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Higher peak, slower pace

Stocks tumbled, and the dollar raced higher after the Federal Reserve raised interest rates by 75bps and signalled the ultimate peak for interest rates will be higher than previously thought. Market reaction was initially positive for risk, with the following line in statement regarded as dovish: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” It very clearly that the Fed wants to slow down a bit to see what it’s done so far. 

In the presser, Powell said that at some point it will become appropriate to slow pace of hikes, and that point may come as soon as December. But then he started to sound hawkish. There was a very clear reaction in the market to Powell saying “data since our last meeting suggests that the ultimate level of interest rates will be higher than expected”. So, a higher terminal rate, and higher for longer seemed to be the message. In other words, we will down slow but no pivot, Powell stressing the “need for ongoing rate increases...ground left to cover...it is very premature to be thinking about pausing". Markets ultimately took it as hawkish and risk took a hit. 

Stocks decline

The S&P 500 finished down 2.5% and closed below its 50-day SMA. The Dow Jones shipped more than 500pts and the Nasdaq Composite decline more than 3.3%. European stock markets have taken the cue and are down by around 0.5-1% in early trade after a similarly soft Asian session. China Caixin Services PMI fell to 48.4 from 49.3, the lowest since May. 

Dollar stronger

The Fed’s hike and the resultant sharp move higher in Treasury yields bolstered the dollar which has risen to two-week highs. The dollar index trades around 112.50 this morning, its best since Oct 21st. EURUSD takes a 97 handle and GBPUSD is below 1.13 ahead of today’s Bank of England decision. 

BoE still cautious?

The Bank of England is also expected to raise rates by 75bps. The appointment Jeremy Hunt as chancellor, subsequent rollback of the mini-Budget measures and the arrival of Rishi Sunak in Number 10 has sent gilt yields falling and the pound higher – boosted by macro trends and a weaker dollar running into last night’s Fed meeting at least. This gives the Bank more wriggle room and it is likely to go for 75bps rather than 100bps as had been anticipated in the wake of the mini-Budget in September.  

Deputy governor for monetary policy Ben Broadbent pushed back against notion the MPC would hike all the way to 5% as implied by markets. This was the most assertive attempt to say the market has overdone it when pricing rate hikes by the Bank. He may be fighting a losing battle though, as the Fed showed last night CBs are not seeing much if any impact from hikes (mon pol does lag a fair bit) and will need to keep on squeezing it higher. They just don’t want the market to price in a higher terminal rate today, in contrast to the Fed. 

In short, expect 75bps, though unlikely to be unanimous vote. Downside risks to the economy heightened, fiscal policy drag means slower growth, but less requirement to raise rates. Inflation likely to stay high. Cable is sharply lower this morning reflecting downside risks for sterling from the announcement. TLDR: Dovish jumbo hike with no good news. 

However, the moves in sterling this morning indicate everyone expects a very cautious Bank of England will say 75bps is not the new normal, citing downside risks to the economy and the tighter fiscal policy. A such if it surprises with a more hawkish line, GBP would react extremely positively. But it could surprise on the dovish side with a 50bps, which would be sterling negative.

Later today

US ISM services PMI, weekly unemployment claims data comes ahead of tomorrow’s nonfarm payrolls. ADP numbers yesterday were surprising good. Earnings today come from Barrick Gold, Moderna, Amgen, Block Inc, Coinbase, Illumina, PayPal, Starbucks, Twilio, Virgin Galactic. 

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