The Fed increases rates by 50 basis points

Last Wednesday at the end of its monetary policy meeting, the Fed decided to raise its interest rates by 50 basis points. This is the biggest increase in the last 22 years. The Fed had already initiated the move with a first quarter-point hike in March. Now the range of rates is between 0.75% and 1%. In addition to this rate hike, the US central bank has announced its willingness to reduce the size of its balance sheet while at the same time clarifying the pace of this reduction: $47.5 billion per month starting in June and then double as of September. This is an extremely fast wind-down. To give an idea the current balance sheet is $9 trillion, it was around $4 trillion before COVID. The increase in size is a direct effect of bond purchases during the pandemic. The Fed waited for a long time before taking action, hoping that inflation would be only transitory, but it must be noted that this is not the case. The central bank is thus shifting into high gear. Looking at economic data, we see that one of the two objectives of the Fed has been achieved but the other is far from the target. On the employment front, job creations are positive and the unemployment rate is historically low (3.6%). This underlines the strength of the US economy. But if we look at prices, we see that inflation at 8.6% is far from the target of 2%, and even if wages rose slightly less than expected last month, they are still rising by 5.5% per year. Yesterday, Joe Biden timely launched a communication and information operation on the topic of inflation explaining that the fight against inflation was his “top domestic priority”; that it is coming largely from external factors (the pandemic and the war) and that all countries are affected but that he was still going to take steps to mitigate its effects. There is talk of a reduction in the tariffs imposed by Donald Trump on Chinese products. The consumer price index will be published today. It is probably the most important macro-economic data at the moment.

The market was expecting the Fed’s announcements and therefore did not respond to the news release. On the other hand, during his post-conference press briefing, Jerome Powell surprised the market by ruling out future interest rate hikes of 75 basis points, which temporarily lowered the dollar and supported the stock exchanges. But the next day we saw a return of the trend observed in recent times with a dollar again rising by risk aversion. In this case, we refer to geopolitical and economic risk as well as the zero-covid policy in China that is weighing on business. In recent days, the strength of the greenback against a basket of currencies (dollar index) reached a 20-year high. Similarly, the dollar/Swiss franc are now close to parity with a high of 0.9975 yesterday. The euro is very volatile: it appreciates when the ECB refers to the need for a strong currency to combat inflation, declines when statistics on the other side of the Atlantic are better. And of course it remains very sensitive to the new policies and military coming from the east. Recently, it was supported by several monetary officials saying that a strong euro would better absorb inflation, suggesting a first interest rate hike this summer. Against the Swiss franc, the euro rose to 1.0515, a three-month high. Our national currency is suffering from the expected rate differential with the US and Europe.

The pound sterling is down to around 1.23, its lowest in almost two years. For the fourth time the UK central bank increased its key interest rate to 1% and lowered its growth forecasts. Inflation is very strong and could reach 10% by the end of the year.

Oil is also very volatile. At the end of last week it was supported by the OPEC’s refusal to increase its production plan and at the beginning of the week it fell in the face of the difficulties in setting up an embargo on Russian oil. These are the two main factors to be monitored. In general, commodities are the only asset class to show positive performance since the beginning of the year. On the other hand, industrial metals suffered a correction with the fall of activity in China. Precious metals are also falling in the face of rising real rates and the US dollar.

On the yield side, the US 10-year rate is slightly below 3% and the 30-year slightly above. The world’s main stock exchanges are still in red (-24% for the Nasdaq since the beginning of the year) and Bitcoin has not been spared since it has dropped from $40,000 to $30,000 in a few days.