The Fed intensified its commitment to its inflation target last week, accelerating the pace of rate hikes to 75bp increments and raising the expected terminal rate to 3.8%. In the statement that followed the FOMC meeting, the Fed emphasized its commitment to price stability but offered no such commitment to the employment side of the mandate. While the Fed isn’t trying to induce a recession, and while no Fed speaker will predict a recession, the Fed has already made clear that if the choice is between recession and inflation, it now chooses recession. The Fed has committed to maintaining rate hikes until inflation is clearly on a path to 2%, something that will likely not be evident in the data for several months. If inflation prevents the Fed from pivoting to rate cuts when the economy turns, a recession feels all but guaranteed under the current guidance...

...The next several months will become very uncomfortable. We have become accustomed to the Fed responding quickly to signs of economic weakness, but in recent history those have always occurred in a period of low inflation. Now the Fed will hold rates higher for longer by design, which will appear as if it is ignoring the real side of the economy. Assuming the Fed does not change its guidance, it needs to see clear and compelling evidence of slowing inflation before it can pause rate hikes. Considering that inflation lags the cycle, we aren’t likely to see significant slowing in the near-term. For example, the Cleveland Fed predicts core-CPI will be 0.49% in June, the only release before the July FOMC meeting (which helps guarantee a 75bp hike).
Moreover, one or two soft inflation prints will not likely suffice to convince the Fed that it will restore price stability given that the Fed tried that strategy last year and was badly burned when inflation rebounded in the fall after an apparent improvement over the summer. That error will create a bias in the opposite direction, and could set up a dichotomy with markets, where the Fed will tend to dismiss any good news on inflation (from, for example, any discounting that occurs when retailers try to shed excess inventories) as insufficient to justify a policy shift. At the same time, we can expect slowing in the interest rate sectors of the economy and eventually a weaker job market...

Beijing’s New Man in Hong Kong
On July 1, John Lee Ka-chiu, a stalwart partner of Beijing’s, is expected to take the reins as Chief Executive of Hong Kong.
To show Beijing’s full-throated support of John Lee as the new Chief Executive of Hong Kong, President Xi will also deliver a speech at a meeting celebrating the 25th anniversary of Hong Kong’s “return to the motherland,” and at the inaugural ceremony of the new Chief Executive of the Hong Kong SAR (Special Administrative Region of the People’s Republic of China).

Going through the various cycles in the ECB’s history, Schnabel recounts periods of dangerously compressed eurozone sovereign yields, as well as the historic blow outs in southern European bond markets during the European debt crisis of 2010-12, putting the current widening of spreads in historic context in a series of charts in the appendix that are highly illustrative.
As to the current state of affairs, Schnabel reiterates the ECB position — which we have repeatedly written as well — that the ECB has dealt with fragmentation successfully many times in its history, can easily redirect Pandemic Emergency Purchase Program bond reinvestments as needed to surf any excess (peripheral) market volatility, can structure new facilities if and as needed for new situations, and that the ultimate backstop against eurozone fragmentation is the ECB’s unwavering and unquestioned commitment to the euro.

Final Thoughts Heading into the FOMC Decision

Is 75bp the new norm? Prior guidance said the Fed would continue with 50bp hikes until inflation rolled over, so will Powell signal that the same is true of 75bp? I can’t see that. It might not be until the end of the year before we see a string of sufficiently low inflation numbers such that the Fed sees the path to price stability. The Fed’s not going to commit to a path likely to mean 75bp hikes at each meeting for the rest of the year, but Powell will not rule out another 75bp hike in July or later. Powell will frame this in terms of a more “expeditious” move toward neutral and I think will not repeat the error of providing strong guidance like that leading up to this meeting...

...Aspirational market pricing? I see market participants pricing in a peak Fed funds rate at 4% next spring, an overly hawkish view that might not be validated by the SEP. I am not far behind that as I see median dots of 3.375% and 3.875% for 2022 and 2023, respectively. As I wrote that puts a 4+% rate potentially in play and that will likely be revealed in some dots, but I don’t think the median will make it there. And to be sure, whatever the end result, this is a Volcker-moment for Powell.

Powell’s Volcker Moment

That was another unpleasant day on Wall Street with stocks, bonds, and crypto all trading deep in the red. The proximate cause was a repricing of risk ahead of the FOMC meeting on the concern that the Fed would deliver a hawkish message with the dots and possibly surprise with a 75bp rate hike. One of the wild cards for me heading into this meeting was the Fed’s reaction function with respect to the elevated inflation and inflation expectations numbers. I think the Fed will reveal that reaction function by opting for the 75bp move.

