The cross-asset impact as the Fed hikes rates by 75bps

The Federal Reserve has hiked its Fed Funds rate by 75 basis points to now sit in a range between 1.50% to 1.75%. Although 50bps had been expected just a week ago, the surprise US inflation rise has ushered in a more aggressive tightening. This move had been touted earlier in the week and has now taken markets by too much surprise. However, as the dust is settling today, the sobering impact is that the move is risk negative but also USD supportive in the weeks to come. This will impact major asset classes

• The decision was fairly well expected, but that does not make the situation any better for market sentiment.
• Forex majors are set to trade with a continued USD positive bias.
• Commodities to have a negative bias
• Indices remain under significant selling pressure.

The highlights of the Fed decision

First of all, let’s take a quick look at some of the most important aspects of the Fed’s decisions taken for the June FOMC meeting.

1. Fed hikes by 75 basis points – This was broadly expected after Monday’s briefing of journalists. Although in the press conference Fed Chair Powell said that 75bps would not be the norm, another hike of +50bps or +75bps could be seen in July, data depending.
2. Statement changes were only minor – the only standout change was that the Fed is “strongly committed” to reducing inflation.

1. Esther George dissents – now this is an interesting one as George is normally one of the more hawkish voices on the FOMC. The fact that doves such as Williams and Brainard (the most dovish of the 2022 voters) went for 75 basis points whilst George only went for 50 raises an eyebrow or two
2. Economic projections worsen – in the past three months since the last set of economic projections, there has been a big cut to the GDP outlook for 2022 and 2023. The Fed is hiking hard and it is expected that unemployment will take a hit. Subsequently, inflation is massively the primary focus right now even at the expense of economic activity. Core inflation is expected to be slightly higher, but headline inflation much higher.

1. Dot plots show huge hikes for the rest of 2022 - an expectation of a massive front-loading of rate hikes in 2022. Then maybe one or two hikes in 2023 will come before the rate cuts start to kick in. 

Today, the Fed Funds rate is in a range of 1.50% to 1.75%. This time next year, the talk amongst market participants will be about when the Fed is going to cut rates, from what could be around 4.0% (if interest rate futures are anything to go by). Faster rate hikes drive economic activity down, requiring sooner rate cuts. 

This chart from ING caught our eye. This is expected to be the most aggressive rate tightening cycle by the Fed since 1988.

Forex will be USD positive again

The initial reaction last night was odd, with a mild sense of relief from traders. The USD fell back. However, this move only seems to be short-lived. The USD is strengthening decisively once more today.

The eye-watering inflation of 2022 is having a key impact on major markets. As all these central banks move to increase interest rates (even the SNB has engaged a surprise 50 basis points hike this morning), fear levels are rising. This drives flow into not only the most highly liquid currencies (USD remains the reserve currency of the world) but also safe havens too. Add in the prospect of US interest rates upwards of 4% in the next six to nine months, once more the USD comes out on top. 

This will retain broad support for the USD in the coming weeks. EUR/USD initially ticked higher yesterday (mostly on the potential for the ECB to move to alleviate core/periphery Eurozone bond yield spreads), however, the downside pressure has resumed this morning. The support of the May low (at 1.0350) and the January 2017 low (at 1.0325) is all that stands in the way of a decline to parity. Technical analysis points to a continued strategy of playing the downtrends and selling into strength.

Looking for lower Commodities

In commodities, the outlook for Gold (XAUUSD) is also negative. Perhaps there is more of a supportive element for gold amidst the ongoing negative risk appetite. However, higher US bond yields and a stronger US dollar are key driving factors for a lower gold price. 

Technicals again point to using strength as a chance to sell within the 4-month downtrend. The initial tick higher yesterday is starting to fade and we would be looking for a retest of $1805 and likely towards the May low at $1787.

Indices to remain under pressure

Finally, we look at the growing negative outlook on indices, especially Wall Street. The speed of the Fed tightening and the high inflationary environment leaves equities vulnerable. With such a large weighting in tech stocks, this leaves Wall Street, especially at risk of further correction. 

The S&P 500 futures (SP500ft) have fallen sharply in the past week. Smashing below support at 3807 (the old May low) the market is trading at 16-month lows. An initial rebound into the close last night has not encouraged buyers, it has only been used as a chance to sell today. The next support is at 3720 but an unwind into the next important band of support 3180/3585 could now be the next move. The negative configuration of momentum and that rallies are still being used as a chance to sell suggest that the sell-off is not done yet.

This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.