Risky assets got their groove back after the Fed restored confidence that they are serious about fighting inflation but that a steady stream of supersized hikes would be unlikely. Wall Street made this an easy policy decision for the Fed as the two-year Treasury yield surged from 2.83% to over 3.40% since Friday’s inflation report. The Fed raised its benchmark rate by 75 basis points, the largest increase since 1994, and signaled more hikes are coming, but that trend won’t last beyond 2023. The dot plots show they expect another 175 basis points of tightening for the rest of the year with a couple more hikes in 2023, before rate cuts are warranted in 2024.
No one was surprised by the sharp downgrades with the growth outlook and higher PCE inflation forecasts. The Fed needs tighter financial conditions and for the economy to cool, so supersized hikes should be expected over the next few meetings.
To get inflation under control, the Fed will see their rate hikes at the end of the year could be the tipping point to sending this economy into a recession. The 2-year Treasury yield had a massive move lower, which means we are seeing a peak in yields.
The ECB emergency meeting showed markets they are accelerating the completion of the design of a new anti-fragmentation instrument. Everyone knew they were working on fragmentation, so today’s announcement simply emphasized this is a top priority. Other than putting it in writing, markets learned nothing new.
The euro initially rallied as the ECB’s latest tool to ease market stress will allow them to raise rates quickly. The focus quickly moved to the FOMC and traders are still trying to decide if the Fed has put a peak in Treasury yields, which could signal a dollar top is in place.
Oil prices declined as the crude demand outlook took a hit as the US consumer is looking weaker and as both the Fed and ECB seem poised to aggressively tighten financial conditions, which should lead to fast slowdown with economic activity.
It was a busy day for energy traders as you also had President Biden reach out to oil refiners. Biden asked oil heads to explain why their margins are so good and why they haven’t produced more gasoline and diesel. Biden’s pressure is mostly political and it probably won’t lead to any serious action by oil companies.
The weekly EIA crude oil inventory report showed a larger-than-expected 2 million bpd build and a boost in production. US crude production rose by 100,000 bpd to 12 million bpd, the highest levels since April 2020. Gasoline demand softened and that could be a reflection of higher prices at the pump.
The oil market is still tight, but demand destruction fears will grow as traders become more focused on recession risks.
Gold prices rebounded as some traders are seeing light at the end of the Fed rate hiking tunnel. Aggressive rate hikes over the next couple of Fed meetings suggests we could be close to seeing a peak with surging Treasury yields. The Fed may deliver one more 75 basis point rate increase, but traders are doubting we will see a steady stream of supersized hikes.
It looks like recession calls are growing for the end of next year and that should also be positive for safe-haven flows for gold. It looks like the dollar could have a short-term top here and that should be constructive for gold prices.
Bitcoin was unable to muster up a rally despite a broad rally on Wall Street following the FOMC decision. The Fed relieved some concerns that they will take rates aggressively higher and that was good news for almost all risky assets.
Bitcoin’s lack of a rally post-Fed could be a troubling sign for some investors. If a big rally on Wall Street can’t excite crypto traders, Bitcoin could be in trouble. The $20,000 level is holding, but it looks like no one wants to jump back in on the crypto trade.
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