Fed set to raise rates to a 22-year high

European markets have seen a cautiously positive start to the week, buoyed by hopes of further stimulus measures from Chinese authorities in the wake of recent poor economic data. The FTSE100 has been a key beneficiary of this, putting in a two-month high yesterday.

The modest improvement in sentiment has also been helped in some part by the recent retreat in short term yields which is being driven by the hope that central banks won’t have to hike rates as aggressively as thought a few weeks ago. Both German and UK 2-year yields have fallen sharply from their highs this month on this basis, helped by inflation which appears to be slowing more quickly than expected.  

US markets have also put together a strong run of gains with the Dow and S&P500 hitting their highest levels since April 2022, on the back of optimism that the start of this week’s earnings numbers will live up to the high expectations place on them.

Last night’s initial reaction to the numbers from Microsoft, and Google owner Alphabet would suggest that optimism might be justified against a backdrop of a still resilient US economy, and a Federal Reserve that looks set to be close to the end of its rate hiking cycle.        

Today’s expected 25bps Fed rate hike, after last month’s pause, looks set to be the last rate rise this year, whatever Fed policymakers would have you believe.

We may hear officials try and make the case for at least one more between now and the end of the year but given recent trends around US inflation its quite likely that PPI will go negative in July.

While Powell will try and make the case for further rate hikes, his time would be better spent in making the case for rates remaining higher for longer, and projecting when the FOMC expected the 2% target to be met. Core prices remain too high even with headline CPI at 3%, and it is here that the Fed will likely focus its and the market’s attention.

If headline CPI continues to fall in the way, it has been doing the Fed will struggle to convince the markets that it would continue hiking rates against such a backdrop.

As things stand markets are already pricing in the prospect that this will be the last rate rise in the current hiking cycle given recent declines in the US dollar and US yields. With the next Fed meeting coming in September the market will have to absorb two more inflation reports and two more jobs’ reports. Nonetheless the Fed will be keen to prevent the market pricing in rate cuts which was one of the key challenges earlier this year.

With inflation slowing and the jobs market resilient the US economy is currently in a bit of a goldilocks moment. This will be the challenge for Powell today, as he tries to steer the market into believing that the Fed could hike rates some more. We also shouldn’t forget that we will get fresh messaging at the end of August at the Jackson Hole annual symposium.

EUR/USD – Retreated from the 1.1275 area which is 61.8% retracement of the 1.2350/0.9535 down move, with the next key support at the 1.0980 level.  Currently have resistance at the 1.1120 area.

GBP/USD – Appears to have found a base at 1.2795/00, breaking a run of 7 daily losses. While above the 50-day SMA the uptrend from the March lows remains intact with the next resistance at the 1.3020 area.    

EUR/GBP – Last week’s failure at the 0.8700 area has seen the euro slip back, with the risk that we could revisit the recent lows at 0.8500/10.

USD/JPY – The rebound from the 200-day SMA at 137.20, appears to have run out of steam at the 142.00 area, however the bias remains for a move lower while below the recent highs of 145.00.

FTSE 100 is expected to open 10 points lower at 7,681.

DAX is expected to open 25 points higher at 16,236.

CAC40 is expected to open 35 points lower at 7,380.