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As expected, the meeting was quite a bit of a subdued occasion, with markets not exhibiting any particular shift change. My ATW thoughts from Monday established the concept of maximum optionality, which is a rational equilibrium in terms of policy setting for the committee as a whole. I think that’s where the FOMC set itself up after yesterday’s meeting.
In addition, the somewhat theoretical concept of rules-based monetary policy settings would still suggest that rates are appropriate for a 3% inflation world and that forward pricing is consistent with a 2% inflation world. I’ve written about this here.
Bond markets didn’t shrug yesterday. This makes sense. From now on, their reaction is tied to economic outcomes. Data-dependent as we were. I will, therefore, focus much more on the likely path of economic data going forward and what to look out for.
As the burden of proof in order to enact another rate hike is now firmly data-driven, the Fed committed itself to keep policy restrictive while anticipating growth to slow and employment to soften. The most notable change was that Jay didn’t press on about the necessity to hike further but rather emphasised that there won’t be an imminent easing either.
Looking at market pricing, September has 6 bps and November 5 bps of hikes priced in. To me, that seems still a bit too low. Also, I would expect the bulk of this to be priced into the September meeting. The Fed will have 2 more payrolls, 2 more CPI reports and other relevant consumer and economic data to gather where momentum is taking them. It is simple: Either September is in play or not. If September is not in play, I see a very small chance of November being live.
Much emphasis, again, was given to the lagged effects of all cumulative tightening as well as a pass-through from credit channels. The word “restrictive” is featured several times, indicating that there is a prevalent will and need for the economy to slow.
SOFR rates are still showing 4%+ rates at the end of 2024, which is far from where we are assuming neutral rates (2.5%) to be.
As anticipated, the curve had a small steepening bias. USD sold off slightly, and after a short pause, risk and commodities have continued their march higher.
Just purely looking at 2-year yields and their weekly change wouldn’t reveal anything spectacular that just happened as the market correctly anticipated this July meeting. Over the past week, the 2-year yield is unchanged.
Over to you madame Lagarde!