Powell wary over credit tightening.

The Federal Reserve increased interest rates by 25 basis points to 5.00% which was in line with consensus forecasts and the vote was unanimous. There was a shift in the statement with the committee considering that rate hikes may be needed as opposed to comments last time that it anticipated that on-going rate hikes would be appropriate.

In the latest projections on interest rates the dot plots forecast rates at 5.1% this year, unchanged from the previous estimate. The 2024 forecast was raised slightly to 4.3% from 4.1%, but the committee still expects that rates will decline next year.

Chair Powell reiterated that the baseline scenario was for no rate cut this year, but there was fresh speculation that rates had peaked.

Powell remained uneasy over the inflation outlook, especially as there had been no progress in reducing core inflation outside the housing sector, and he reiterated there was still a long way to go in the process of getting inflation back down to 2%.

According to Powell, recent banking events might result in tighter credit conditions which would have an impact on the economy and how the Fed responds. Powell also indicated that credit conditions will be an important element and in principle can be seen as equivalent to a rate hike and that monetary policy will have less work to do.

There were gains in US Treasuries after the Fed decision and Powell’s press conference with stronger expectations that rates could have peaked. The 2-year yield declined to below 3.90% with the 10-year yield around 3.45% on Thursday.

The shift in Fed guidance and decline in yields was important in undermining dollar support. After a slide to 6-week lows, the dollar index recovered as equities dipped sharply, but there was renewed selling on Thursday with the index again testing 6-week lows.

The Bank of England will announce its latest interest rate decision on Thursday. Although bank economists are still split, markets are pricing in close to a 100% chance of a further rate hike to 4.25%. Forward guidance from the bank will be an important element for markets.

Consensus forecasts are for a further increase of 50 basis points by the Swiss National Bank to 1.50%.

The dollar dipped sharply in immediate response to the Fed policy decision. A shift in guidance and possible peak in rates undermined the US currency. With expectations of further ECB rate hikes, EUR/USD jumped to 6-week highs above 1.0900. After a brief slide, EUR/USD traded back above 1.0900 on Thursday.

As US yields dipped, USD/JPY also posted sharp losses to near 131.00. Credit tightening fears provided some yen protection. USD/JPY dipped to lows just below 130.50 on Thursday.

The Swiss franc lost ground on relatively hawkish ECB expectations. EUR/CHF strengthened to 0.9980, although USD/CHF dipped sharply to lows around 0.9150 after the Fed decision.

Commodity currencies posted gains after the Fed decision and, after a slide as equities dipped, there were fresh gains on Thursday. AUD/USD peaked above 0.6750 before trading around 0.6735 on Thursday. USD/CAD dipped to lows just below 1.3660 before consolidating around 1.3675.

Economic Calendar