Central bank rate hike expectations harden
A further rise in oil prices – fuelled by Trump’s announcement that “we are reinstating the Iranian blockade” – and hawkish Fed commentary contributed to higher bond yields, weaker equity markets and a (modest) firming of the dollar. The US currency traded up to highs of about $1.1380 and $1.3340 versus the euro and sterling respectively during the course of yesterday’s session before easing a touch. EURGBP is little changed from yesterday morning’s levels at around £0.8525. There’ll be plenty of focus on today’s CPI inflation data for June in the US following remarks yesterday by Fed Governor Waller, who said “if we get another hot reading on core inflation this week, then (the Fed) will need to consider tightening monetary policy in the near term”. As it happens, both headline and core inflation are expected to have eased last month according to the consensus forecast, to 3.8% and 2.8% respectively from 4.2% and 2.9% in May, but we’ll have to wait and see. Also today, Fed Chair Warsh testifies on the outlook for the US economy and monetary policy at the House Financial Services Committee.
With oil prices surging to over $85 per barrel, market expectations for central bank rate hikes are hardening notably. About 65bps and 60bps of hikes over the next year or so are now priced in for the Bank of England and ECB respectively, up some 25bps and 15bps since last Friday’s close, while about 55bps of hikes is priced in for the Fed over the same period, up 10bps or so since the end of last week. Moreover, the market expects all three to deliver a 25bps rate increase by September. The firming of rate expectations is contributing to a sizeable increase in government bond yields, led by the short-end of curves with 2-year yields up by 10-20bps across the main markets. In equity markets, US indices sold off, with the Nasdaq down more than 1.5% at the New York close. European stocks had earlier finished flat on the day, though they are off almost 1% at the open this morning.
Fed Governor Waller says “he would need to see several months of lower readings to feel that inflation is moving in the right direction (in order) to continue to hold the policy (interest) rate at its current target range.” While he believes there is a reasonable chance of such an outcome, he warns that “if we get another hot reading on core inflation this week, then the FOMC will need to consider tightening monetary policy in the near term”. He notes that “we are at a crossroads for (interest rate) policy, and the appropriate action will depend on incoming data.”
For the day ahead, the focus will be on the US CPI data and Warsh’s appearance in Congress. Other economic data due include the small business optimism index, real hourly earnings, and ADP weekly employment report in the US, while other central bank speakers include Bank of England Governor Bailey, who delivers his annual Mansion House address later.