Fed pauses rate hike cycle as expected but projections show, surprisingly, two more hikes this year. US PPI data points to moderating inflation data. Treasuries curve flattens

Markets have been whippy with weak US PPI data and the FOMC update driving market movements. As we go to print, the USD is broadly weaker and the NZD has notably outperformed overnight for no obvious reason. The Treasuries curve has flattened with only small net changes on the day, while US equities have oscillated and are currently flat.

After ten successive rate hikes, the Fed left the target range for the Fed Funds rate unchanged at 5-5.25%, as widely anticipated. The pause in policy was “to assess additional information and its implications for monetary policy”. The Fed maintained a tightening bias, with similar forward guidance to that expressed previously, being data dependent “in determining the extent of additional policy firming that may be appropriate.”

The initial market reaction was one of being surprised to the hawkish side, with the new set of projections showing the median FOMC member expecting two more rate hikes, compared to one extra hike being widely anticipated. The “dots” showed a clear majority seeing the need for at least two more rate hikes, with 9 out of the 18 members at two hikes, two members at three hikes and one member at four more hikes. At the dovish end of the spectrum, four members thought one more hike would be appropriate while two members saw policy unchanged over the rest of the year. The subsequent years showed even more divergent views, but with the median expecting 100bps of cuts next year.

The economic projections showed a modest upgrade to activity and core inflation estimates for 2023, but this should be seen in the context that the March projections came soon after the failure of Silicon Valley Bank. Projections for 2024 and 2025 were little changed.

Heading into the announcement, US Treasury rates and the USD were lower following weaker than expected PPI data (see below). Post FOMC, there was a notable reversal, with US Treasury rates higher, led by the short end, and the USD paring its prior loss. As Fed Chair Powell spoke, that initial market reaction faded. Powell noted that the pause was a continuation of moderating the pace of rate hikes and he conveyed a sense of data dependency.  He wouldn’t frame the rates decision as a “skip”. While he wasn’t explicit, a skip would imply there’s more hikes to come and he didn’t seem prepared to commit to that view.

From a pre-FOMC level of 4.62%, the 2-year rate traded up towards 4.80% but has since slipped back to 4.7%. The 10-year rate has traded a range of 3.76-3.85% and currently sits down slightly for the day. Market expectations for Fed hikes has not changed significantly. The OIS market prices a 15bps hike for July, similar to the pre-FOMC level, and a cumulative 20bps is priced by September, suggesting that the market isn’t fully pricing in one more hike let alone two.

The USD has been whippy, falling after the PPI report, paring the fall after the FOMC statement, and falling again as Chair Powell spoke. The weaker USD saw an outsized move for the NZD as it broke above it 50-day, 100-day and 200-day moving average and reached a high around 0.6235.  Post-FOMC the NZD has whipped around the 0.62 level but has maintained its outperformance on all the key crosses. NZD/AUD has pushed up to 0.9130, NZD/GBP is up through 0.49, NZD/JPY is approaching 87 and NZD/EUR is higher at 0.5740.

As noted, US PPI data were weaker than expected, with lower gasoline prices dragging the headline rate down 0.3% m/m and taking the annual increase to 1.1%. The core PPI rose 0.2% m/m and 2.8% y/y. Stripping out trade services, which measures gross margins for retailers and wholesalers and can be volatile, the core figures were even better, running at pre-COVID levels. The data added to the mounting evidence of a weaker pipeline of inflationary pressure.

In other news, the WSJ reported that “the Biden administration has quietly restarted talks with Iran in a bid to win the release of American prisoners held by Tehran and curb the country’s growing nuclear programme.” The US approved €2.5b in payments by the Iraqi government for Iranian imports that had been frozen by economic sanctions and diplomatic relations have resumed indirectly using Oman as a go-between. The thawing of relations between US and Iran matches the speculation reported elsewhere last week that led to a fall in oil prices on fear of increased Iranian supply.  This has limited the damage to oil prices overnight and they show a modest fall of just over 1% for the day.

Yesterday, global forces pushed up NZ rates, with swaps and NZGBs up 4-6bps across much of the curve, a modest outperformance on a cross-market basis. There was no reaction to NZ data releases. NZ’s annual current account deficit for Q1 was much better than expected at 8.5% of GDP, but was a still terrible figure in absolute terms. However, it was a step in the right direction after the upwardly revised 9% of GDP deficit for 2022. Food price inflation also moved in the right direction, with annual inflation dropping from 12.5% to 12.1%, with leading indicators suggesting a significant decline ahead over the coming year, which will feed weaker headline CPI inflation.

In the day ahead, REINZ housing market data should convey some stability in the market after the extended downturn in activity and pricing. We’re in the camp that expects Q1 GDP to come in slightly negative and thereby signal that a technical recession began from Q4 last year. Globally, there will be a lot of data to digest including Australian employment data, China monthly activity data, US retail sales and a host of other US activity indicators. The ECB meets tonight, where a 25bps hike in the deposit rate to 3.5% is widely expected and priced, with the forward guidance likely to signal more tightening required.