Weekly house view | Powell compromises

The US Federal Reserve left interest rates unchanged last week but it was a hawkish pause, with the updated ‘dot plot’ of where Fed officials think interests are heading moving higher by 50 bps for 2023. This confirmed our view that the Fed will not cut rates in 2023. The Fed decision was marked by compromise as Chair Jay Powell justified the pause by citing the need to assess policy lags and the impact of banking sector stress. But, despite the hawkish dot plot, he did not commit to a July hike. The Fed’s decision came after headline annual inflation fell sharply to a two-year low of 4.0% in May, from 4.9% in April, but core consumer price inflation increased by 0.4% on the month. 

The Fed meeting prompted a rise in US Treasury yields, especially at the shorter, more policy-sensitive end of the yield curve. In equity markets, a rebound in small caps faded, but the overall market marched higher as investors anticipate the end of the tightening cycle and recession being avoided. We need to watch PMI data this week for confirmation the US is heading towards a soft landing. Delinquency rates on commercial mortgage-backed securities backed by office properties rose in May to 4.02% – the first time they were above 4% since 2018. We are negative on real estate investment trusts (REITs).

The European Central Bank (ECB) hiked rates last week and, in contrast with Powell’s non-committal, its president, Christine Lagarde, said the ECB is “very likely” to hike rates again in July. This helped the euro against the dollar. ECB staff projections were surprisingly hawkish, with an upward revision to inflation forecasts on a strong labor market. The Bank of England (BoE) and the Swiss National Bank have policy meetings this week and we expect both to hike. In the BoE’s case, stubborn inflation combined with rising rates is resulting in a stronger GBP, but eventually the negative economic impact of policy tightening should take the lead in driving the currency.

In China, recent data have disappointed. The People’s Bank of China lowered its seven-day reverse repo rate by 10 basis points to 1.90% from 2.0% and more interest rates cuts are likely together with new government support measures. In our view, while recovery momentum has stalled in the second quarter, it may accelerate again in the third quarter with the new round of stimulus. Our Chinese GDP forecast for 2023 remains unchanged at 5.5% for now. Rate cuts have weakened the renminbi by over 2% against the USD in the last month, but anticipation of new support measures – an expectation we share – led the MSCI China Index to rebound by almost 5% last week (in USD) and Chinese tech by over 7%. We are overweight Chinese equities.