Fed hikes 25bps, the same as the NZ OCR. Fed keeps options open, maintains slight tightening bias. US rates and USD down modestly after Fed Chair spoke

Market reaction to the Fed’s widely anticipated 25bps hike has been modest. There was little immediate reaction, but after Chair Powell spoke Treasury rates fell a little, US equities turned positive after a modest pre-FOMC fall, and the USD slightly weakened.  The NZD is back trading over the 0.62 mark.

As widely anticipated, the US Fed raised its policy rate by 25bps, taking the Fed Funds target range to 5.25-5.5%, a 22-year high. Compared to June, there was only a small tweak to the Statement, assessing that recent economic activity had been expanding at a “moderate” pace (upgraded from “modest”). There was no acknowledgement in the Statement that inflation has fallen as the Fed maintained the comment “inflation remains elevated”.

Forward guidance was left unchanged as “In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” So this left the impression of a modest tightening bias that kept alive the chance of another hike later in the year, consistent with market expectations.

In his press conference, Fed Chair Powell outlined that the Fed would be data dependent and that meant at the next meeting in September the Fed could hike or hold steady. The Fed was taking a meeting by meeting approach.  While the slowdown in June CPI was welcome, it was only one month – the process of getting inflation to 2% has a long way to go. Powell also noted that the real Fed Funds rate was a at a meaningfully positive level.

Ahead of the Fed statement the market was trading cautiously, with US equities down modestly, the Treasuries curve slightly flatter (2-year rate up a touch and the 10-year rate flat at 3.89%), and the USD flat for the day. Not surprisingly, there was little immediate post-Statement reaction. As we go to print, Chair Powell is still speaking, but after his early comments, Treasury rates have fallen modestly, the USD is modestly weaker and US equities have turned positive. The market is pricing a high chance of the Fed skipping a hike in September and with a slightly less than even chance of another 25bps hike by November.

Yesterday, Australian Q2 headline and trimmed mean inflation figures were slightly weaker than both market and RBA forecasts, the core measure coming in at 0.9% q/q and 5.9% y/y. This saw the market pare back expectations for a possible RBA hike next week from a 60% chance down to about a 25% chance. Lower Australian rates drove the AUD down, but the fall in the AUD has now been retraced.

The weaker AUD spilled over into a weaker NZD yesterday, taking it back below 0.62 before recovering those losses within a few hours. Ahead of the Fed meeting the NZD had drifted back down to 0.62, and as we go to print it has pushed higher. The top of the Fed Funds target range and the RBNZ’s OCR rate are now both equalised at 5.5% and our central case is that these rates are held steady through the rest of the year, imparting little influence on the NZD. NZD/AUD is trading near 0.92, modestly higher since the low Australian CPI print.

Other major currencies show modest movements over the day, with the small USD fall post-FOMC resulting in modest gains for most majors overnight.

The domestic rates market had a quiet session. Rates were marked higher from the open on the back of offshore moves overnight and then lower Australian rates drove NZ rates back down. There was minimal net change in the swaps curve while NZGBs closed the day up 1-2bps across most of the curve.

On the calendar, a 25bps hike from the ECB to take the deposit rate up to 3.75% is almost a sure thing. The market’s focus will be on the following September meeting and, with still-strong core inflation, President Lagarde will want to keep alive the option of further policy tightening.

US Q2 GDP growth is expected to come in at a respectable 1.8% annualised. Durables goods orders, initial jobless claims, trade and pending home sales data round out the calendar.