The Fed hiked rates 75 bp, as expected; Powell sounded a bit more measured at his press conference; Fed tightening expectations have picked up significantly; U.S. yields have recovered; May retail sales came in soft; June regional Fed manufacturing surveys will continue rolling out
The BOE hiked rates 25 bp to 1.25%, as expected; the ECB emergency meeting yielded nothing but disappointment; ECB tightening expectations remain elevated; the SNB surprised markets with a 50 bp hike to -0.25% and signaled a shift in its FX intervention policy
The BOJ began its two-day meeting today and is expected to keep all policy settings unchanged when it ends tomorrow; Japan reported May trade data; Australia reported strong May jobs data

The dollar has recouped much of its post-FOMC losses. DXY is trading back near 105.23, just below the new high for this move near 105.65 on Tuesday. We maintain our next target as the December 2002 high near 107.30. The euro is testing $1.04 again as the emergency ECB meeting yielded nothing of substance (see below). The May 13 low near $1.0350 remains in play and after that, we have to start talking about parity. The weakening trend in the yen has stalled, with USD/JPY trading back near 133 on renewed risk-off impulses after making a new cycle high near 135.60 yesterday. As risk-off impulses fade and BOJ dovishness comes back into view tomorrow, we believe the pair will eventually test the August 1998 high near 147.65. Sterling remains heavy near $1.2050 after a disappointing BOE decision (see below). We continue to target the March 2020 low near $1.1410. Lastly, Swissie is outperforming after the SNB surprised with a 50 bp hike (see below). With the Fed maintaining a very hawkish stance yesterday, higher U.S. yields should continue to underpin the dollar.

AMERICAS

The Fed hiked rates 75 bp, as expected. Kansas City Fed President George dissented in favor of a 50 bp hike, presumably to maintain consistency in the Fed’s communications. The Fed said that is sees ongoing rate hikes to be appropriate. There was a very hawkish shift in the Dot Plots (see table below), while Quantitative Tightening will proceed at the announced pace. This was all pretty much all anyone could hope for if the Fed really wants to get ahead of the curve.

Powell sounded a bit more measured at his press conference. He said ““Clearly, today’s 75 bp increase is an unusually large one and I do not expect moves of this size to be common,” adding that a 50 or 75 bp hike is likely at the July meeting. We’ve said it before and we’ll say it again: policymakers should neither pre-commit nor take anything off the table. In such an uncertain environment, it is simply much more prudent to maintain maximum optionality. Yet markets took Powell’s press conference as somewhat dovish and so equities and bonds rallied into yesterday’s close. Today, markets are waking up to the fact that the Fed is still moving ahead with its aggressive tightening and so equities and bonds are giving back much of yesterday’s gains.

Indeed, Fed tightening expectations have picked up significantly. WIRP suggests a follow-up 75 bp move July 27 is nearly 75% priced in. Then, 50 bp hikes September 21 and November 2 are fully priced in, followed by 25 bp hikes December 14 and February 1. This is pretty much unchanged from before the meeting. What’s really changed is that the swaps market is now pricing in a terminal Fed Funds rate between 4.75-5.0% over the next 12 months, up from 4.0% ahead of the FOMC meeting and 3.0% at the end of May. This seems way too high to us and we think market expectations are likely to calm in the coming days.

New macro forecasts and Dot Plots were released. The Dot Plots show Fed Funds at 3.4% in 2022, 3.37% in 2023, and 3.375% in 2024. At the same time, forecasts show growth slowing, unemployment rising, and inflation easing but no recession. The Fed is forecasting a successful soft landing and this is obviously a bit of a different approach than the BOE, which explicitly forecast a recession at its May meeting.

U.S. yields have recovered. The 10-year yield is trading near 3.45% and nearing the recent peak near 3.50% on Tuesday, which was the highest since April 2011. Inflation expectations remained fairly steady and so as a result, the real 10-year yield has risen to 0.76% and nearing the recent peak near 0.82% on Tuesday, which was the highest since February 2019. Elsewhere, the 2-year yield is trading near 3.37% and nearing the peak near 3.45% on Tuesday, which was the highest since November 2007. When all is said and done, we believe monetary policy divergences remain the dominant driver for FX. As the U.S. economic outlook remains the best relative to its DM peers, we believe the dollar uptrend remains intact.

May retail sales came in soft. Headline sales came in at -0.3% m/m vs. 0.1% expected and a revised 0.7% (was 0.9% in April), while sales ex-autos came in at 0.5% m/m vs. 0.7% expected and a revised 0.4% (was 0.6%) in April. Lastly, the so-called control group used for GDP calculations came in flat m/m vs. 0.3% expected and a revised 0.5% (was 1.0% in April). As a result, Q2 GDP took a bit of a hit as the Atlanta Fed GDPNow model is now tracking 0.0% SAAR vs. 0.9% before the sales data. Of note, Bloomberg consensus sees 3.0% SAAR growth in Q2 but we suspect this will come down after the retail sales miss.

