Thursday, 28 July 2022
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•          The Fed as expected lifted policy rates by 75 bps to what is now considered a neutral 2.25/2.50%. Chair Powell made clear that more tightening is appropriate as inflation remains high and the labour market still strong. And although the new statement mentions the softening in spending and production indicators, Powell refused to accept the US is already in a recession. Regarding the size of the next hikes, Powell didn’t give any guidance. Decisions will be made “meeting by meeting” and determined by incoming data. Another “unusually large” (ie 75 bps) move could be possible if warranted by the data but slowing down the pace could be equally appropriate “at some point”. If anything, the June dot plot offers the best guidance for now, he added. That’s telling because in it the Fed expects more hikes in 2023. This compares to markets already pricing in rate cuts. All in all, the onus is still very much on inflation. The Fed is willing to sacrifice growth with Powell reiterating that doing too little would turn out to be more costly. However, this is not how markets read it. The possibility for going slower from September on, even though this was by and large expected as US money markets didn’t budge a single bit, combined with the “dovish” twist in the statement was seen as a policy pivot. Stock markets surged more than 4% (Nasdaq) and the US yield curve steepened. Yields dropped 5.7 bps at the front and added 4 bps at the longest tenors. The dollar slipped in a knee-jerk reaction against most peers. EUR/USD rebounded from intraday lows sub 1.01 to 1.02, also supported by significant Bund underperformance. Yields added almost 10 bps in the 2y. The trade-weighted dollar index gave back gains of the day before to finish at 106.45. USD/JPY capped losses to 136.57.

•          The USD remains on the back foot in Asian dealings. Equity markets follow WS’s performance by advancing up to 1.5%. US Treasuries seem to backtrack already on yesterday’s gains. German Bunds have a much clearer downward bias, following a strong regional inflation print in NRW ahead of the national release this afternoon. It provides a glimpse of the European reading due tomorrow and it seems another upward surprise is in the making. It may keep German/European yields better protected after the recent sharp decline. For (ST) US yields Q2 GDP will be important. We’re not expecting it after yesterday’s solid batch of June (trade, capex and inventory) data, but in case of a negative figure (ie a technical recession), yields probably have room to ease. Markets would see it as a confirmation of yesterday’s presumed pivot. The USD may be in for a tactical pause but we don’t believe in a sharp and sustained correction lower. With the euro strategically under pressure, we see EUR/USD’s topside limited to south of 1.03.

News Headlines

•          New Australian Treasurer Jim Chalmers revealed that the government now assumes growth for this fiscal year (2022/23) of 3.0%. 2023/24 growth is even expected to ease further to 2.0%. For both years, the growth outlook is 0.5% lower compared the pre-election forecast. The new government expects inflation to peak at 7.75% (was seen at 4.25% previously). It now sees inflation at 5.5% in 2022/23 and at 2.75% in 2023/24. Unemployment is expected to rise to 3.75% next year and 4.0% in 2024 from the current historic low 3.5%. With expected wage rises of 3.75%, real wage growth is still expected to be negative the coming year. Economic data published this morning confirmed the cooling of spending due to higher prices. June retail sales unexpectedly slowed to 0.2% from a downwardly revised 0.7%. The Reserve bank of Australia meets next week and another 50 bps rate hike is largely expected. The Aussie dollar this morning stabilizes just below 0.70 after a USD driven rise yesterday.

•          The US Democratic Party reached an agreement on a broad budget and spending bill. According the Senator Joe Manchin who long opposed the Biden spending plans, it should be called the ‘inflation reduction act of 2022’ rather than the ‘Build Back Better’ act. The bill foresees an increase corporate taxes (including an higher corporate minimum tax and better enforcement of existing taxes) helping to reducing the national debt by $300bn but at the same time raising investments  in energy technology and lower the cost of prescription drugs for which $430bn in additional spending is foreseen.


The ECB ended net asset purchases and lifted rates with a 50 bps inaugural hike. More tightening is underway but the ECB refrained from guiding markets on the size of future rate hikes. Economic indicators however show growth is stalling or even contracting. Markets doubt whether tightening may last in 2023. Germany’s 10-yr yield extended a correction lower. Important support at 1.12% and at 1.03% are broken.

The Fed started an aggressive tightening cycle. It hiked to neutral by a back-to-back 75 bps in July. The size of future moves depend on the incoming data. QT will hit max speed by September. Markets discounted a good deal already for 2022 while focus is at least as much on growth currently. A batch of weak economic data brought the 10y yield back to the lower bound (2.72% area) of the sideways trading range.

The euro zone’s (energy) crisis is being accompanied by an Italian political crisis. Growing recession fears hammered EUR/USD below the 2017 low of 1.0341. Parity was tested before a technical (USD-driven) correction higher kicked in. A tactical dollar pause is at hand but the euro remains strategically under pressure. It takes a return above EUR/USD 1.035 to call off the immediate downside alert.

A combination of euro weakness, PM Johnson’s exit clearing some political fog, a correction in the oil price and the BoE reiterating, potentially stepping up its anti-inflation commitment, triggered a sterling short squeeze early July. EUR/GBP fell below the established uptrend before finding support around 0.84. A balance of weakness could keep the pair in a sideways 0.84/0.86 trading range. Euro weakness is a risk.

Calendar & Table

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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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