We’ve seen a fairly muted market response following the end of a relatively more hawkish FOMC meeting last night where, as largely priced in, the Fed hiked rates by 25bps, to 1.75%-2.00%. Of note, however, was the flattening of the UST curve, which saw the 2s10s spread fall below 40bps to September 2007 levels (at time of writing). Meanwhile, the dollar took a tumble; this could also be due to the reignition of US-China trade tensions which we expect to hear more on as both sides have said they will publish tariff lists as early as tomorrow.
In terms of forecasts, the Fed upgraded: unemployment expectations to 3.6%, growth to 2.8% and core PCE to 2%. On inflation, Fed Chair Powell reiterated a tolerance for a target overshoot following the recent pick-up in headline expectations off the back of higher oils prices, adding that the Fed is “not ready to declare victory on inflation”.
As for other revisions, the dot plot nudged higher to price in a further hike this year (taking it to 4 rate rises in total, so a further two), driven by an upward revision of one member (so the central bank remains split). Bloomberg is however still only pricing in one more hike (currently), in September, and Powell restated a gradual approach to normalisation. We also heard that starting next year the Fed will hold a press conference after each meeting rather than every quarter; where in the past there has been a higher chance of a hike than non-presser meetings, thus removing some predictability, although throughout this tightening cycle the central bank has clearly telegraphed any and all chances of a hike ahead of time.
Interestingly, the People’s Bank of China refrained from increasing its repo rate following the Fed hike; the PBoC has increased its money market rate four times during the US tightening cycle. Following the previous Fed hike back in March, the PBoC did state that there was no guarantee that it would continually hike money market rates alongside the Fed. As the country strives to deleverage, we expect the PBoC will maintain a neutral stance, however, a cut to the reserve requirement ratio may follow, especially after the broadly softer series of activity data releases this morning, for May.