In a closely watched move, the Federal Reserve opted to maintain interest rates, aligning with market expectations. However, what followed were revisions to its economic forecasts and interest rate projections, steering them towards an upward trajectory. Reflecting a recent streak of resilient US economic data, the Fed bolstered its growth predictions for both 2023 and 2024. This subtle shift in tone suggests that the looming specter of an imminent recession has now receded. Crucially, the updated 'dot plot' indicates one more rate hike for this year and fewer rate cuts for the following year. Specifically, Federal Open Market Committee (FOMC) officials anticipate interest rates closing at 5.1% by the end of 2024, a 50 basis point increase from their previous projection of 4.6% in June. Consequently, the Fed now envisions only two rate cuts for the upcoming year, down from the four expected earlier.
The Fed's Pledge to Prolonged Higher Rates
In essence, the Federal Reserve unveiled an optimistic economic outlook and adjusted its rate trajectory to signify that interest rates will remain at elevated levels for a more extended period. This overarching message was underscored by Chairman Powell himself.
The market response to this recalibration of the first anticipated Fed rate cut has been to push it out to one year from now. This, in turn, bolstered US Treasury yields, with the ten-year yield surging to levels not seen in 16 years.
Dollar Takes Center Stage; Equities and Gold Step Back
The US dollar emerged as the primary beneficiary of the Federal Reserve's revised rate path, reaching its highest level in 11 months against the low-yielding Japanese yen. The dollar now boasts a unique combination of robust economic fundamentals, high interest rates, and safe-haven appeal. In stark contrast, other major currencies like the euro grapple with dwindling economic growth, escalating fuel prices, and substantial exposure to slowing Chinese demand. This economic divergence is increasingly likely to manifest itself in FX rates in the foreseeable future.
Meanwhile, Wall Street encountered losses on Wednesday as the prospect of elevated interest rates for an extended duration proved detrimental to riskier assets like stocks. Market valuations are stretched by historical standards, and rising yields often serve as the 'remedy' that compresses valuation multiples, which was indeed witnessed following the Fed's decision.
Simultaneously, a backdrop of surging yields and a strengthening dollar spells trouble for gold, which faced a sharp downturn after the Fed announcement, failing to breach the $1,947 mark. Nevertheless, gold remains relatively resilient, standing 7% below its record highs despite US yields reaching their highest levels in decades. This suggests that there is substantial 'real' demand, possibly from central banks looking to augment their gold reserves.
BoE's Decision - A Coin Toss
As the spotlight shifts to the Bank of England today, the market consensus for this rate decision is nearly evenly split. The latest inflation report revealed figures lower than anticipated, causing markets to perceive this rate decision as almost a 50-50 coin toss. On one hand, data trends argue against any immediate action. Job losses in July coupled with stagnant economic growth and ongoing discouraging business surveys all seem to reinforce the case for no rate hike. The lone factor favoring a rate increase is the scorching wage growth, which continues its upward trajectory.
Regarding the British pound, the balance seems tilted towards the downside. Even if the BoE does choose to raise rates, the vote is expected to be split, and the officials are unlikely to commit to further action. Consequently, any initial FX upswing resulting from a hike may be brief, while the pound could face an immediate downturn if rates remain untouched.
Elsewhere, the Swiss National Bank recently kept rates unchanged, putting pressure on the Swiss franc. The Bank of Japan will seize the spotlight early on Friday, with limited prospects for any policy modifications. This leaves the battered yen vulnerable to further depreciation as interest rate differentials continue to widen against it.