“The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead,” Governor Philip Lowe said in his post decision statement.
In practice, this means the RBA likely wants to raise the official cash rate another 100bps this year. Another 50bps could be in the offing when it meets July 5 before it steps down to 25bps moves at a couple of its five remaining Board meetings between August and December. That would give the Bank an opportunity to see somewhat backward looking but key quarterly inflation releases due July 27, and October 26.

Weaker UK growth and wages data all but lock in another 25bp hike by the Bank of England tomorrow as it races to get spiraling inflation under control to avoid it ravaging household spending power and plunging the UK economy into recession.
This week’s data will likely constrain the Bank’s policy choice for this meeting to a 25bp hike despite the possibility for additional dissents for a larger move by the Bank’s Monetary Policy Committee (MPC) members. At its early May meeting when the MPC raised rated 25bp to 1%, Michael Saunders, Catherine Mann, and Jonathan Haskel dissented in favor of 50bp.
This time around, that continued pressure may however force the MPC to amend its forward guidance so that it at least widens its options for additional moves later this year.
In May the Bank said, “most members of the Committee judge that some degree of further tightening in monetary policy may still be appropriate in coming months,” but it noted “risks on both sides of that judgement.”
The Bank may seek to harden that guidance as it continues to navigate what it calls a narrow path between the twin risks of upside prices and the intensifying squeeze on real household incomes that is coming from higher energy and goods prices. That dichotomy is splintering consensus as members are increasingly forced to choose between hitting their inflation target within their forecast horizon and avoiding a more pronounced recession.

Tuesday Morning Notes
If You Don’t Have Time This Morning
We are still waiting for data to provide guidance on the Fed’s path beyond the July FOMC meeting. As a baseline, the Fed will not skip a meeting in September but instead continue hiking through the end of the year. When and if the Fed can transition to 25bp rate hikes is still an open question. The Fed doesn’t want to get too far ahead of the data, and while it waits for the inflation and labor market data still to come before the September meeting, it has a hard time committing to anything more than a return to a “measured” pace of rate hikes in September. Still, the Fed leans hawkishly, and we think the data will most likely push the Fed to continue with another 50bp hike after the July meeting.

Importantly, the EU is also looking into a potential ban on European firms insuring or re-insuring shipments of Russian oil to curtail Moscow’s ability to redirect its oil tankers to other countries around the world.

This is another very important space to watch. For those that recall the oil sanctions measures that were taken against Iran, the Western ban on insuring tankers carrying Iranian oil was perhaps the single most effective measure in taking a significant part of the Islamic Republic’s clandestine oil exports off markets.

Our understanding is that the United Kingdom and United States have indicated they would join the EU on a tanker insurance ban.

Fed Not Thinking About a September Pause

It has been quite the swing in market sentiment over the past few weeks as contemplation of a 75bp rate hike gave way to speculation that the Fed will pause in this cycle as early as the September meeting. We think neither scenario is likely. Our baseline remains that the Fed will hike rates 50bp in each of the next two meetings while September stands as an opportunity for the Fed to transition back to 25bp rate hikes if the data allows. We are skeptical that the data will break in the Fed’s favor by September, but that is where the debate stands. Federal Reserve Chair Jerome Powell was very clear earlier this month that he doesn’t expect the Fed to pause until there was clear and compelling evidence that the Fed was on a path to restore price stability, and it is very unlikely that such evidence will emerge this year.

The near-term path for rates remains unchanged. Fed speakers consistently endorse the consensus view of 50bp rate hikes at the June and July FOMC meetings. The September meeting is a potential opportunity to transition back to 25bp rate hikes if the data allows. If the Fed can’t find sufficient cover in the data to see a path back to 2% inflation within the forecast horizon, it will press forward with another 50bp. Ultimately, the decision may hinge on the September SEP inflation forecast. I think that if FOMC participants see they can hold steady or even lower the 2022 and 2023 inflation forecast, they will be inclined to transition to 25bp. However, I have been skeptical that the data will break in that direction, leaving me leaning toward another 50bp hike in September. The Fed will try to form a consensus around the September outcome at the July meeting but may not have sufficient data to establish a consensus either way. That of course would put the August Jackson Hole conference in the spotlight, although arguably it’s always in the spotlight.

...That said, a senior official concedes, as we have written, that April may indeed prove to be the toughest month for economic growth this year. He goes on to suggest that China’s State Council will step up fiscal, investment, and monetary stimulus efforts if consumption during China’s five-day International Labor Day holiday, starting on May 1, falls short of expectations...