Every central bank last week went for the ‘price stability’ mandate as its biggest concern, which is completely understandable. We expect the same this week with each central bank that meets. However, how the banks went about moving policy to start to reign in price inflation caused anything but stability.
We only need to look at the fallout from the Federal Reserve’s FOMC’s May meeting. As expected, it raised the federal funds rate by 50 basis point (bps) to a range of 0.75 per cent – 1.0 per cent the voting was unanimous. Big ticket showing unified conviction – However there was surprise when Powell asserted that 75bps or more were not actively considered and will not be considered going forward. That ends Jamie Bullard’s hawkish wishes – or will it?
The FOMC made it clear that is core focus is inflation and expectations and signalled this will likely mean more tightening to come most likely in the form 50 bps hikes likely at the next two meetings. Powell even went as far to say the FOMC would not hesitate to push rates above the neutral rate which is believed to be between 2 per cent and 3 per cent. The Board finally outlined how it intends to reduce its balance sheet. Starting 1 June, the Fed will reduce is holdings at a pace capped at $47.5billion per month – $30 billion in Treasuries, $17.5 billion in mortgage-backed securities but will step up to $95 billion a month from September.
The initial reaction was one of positiveness because apparently this gave ‘clarity’ and the Board signalled that this would see the US economy having a ‘softish’ landing. That idea evaporated 24 hours later when its cross-Atlantic peer in the Bank of England (BoE) suggested that wouldn’t be possible for the UK. As expected, the BoE hiked its cash rate by 25bp to 1.0 per cent interestingly it was fair from clearly cut with the MPC voting 6-3. The 3 dissenters where not voting against it they were advocating a 50bp hike so even more hawkish than expected.
But what sent markets into a spin and hit global confidence was the BoE’s quarterly forecasts – fuelling the idea the UK is in for stagflation. According to the BoE there is a large risk of a “significant adverse impact of the sharp rises in global energy and tradable goods prices on most UK households’ real incomes and many UK companies’ profit margins.” This lead the Board to conclude that CPI would “average slightly over 10% at its peak in 2022 Q4” and forecasts zero GDP growth over the year to Q2 2023 and could even decline.
In short the UK is forecasted to possibly see a recession, with high inflation and rising unemployment. Which then got the market asking – If it can happen in the UK why not the US as well?
That point was hammered home on the release of the US non-farm productivity. In the 3 months to March 2022 productivity fell 7.5% from +6.3 per cent in the prior quarter. It’s the worst quarter of productivity since 1947. There is a good reason for this productivity is likely to be reversing after the rapid acceleration seen during the pandemic and low-wage workers return to the labour pool, but it doesn’t bode well. The final fall out from all this was the USD to rallied hard against all G10 currencies The US EUR/USD fell a low of $1.047 its lowest level since January 2017 and new
GBP/USD crumbled falling 2.7 cents or -2.2% to $1.2360 as the Bank of England’s rate hike was wiped out by its outlook now at its lowest level in 2 years.
USD/JPY rose from ¥129.10 to ¥130.25 a new 20 year high.
AUD/USD fell from $0.7250 to $0.7115, a 2 per cent fall, with a low of $0.7077.
Stability is a long way away in the current environment.