• The Fed lifted policy rates by 50 bps to 4.25-4.50% at its final policy meeting of the year yesterday. The slowdown from the previous 4×75 bps was telegraphed well in advance. December’s statement was an exact copy of the November one and stated that ongoing increases in the policy rate will be appropriate. The new forecasts contained several hawkish elements, including an upward revision in PCE inflation, both headline and core. The Fed now assumes 3.1% headline price growth (3.5% core) in 2023, 2.5% (2.5%) in 2024 and 2.1% (2.1%) in 2025. Stubborn and above-target inflation requires more rate hikes, with the central bank penciling in a 5-5.25% terminal rate through 2023. That’s 50 bps higher than the September forecasts. The distribution in estimates was widely skewed to the upside with 7 out of 19 policy makers expecting the peak (well) above the median and only 2 below that level. In 2024, and not before – as stressed by chair Powell during the press conference – the Fed sees room for rate cuts. The longer-term (neutral) rate was unchanged at 2.5%. The December dot plot triggered a knee-jerk move higher in US yields across the curve (>10 bps intraday) but the move didn’t make it through the end of the press conference. Powell didn’t push back on the recent sharp easing of financial conditions as hard as he could have and suggested an at least equal possibility of a 25 bps hike instead of 50 at the next meeting. According to money markets it’ll be the former and that will be the end of it. There was a slight outperformance in the belly of the curve (up to 10y). This may reflect recessionary concerns, which was also slightly visible on equity markets (-0.76%, Nasdaq). GDP growth has indeed been lowered to 0.5% in 2023 and 1.6% in 2024. The unemployment rate was revised higher to (an admittedly still relatively low) 4.6% in the next two years. Yields fell between 0 and 3.7 bps on a net daily basis. The dollar quickly returned post-dot plot gains to finish lower. EUR/USD closed at 1.0682. DXY eased to 103.77.
• Up next: the ECB and Bank of England. Both will raise rates by 50 bps to 2% and 3.5% respectively. Frankfurt will in addition lay the groundwork for quantitative tightening, which we expect to start soon in 2023. It’ll be a gradual process during which the ECB won’t fully reinvest proceeds from maturing bonds. Doing so extracts excess liquidity from the market, something which the central bank is also achieving through voluntary TLTRO repayments. There will be new forecasts here too. Reuters citing sources yesterday reported that inflation is seen “comfortably above” 2% in 2024 and still just above target in 2025. This would be an important signal to markets. The Bank of England is holding an interim meeting but it’s still worth watching. If there even was a case for a 75 bps move, then UK CPI yesterday (easing slightly more than expected) has dismissed it. Back in November, Sunak’s fiscal plans couldn’t be taken into account yet. In essence, they kick the austerity can down the road with spending cuts mostly kicking in from 2024 on. Today’s meeting (minutes) may shed some light on how this affects BoE policy going forward.
• Australian November labour market data beat consensus this morning. Net job growth increased by 64k, almost evenly split between full time and part time occupations. October figures were also upwardly revised from 32.2k to 43.1k. The unemployment rate stabilized at 3.4%, but this occurred against an unexpected increase of the participation rate from 66.6% to 66.8%, the highest level on record. The strong labour data suggest that the Reserve Bank of Australia has more room to extend its tightening cycle, starting with another 25 bps rate hike in February. Australian money markets put the cycle peak at 3.75% compared to the current rate of 3.1%. AUD swap yields add 5 to 7 bps across the curve this morning, but the Aussie dollar fails to capitalize on it. AUD/USD trades near recent highs around 0.6850.
• Stellar third quarter New Zealand GDP figures keep the more hawkish RBNZ at course as well. Quarterly growth came in double expectations (even of the RBNZ) at 2% with the Q2 figure upwardly revised from 1.7% Q/Q to 1.9% Q/Q. The annual growth pace stood at 6.4% Y/Y. The Q2 and Q3 growth spurt comes following lockdown-triggered negative growth in Q1. Details showed that net exports drove growth with service exports up 25.7% Q/Q on the recovery of inbound travel. Domestic demand was weak with household consumption falling 0.1% Q/Q and government spending 1.4% Q/Q lower. NZD swap yields added 14 to 18 bps, but the yield support also fails to boost the kiwi dollar around NZD/USD 0.6450. The risk-off setting could be holding back both NZD and AUD.
The ECB ended net asset purchases and lifted rates by a combined 200 bps since the July meeting. More tightening is underway but the ECB refrained from guiding markets on the size of future hikes. Germany’s 10-yr yield rose to its highest level since 2011 (2.5%) before a correction kicked in. Losing the neckline of the double top formation at 1.95% calls for a return towards the 1.82%/1.77% support zone.
The Fed policy rate is expected to peak above 5% early 2023 and remain above neutral over the policy horizon. The December Fed dot plot confirms our view but markets aren’t buying it. After a 50 bps in December, they expect one last 25 bps move next year. Recession fears dominate. The move below the neckline of the double top formation at 3.91% gave more downside potential towards the June top (3.5%) and 50% retracement (3.42%).
USD for the largest part of this year profited from rising US (real) yields in a persistent risk-off context. But EUR/USD left the strong downward trend channel since February as the current correction on bond markets caused turnarounds on FX and equity markets as well. Key resistance at 1.0341/50/68 gave away. The next zone is/was situated at 1.0611 first, followed by 1.0747/1.0806.
The UK government ditched lavish fiscal spending plans which sent sterling tumbling towards the EUR/GBP 0.90+ area. Yawning twin deficits and elevated risk premia will continue to weigh on the UK currency longer term. The Bank of England stepped up its tightening with a 75 bps rate hike, but warned simultaneously that UK money market expectations about peak cycle are too aggressive. EUR/GBP remains near key support at 0.8559/67.
This document has been prepared by the KBC Economics Markets desk and has not been produced by the Research department. The desk consists of Mathias Van der Jeugt, Peter Wuyts and Mathias Janssens, analists at KBC Bank N.V., which is regulated by the Financial Services and Markets Authority (FSMA). Read the full disclaimer.
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