USD Rates: Final 25bps delivered
Overnight, the US Federal Reserve’s Open Market Committee hiked by 25bps, taking the Fed Funds rate upper bound to 5.25%. This marks the same peak of the 2004/06 cycle, but the pace of tightening is much quicker (500bps 15 months now versus 425bps over two years). The FOMC statement removed the phrase “anticipates that some additional policy firming might be appropriate” suggesting that the Fed now views policy settings to be sufficiently restrictive. Moreover, “tighter credit conditions” are now a given and likely to impact on households and businesses. Overall, the Fed has struck a neutral note, but this is the least hawkish statement we have seen in several quarters. We think that the hurdle for further tightening has probably been implicitly set high.
While the decision to hike was unanimous, market participants (including ourselves) have misgivings around tightening when banking system stress is elevated. Notably, 2Y and 10Y yields broke below their respective short-term supports of 3.90% and 3.40% respectively. In an intraday basis, yields took the first leg down post the FOMC decision and another big leg down as banking stocks resumed their selloff late day. News that another regional lender is looking at strategic options so soon after First Republic failed is a reminder that stresses on regional banks remain acute as long as risk-free rates stay high and there is no wider deposit guarantee from the FDIC. In the front of the curve, the market added to Fed cut bets, seeing 3.5 cuts by the end of the year. Looking out to end-2024, the total amount of cuts priced now exceeds 200bps. These levels look quite stretched as the market rushed to protect against further bank failures and elevated recession risks. Tactically, some wariness might be in order before the release of NFP on Friday.
Overall, we reiterate a bias for receive positions (just in case things go awry) and maintain our steepening stance for the USD curve (2Y/10Y, 5Y,30Y). We also see considerable risks that the Fed will cut rates sooner (perhaps as early as late 2023) if the banking crisis worsens and inflation comes off.
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