Was it all that hawkish? Markets recovering poise after Fed meeting

Morning Note

European stocks fell slightly in early trade Thursday, following Asia (ex-China) and the US into the red after the Federal Reserve signalled it thinks rates will rise a year earlier than previously forecast. Bonds fell, with US 10yr yields up to 1.59% before easing back a touch to 1.56% this morning, and the 2yr hitting its highest in a year. The dollar rallied on expectations of tighter US monetary policy, with sterling back under $1.40 and the euro under $1.20. Gold is weaker amid the strong USD, higher yield picture. Oil remains bid after another bullish inventory report.

 

The Fed’s much-maligned dot plot signalled policymakers believe there will be two rate hikes by the end of 2023, vs the previous zero moves until 2024. The interest rate on excess reserves was raised by 5bps – worries about inflation perhaps.  It’s a technical move, but it points to the direction of travel: tighter not looser. The forecasts for this year were a lot punchier – 7% GDP growth and 3% core inflation. The market took all this as unvarnished hawkish – certainly it paves the way for an Aug/Sep taper announcement. Powell also dialled back the transitory language around inflation. 

 

So, was it all that hawkish? I thought we’d stop bothering with the dots a long time ago – Powell said you should take them with a “big grain of salt”. As I said a couple of years ago, “decisions to cut or hike are binary and tangible; dots are like dreams; imaginary and fluid. They also cannot account for things when there is very great, and very real, uncertainty in the economy”. None of the policymakers know what’s going to happen tomorrow, let along in 2023 – they are not fortune tellers. I don’t think it told us much we shouldn’t already have expected – the April meeting minutes showed the Fed is thinking about thinking about tapering, while rates are going to remain anchored at zero for a couple more years. Powell said this meeting was the talking about talking about tapering (and said this phrase should be retired). Lift off not until after 2023 always seemed unlikely given the pace of the reopening and Fed is reflecting this – we can all see the data coming in every week – these dots only get wheeled out every quarter and since the March projections things have clearly improved – it is not a surprise that Fed policymakers have noticed.

 

But the meeting did signal a shift on inflation: confidence in the labour market + economy is still there but they are just a shade more concerned about inflation, which might be seen as odd since they were expecting it and some hot readings this summer were guaranteed. But there is a clear sense they are less confident in the transitory narrative. Indeed, the shift in the number of policymakers forecasting hikes in 2023 can probably be attributed to a couple of hot inflation prints we have had since the last projections. Whilst growth and inflation forecasts for 2021 were raised substantially, projections for growth, unemployment and inflation for 2022 and 2023 were almost unmoved. It’s saying – we saw those CPI numbers, don’t worry.

 

“Inflation could turn out to be higher and more persistent than we expect,” Powell said in the presser. In some ways this tells us less about the Fed’s view of 2023 and more about the concerns of some policymakers right now, that they are presiding over an overheating economy, and they need to get back in front of the curve PDQ.  They’re not saying the economy is going to be booming in 2023, it’s just that the dots are a way to express concern about inflation today.

So far not much damage: The S&P 500 closed just half a percent lower. European markets are a shade lower this morning but hardly tumbling. The Fed is communicating its views reasonably well and has managed to signal its intent to tighten without actually doing anything. The question remains over whether inflation becomes more troublesome before labour market recovery is established, which could force the Fed into tightening before it would like and forcing a recession.

Amid all this, bank stocks liked the hawkishness as higher yields help them, with shares in Barclays and Lloyds both up about 2% this morning. Airline stocks are also higher this morning amid reports ministers are looking to ditch quarantine rules for Brits travelling to amber list countries who have had both jabs. IAG rose 3.5%, EasyJet +4% and Ryanair +3.8%. Finally CureVac stock dropped 50% after its vaccine candidate showed an efficacy of just 47%.