The Fed raised the interest rate by 50bp for the first time since 2000 and said there will be more 50bp hikes in the coming meetings. And the major US indices rallied as the Fed played down the possibility of a 75bp hike.
That’s the magic of expectations.
The reduction of the Fed balance sheet will start with an initial combined amount of $47.5 billion and reach the $95 billion level within three months.
The S&P 500 rebounded 3% as Nasdaq, which had started the day in the negative ended the day 3.40% higher, at around 13'535. The Dow gained 2.80% as well, and all this Fed optimism sent a positive wave to the global equities, as European stock indices rallied more than 2% in the overnight trading, shrugging off the weakness of yesterday, that was mostly due to the rally in oil prices on news that Europe would finally ban the Russian oil and gas.
At this point, many expect the Fed to raise the rates above the neutral-rate estimate of about 2.5% by the end of this year to tame inflation, and Bloomberg economists believe that the balance sheet will come back to the pre-pandemic levels by 2024. But we will still be only halfway from the levels pre-2007/2008 subprime crisis. Therefore, there is still a lot of room for more Fed hawkishness.
How hawkish the Fed could get depends on inflation.
ADP disappoints
Yesterday’s ADP report showed that the US economy added nearly 250’000 new private jobs in April, which came in well below the near-400K expected by analysts. And more critically, the data showed that businesses with less than 50 workers shed jobs, highlighting the challenges that small businesses are facing in the actual high inflation environment. And these small businesses account for around 40% of the US economic activity, meaning that the inadequately dovish policy that the Fed conducted so far is doing more harm than good to the economic tissue.
Therefore, the weakness in the US jobs figures doesn’t necessarily mean that the Fed would change the course of its policy in the coming months.
Yesterday’s decision sent the US 10-year yield below the 3%, and the dollar index dived below the 103 mark, but the Fed hawks will remain in charge of the market despite the weakness that we may see in economic data from here.
BoE to raise as well
The Bank of England (BoE) is also expected to raise its policy rate by 25bp to 1% at today’s monetary policy meeting to tame the rising inflation in Britain. That would be the fourth straight rate hike to push the bank rate to a 13-year high in England.
The hawkish tone from the BoE hasn’t helped sterling recover against the US dollar over the past months. Cable rapidly came around the 1.25 mark after slipping below the 1.30 support about two weeks ago, and today’s decision will certainly not change the bearish trend as it is clear that the US dollar is the one that leads in this dance.
Oil up
Energy prices remain under a decent positive pressure as the European nations now consider walking away from the Russian oil as the next step of the economic sanctions that they impose on Russia as a result of the war in Ukraine.
But the European decision is not OPEC’s problem. OPEC countries will stick to their plan to increase the daily output by around 430K barrels per day. On the other hand, the OPEC countries haven’t been able to meet the daily quotas over the past couple of months, so it doesn’t really make sense to have quotas in place if the producer countries fall repeatedly behind their target.
There is also a political power battle around oil supply, as OPEC remains allied with Russia, and plays against the US' will to increase the oil output and the OPEC countries are not willing to replace the Russian oil. Therefore, the OPEC decision will only play a minor role in energy prices.
The war in Ukraine, the sanctions on Russian oil, combined to capacity restrictions, other disruptions like attacks and social unrest in oil producer countries, and the lack of investment should continue increasing the gap between supply and demand and give investors enough reason to remain bullish in oil in the short to medium run.
But, it also looks like the oil rally will likely remain capped below the $120/130 area, as above this price range, the slowing demand could also slow the rally. Therefore, the levels we saw at the beginning of the Ukrainian war, maybe the peak levels.