The statement acknowledged activity appears to have picked up after edging down in Q1, a robust labour market, and elevated inflation. The war in Ukraine and lockdowns in China were noted with implications for activity, supply chain disruptions, and creating additional upward pressure on inflation. GDP forecasts were revised lower over coming years, while 2022 PCE inflation was revised sharply higher but a tick lower through 2023 (now 2.6%) and 2024 (now 2.2%) compared to March forecasts. Of course, there was a sense of data dependency with the FOMC ‘to monitor the implications of incoming information for the economic outlook’.

We won’t dwell on the detailed moves, as they remain volatile as the market further absorbs the FOMC statement and Chair Powell’s ongoing press conference. But US rates are generally lower and the curve steeper. As we go to print, markets still favour a 75bp hike in July, but it is not fully priced as it was pre meeting. Market pricing for the Fed Funds peak in mid-2023 has slipped back below 4%. US 2-year bond yields are down around 19bps, while US 10-year yields are down around 10bps – extending the slide over the past 24 hours aided by lower European yields.

News, after the local close yesterday, that the ECB were to hold an emergency ad hoc governing council meeting to discuss market conditions (sparked by a widening in peripheral spreads) saw an immediate improvement in risk appetite. In a short statement, the GC pledged to act against resurgent fragmentation risks. The GC decided that ‘it will apply flexibility in reinvesting redemptions coming due in the PEPP portfolio’, to preserve the function of monetary policy transmission. The GC also mandated to accelerate the completion of the design of a new anti-fragmentation instrument.

European bonds rallied hard overnight, ahead of the Fed, with 10-year core yields down in the order of 11-16 bps. Peripheral spreads crunched back in, with 10-year bond yields in Greece down around 45bps and in Italy down circa 36bps. The EUR initially rose, poking above 1.05 at one point, before reversing back under 1.04.

After approaching 3.50% yesterday, US 10-year rates pulled back to around 3.35% at one point before stabilising around 3.40% ahead of the Fed.

In data news, US retail sales disappointed by falling 0.3% in May against expectations of a small rise. Auto sales slumped 3.5%. But various core measures also undershot expectations. These nominal sales look even weaker when adjusted for still strong inflation. The soft results saw the Atlanta Fed’s GDPnow Q2 estimate cut from 0.9% to flat.

Earlier, the BoJ announced buying operations of unlimited 10-year JGBS at 0.25%, driving a sharp drop in Japanese 10-year bond futures, ahead of the next meeting Friday.

Yesterday, China’s May activity data was slightly better than expected across industrial production, fixed asset investment, and retail sales. For the latter, it was a case of less weak with the annual 6.7% drop in sales better than the -7.1% expected and April’s -11.1%, as COVID restrictions continue to weigh. But the somewhat better than expected data helped Chinese equities outperform, with the CSI300 index closing up 1.3%. Before the data, the PBoC left its key one-year interest rate unchanged at 2.85%. Meanwhile, Shanghai recorded two cases out of quarantine. In keeping with China’s zero COVID policy, Shanghai will conduct mass testing in residential compounds every weekend through to the end of July.

In NZ, REINZ housing data for May continued the trend of a weakening housing market with fewer sales and falling prices. The house price index fell 1.6% in the month to now be 7.7% back from its November peak. This suggests house prices are tracking lower (or at least earlier) than the RBNZ had factored into its May MPS.

Markets paid no attention with NZ bond and swap curves extending their sharp increases from the local get-go yesterday. Yields were pulled higher as follow through from the prior offshore session along with its flattening bias as markets reprice the outlook for central bank action. Market pricing for the OCR is now favouring a 75bp move rather than a 50bp move in July and a decent chance of a follow up 75bp hike in August. NZ 2-year swap rose to its highest level since 2010, closing 16 bps up on the day at 4.555%. NZ 10-year swap increased 12bps, to just over 4.57%. NZGB 10-year yield rose 7bps, an outperformance relative to swap and a large outperformance relative to the circa 25bps lift in ACGB 10s during the NZ session.

Yesterday’s Q1 current account data matched expectations with an annual deficit equivalent to 6.5% of GDP. So no market reaction, but it continues the theme of a rapidly widening external deficit adding to the hallmarks of an overheated economy as well as the potential to put more downwards pressure on the NZD as we expect the external deficit to widen further yet.

In other news, Australia’s minimum wage is to be lifted 5.2%, to $A21.38 per hour, following Australia’s Fair Work Commission’s review. A bigger increase than the recent past and adds to confidence that wage growth will pick up. The changes are expected to mostly show up in Q3 data.

In the day ahead we are picking a flat Q1 NZ GDP result against market and RBNZ expectations of 0.6-0.7%. We wouldn’t overplay a weak or negative outturn, as the quarter was negatively impacted by Omicron restrictions and a strong bounce-back in Q2 is expected. But sticker shock from a poor result could cause a fleeting market reaction. Australia’s employment report is expected to be strong, with the unemployment rate falling to a fresh multi-decade low of 3.8%, keeping the heat on the RBA to quickly normalise monetary policy. The Bank of England meets tonight and the market anticipates only a 25bps hike, going against the grain of larger hikes elsewhere, given the economy looks to be on the leading edge of economic recession.