The Fed takes a break before a final encore

Despite a plethoric agenda, last week saw no major disruptions on Wall Street or in the dollar capital markets. This calm can be explained by a flow of news and decisions largely in line with investor expectations.

US inflation annual inflation rated continued to recede in May, settling at 4.0% after peaking at 9.1% in June 2022. However, “core” inflation, excluding energy and food, remains problematic, with increases of 0.4% month-on-month and 5.3% year-on-year. This pace, well above the 2.0% target, does not allow the Federal Reserve to claim victory. The battle to restore price stability has not been won, but the fall in producer prices (-0.3% monthly, 1.1% year-on-year) is a welcome development.

Unsurprisingly, the FOMC meeting ended with a pause in a cycle following ten consecutive interest rate hikes for a cumulative 500 basis points. This unanimous decision allows Jerome Powell and his colleagues to better understand the lagged effects of previous interest rate hikes and the stress episode that hit the regional banks.

The updated economic projections point to a further interest rate increase of between 5.5% and 5.75%, which would imply two further hikes, whereas CME futures now predict only one Fed funds rate hike on July 26. Despite this minor disagreement, investors are well aware that they should not expect any monetary easing before the end of the year. The “pivot” is expected in 2024, which is realistic and in line with the FOMC members’ projections, which suggest a reduction in the key interest rate to 4.6% by the end of 2024 and 2.5% in the “long term”.

Recent indicators tend to confirm the strength of household demand (rising retail sales and improving consumer confidence), while manufacturing activity is stagnating. These comforting developments look like a green light for the rate hike expected in July.

In Europe, the ECB’s decision to increase its three key interest rates by 0.25 % came as no surprise. The statement hints at further tightening to restore price stability. Indeed, the central bank revised upwards its inflation forecasts excluding energy and food to 5.1% for 2023 and 3.0% in 2024 (i.e. 0.5 points higher than predicted in March), citing rising unit labor costs. During the press conference, Christine Lagarde clearly hinted at a further interest rate hike in July, but was cautious about the trajectory of monetary policy from September onwards. A pause in September or in the fourth quarter still seems likely. In any case, the end of the interest-rate hike cycle no longer seems far off. The ECB’s hawkish message has caused the euro yield curve to steepen. While the yield on the 10-year German Bund has risen above 2.5%, the yield on the 2-year Schatz is now close to 3.1 %.

Outside the euro area, yields in sterling and the Swiss franc are also trending upwards as we await the monetary policy meetings of the Bank of England and the Swiss National Bank, which are also preparing to raise their key interest rates by 0.25%.