UST yields higher and USD stronger as Powell signals a higher terminal rate for the fed funds rate
UST yields higher again this morning – up 4-6bps across the curve to be about 10bps (or more) higher from this time yesterday – after Jay Powell yesterday made clear in his post-FOMC press conference that the terminal fed funds rate for the current hiking cycle is likely to be higher than previously suggested by the Fed’s dot-plot. Powell also insisted again that the FOMC planned to remain restrictive “for some time”, and reiterated that he judged the risks of tightening insufficiently to be greater than the risks of tightening too much. So, futures and swaps are also now pricing a greater likelihood that the FFR tops out above 5.00% next year. And the dollar’s stronger again, with the yen back close to ¥148/$.
Comments outweigh impact of subtle hint of slower pace of future hikes in the FOMC statement
Initially, of course, the market had moved in the opposite after the FOMC’s statement provided the expected 75bps rate hike (to 3.75-4.00%) and signal that the increment of rate hikes to come should be somewhat smaller. Most notably, mimicking comments from ECB President Lagarde last week, the statement noted that policymakers in coming months will take into account the cumulative effects of policy changes and the lags in policy adjustments. This implied that the Committee was aware of risks associated with over-tightening and would seek to avoid such a policy mistake. But the statement did not directly indicate that a slower pace of tightening would be under consideration in December, and rate decisions will remain data-dependent. For more discussion of the Fed, please see the comment of our US economists here.
BoE likely to hike Bank Rate by 75bps to 3.00%
While the Fed’s hike yesterday was fully expected, the BoE’s policy announcement today is somewhat less certain. Like the consensus, we expect to see the MPC raise Bank Rate by 75bps to 3.00%. However, with conditions in the Gilt market now stable, the BoE’s first round of quantitative-tightening related Gilt sales having passed smoothly this week, sterling firmer than of late, and certain MPC members having cautioned that market pricing of future tightening was probably too aggressive, particularly in light of the tightening of financial conditions – not least via higher mortgage rates – since the mini-budget, the risks to that view are skewed to the downside.
The size of the rate hike will, in good part, depend on the BoE’s updated economic forecasts. Despite the recent rise in inflation to double-digits and continued evidence of a very tight labour market, the government’s decision to cap the increase in household energy bills between October and April means that the near-term inflation forecast will be significantly lower than projected in August. Moreover, data also suggest the economy contracted in Q3 by more than the BoE previously expected (by as much as 0.5%Q/Q vs the BoE’s forecast of -0.2%Q/Q), and high inflation will likely result in further contractions to come, which should help inflation fall back in due course.
But with the Sunak government having postponed its fiscal update until 17 November, there remains a lack of clarity surrounding the magnitude of further increases in household energy bills from April on, as well as the extent of forthcoming public spending restraint and tax measures that are likely ultimately to result in a tightening of the fiscal stance. And it remains to be seen what the BoE will assume in this respect for its projections. Nevertheless, given continued tightness in the labour market we continue to expect the MPC to flag concerns about domestically-generated inflation, justifying the hike of 75bps. And the BoE’s updated forecasts will maintain expectations of further hikes to come, albeit perhaps suggesting a terminal rate below the current market-implied rate of 4.75%.
In addition to Governor Bailey’s post-meeting press conference, external MPC member Catherine Mann is due to speak later this evening on a panel discussion at a webinar on the world economy’s inflation challenge.
UK final services PMIs likely to confirm a marked decline in activity at the start of Q4
In terms of data, the final UK October services and composite PMIs are due. The flash release had signalled a marked deterioration in activity at the start of Q4, with the services index down 2½ pts to 47.5, the weakest since January. And while the modest upwards revision to the manufacturing output index might see the preliminary composite PMI (47.2) revised a touch higher it will still be consistent with a contracting economy.
Euro area unemployment rate likely to remain at a series low
Today will bring September unemployment rates from the euro area and member states, with the aggregate jobless rate for the region expected to have moved sideways at the series low of 6.6%. The latest Spanish labour market numbers for October exceeded expectations, with jobless claims unexpectedly falling on the month, by 104k to the lowest since October 2008. Separately, numerous Governing Council members are due to speak today, including President Lagarde at a Latvian central bank conference.
US services ISM, productivity and trade reports due
It will be a busy day for US economic data. The services ISM is expected to have eased slightly in October, with tighter financial conditions likely to have weighed on activity and new business in the sector. Nevertheless, the anticipated drop of more than 1pt in the headline index to 55.3, would still represent a solid performance in a challenging environment. Productivity numbers for the third quarter are expected to report a modest pickup following sharp declines in the prior two quarters, although a solid increase in compensation suggests another firm increase in unit labour costs, albeit softer than the surge of 10.2% in Q2. September’s trade report and factory orders numbers are also due.