Sunrise Market Commentary – ActionForex

Markets

Yesterday, the Fed decided on monetary policy for the second time under chair Warsh. As this Fed chair abstained from giving direct forward guidance on upcoming Fed policy steps, markets went into the decision with some more than usual uncertainty left on the outcome. Still, at his first policy meeting in June, Fed Chair Warsh delivered a straightforward message. As the economy and the labour market are doing quite well, the Fed can focus on inflation. Inflation already for quite some time is elevated compared to the Fed inflation target. The Warsh Fed simply ‘promised’ that it would deliver on its price stability mandate. Not words (forward guidance), but actions. The market gave it a chance. However, maintaining credibility on this commitment yesterday proved not easy. The Fed kept interest rates unchanged (3.50%/3.75%). No real surprise, even as money markets discounted a 30% chance that the Fed would already put its money where its mouth is. (25 bpn increase). Three (regional) governors also voted in favor of an increase. However, during the press conference, Fed Chair Warsh failed to clearly explain why the policy committee didn’t already take action now or at least what concrete further developments are needed for the Fed to act. The market gradually started to question the strength of the Fed’s inflation commitment. Even as conditions had tightened since the previous meeting, markets apparently also indicated that they couldn’t do the job alone. At some point they need backing from Fed action. Short-term interest rates fell. The market now estimates the chance of a September hike at only 65% (was 100%). Contrary to the flattening post last meeting, the US yield curve this time steepened sharply. The 2-y yield declined 1.5 bp, but the 30-y rose 11.2 bps. The price of credibility! The 30-year yield rose to 5.23%, the highest since 2007! The dollar equally lost credibility. EUR/USD rebounded to close near 1.1465 (from 1.139). DXY finished at 100.88 (from 101.43). The yen only gained modestly (USD/JPY close 163.4).

Earlier in the day, UK and EMU interest rates in particular rose sharply due to the renewed tensions regarding the war between the US and Iran, and higher energy prices. (2-5-y EMU + 7 bpn). The higher (long-term) interest rates during the Fed press conference also kept the stock markets on the defensive (S&P 500 -1.52%).

This morning, Asian equities again show a mixed picture. The dollar regains some modest ground (EUR/USD 1.145). Brent oil rises further to currently trade well above $91 p/b as tensions in the Middle East are rising again. (US) yields build on yesterday’s rise.

A very busy eco calendar today with, amongst others, preliminary Q2 GDP figures in the US and EMU and PCE inflation figures/deflators (June) in the US. The latter predate the renewed tension around Iran. After Fed Chair Warsh’s performance yesterday, it remains to be seen how the market may assess (temporary) milder figures. Not so easy without some form of guidance by the central bank. Several EMU countries (including Germany, Spain, Belgium) will publish inflation figures for July. After the Fed yesterday, the BoE today will decide on monetary policy. The BoE has a new economic update available. Governor Bailey and its MPC are widely expected to keep the BoE policy rate unchanged at 3.75%, even as some more hawkish oriented members (2?) might raise the case for a rate hike. That said, at the previous meeting, the majority of the MPC considered fragile growth and risks to the labour market at least as important as inflation when balancing their policy assessment. The jury is still out, but if the majority maintains this bias, it probably won’t help sterling. EUR/GBP yesterday extended its gradual comeback (close near 0.8575). Aside from the data and BoE decision, markets of course still will have to cope with an apparent re-escalation of the conflict in the Middle East. This suggests a further rise in risk premia, in the first place for (LT) bonds, but potentially also on other parts of the market.