BNY Mellon

The Message Gets Through, Finally

The FOMC last week finally broke the spell markets had been under, leaving them now spooked by the prospect of the 'pain' that Chair Powell has warned is the price of the Fed's anti-inflation push. Adding to the disquiet, Japan's intervention to support the yen was predictably ineffective after roughly 24 hours, calling into question whether anything can stop the US dollar’s prolonged ascent. And to end a wild week, the new UK government’s mini budget was greeted with an equally predictable negative verdict by financial markets.

Five of the six G10 central banks that met last week raised interest rates, the Bank of Japan the notable and – again – predictable exception. The message finally got through to markets. But interestingly, a total of 350 basis points in combined hikes by the other central banks still didn’t dent the dollar’s pre-eminence in the current FX pecking order.

US forward curves finally moved to levels that reflect what we think is appropriate for rates in this cycle, peaking at 5% by the end of Q1 2023. Furthermore, they no longer price a quick move to rapid rate cuts thereafter, as the chart below shows, in which we compare Eurodollar futures at several key recent dates, including the days of recent FOMCs and Chair Powell's speech at Jackson Hole.

This past Friday’s pricing, helped along by the September dot plot from the Summary of Economic Projections (SEP), seems to show markets and the Fed in broad agreement – if anything, the market is even more aggressive for the remaining two FOMC meetings this year. As we said, the message got through and the spell has been broken: rates are going higher, even at the cost of a recession, which Chair Powell could not rule out at his press conference.

Moreover, as Powell also warned, “the Committee is committed to getting to a meaningfully restrictive stance of policy and staying there until we feel confident that inflation is coming down.” Rates aren’t going to quickly drop once they have reached their terminal level. The markets have finally realized – long coming, in our opinion – that this is the policy path, and understandably have not liked the implication.