June regional Fed manufacturing surveys will continue rolling out. Philly Fed is expected at 5.0 vs. 2.6 in May. Yesterday, Empire survey kicked things off and came in at -1.2 vs. 2.3 expected and -11.6 in May. May IP will be reported tomorrow and is expected at 0.4% m/m vs. 1.1% in April. Despite the weak Fed surveys for May, the manufacturing sector remains in solid shape. May building permits, housing starts, and weekly jobless claims will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

The Bank of England hiked rates 25 bp to 1.25%, as expected. The vote was 6-3, with the dissents in favor of a larger 50 bp move. WIRP had suggested significant odds of a 50 bp move and so the market is clearly disappointed. With the Fed, SNB, and other central banks delivering 50-75 bp hikes, today’s 25 bp move seems weak. WIRP suggests a 50 bp move at the August 4 meeting is fully priced in and 50 bp at the November 3 meeting is nearly 75% priced in. Looking ahead, the swaps market is now pricing in 200-225 bp of tightening over the next 24 months that would see the policy rate peak between 3.25-3.50% vs. 3.50% at the start of this week and 2.5% in late May. Given today’s disappointing BOE outcome, sterling is likely to remain under pressure and we continue to target the March 2020 low near $1.1410.

The ECB emergency meeting yielded nothing but disappointment. Besides repeating the previous pledge to use PEPP reinvestments to help prevent fragmentation, the bank said it has told staff to prepare a new crisis tool for approval. Shouldn’t this have been ready to go last week when it announced an end to PEPP? Once again, the ECB is struggling to stay ahead of the curve. We think most in the market knew that when they ended PEPP, the ECB needed to have something ready to replace it. They didn't. Yet peripheral spreads have come in for the second straight day. It seems the ECB may have bought itself from time, which we hope it uses wisely to come up with a comprehensive, credible plan to address fragmentation.

ECB tightening expectations remain elevated. WIRP suggests a 25 bp hike July 21 is fully priced in. Then, 50 bp hike are now priced in for the subsequent three meetings on September 8, October 27, and December 15 that would take the deposit rate to near 1.25% by year-end. Looking ahead, the swaps market is now pricing in 300 bp of tightening over the next 24 months that would see the deposit rate peak near 2.5% vs. at the start of this week and 1.75% before last week’s meeting.

The Swiss National Bank surprised markets with a 50 bp hike to -0.25%. One major bank had called for a 25 bp hike but most observers (including us) had penciled in September for liftoff. It’s the first hike in 15 years and comes as inflation is running above target, which led to some upward revisions to the SNB’s forecasts. However, the revisions were modest as Switzerland is not facing the type of price pressures that the U.S. and eurozone are. SNB President Jordan said “We do not exclude further rate hikes, but we are also not in the business of forward guidance.” The updated forecasts don’t suggest any rush to tighten. However, the swaps market is pricing over 350 bp of tightening over the next 12 months that would see the policy rate peak near 3.25% vs. 1.25-1.50% at the start of this week.

More importantly, the SNB signaled a shift in its FX intervention policy. It dropped any reference to the franc being “highly valued,” while Jordan said the bank will remain active in the FX market and could intervene in both directions. The market quickly took EUR/CHF down to trade near 1.01694, the lowest since April 19. The swaps market is pricing in greater monetary policy divergence between the SNB and ECB, which argues for further losses in EUR/CHF ahead. Clean break below 1.01798 would set up a test of the March low near .99723. We expect markets to test the SNB’s tolerance for a stronger franc in the coming weeks.

ASIA

The Bank of Japan began its two-day meeting today and is expected to keep all policy settings unchanged when it ends tomorrow. Updated macro forecasts won’t be released until the next meeting July 21. While the bank is unlikely to signal any shift in its monetary stance, officials may express some concern about renewed weakness in the yen. The yen is seeing some relief today as risk-off impulses drove USD/JPY down to 132.35, the lowest since June 7. Yet as long as the BOJ remains ultra-dovish, the yen will continue to weaken as risk-off impulses fade. Jawboning is all we are likely to see for now as any FX intervention would be going against the fundamentals and likely doomed to failure.

Japan reported May trade data. Exports came in at 15.8% y/y vs. 16.1% expected and 12.5% in April, while imports came in at 48.9% y/y vs. 44.0% expected and 28.3% in April. Exports have held up surprisingly well, while imports are clearly getting boosted by higher energy prices. While the trade balance has been in deficit since mid-2021, the current account remains in surplus from investment income due to Japan’s status as a net creditor nation.

Australia reported strong May jobs data. There were 60.6k jobs created vs. 25.0k expected and a revised 4.4k (was 4.0k) in April, while the unemployment rate remained steady at the 3.9% cycle low as the participation rate jumped to 66.7% vs. 66.4% in April. The details were good, as 69.4k full-time jobs were offset only slightly by -8.7k part-time jobs. The RBA has expressed concerns about rising wage pressures when this rate falls below 4.0% and so it will remain on high alert. WIRP suggests a 50 bp hike is fully priced in for the next meeting July 5,, with over 25% odds for a larger 75 bp move. Looking ahead, the swaps market is pricing in 375 bp of tightening over the next 12 months that would see the policy rate peak near 4.60%, up from 4.0% at the start of this week.