A monumental shift rippling through global markets in his first Fed meeting as Feder Kevin Warsh delivering a surprise hawkish shock while the central bank unanimously held rates steady, the new dot plot revealing a board split right down the middle with 9 of 18 officials penciling in a rate hike this year.
While the reaction was with the dollar rally, the Treasury curve flattened. took a hit as the Fed stripped down its statement to a single forceful message that quote the committee will deliver price stability.
Yet there is a competing force that play as falling energy prices on the back of the signed peace deal between the US and Iran, and this could provide the inflation relief that the central bank is looking for.
Well joining us this morning ahead of the holiday weekend is James Knightley, Chief International Economist for the U.S. at ING.
Good morning, James.
Thank you so much for joining us.
So here we are on this Thursday morning after the Fed meeting.
Half the Fed board penciled in a rate hike, but Kevin refused to even submit a dot plot forecast.
So what does this aggressive new communication style tell us about how war may potentially be managing the markets moving forward.
Yeah, well, that belief that Kevin Walsh, appointed by a president that wants lower rates, he would he would comply was completely been thrown out of the window on this one.
We'd always been a little bit skeptical of that view, you know, Kevin Walsh has been on the Fed before.
He's a very credible guy, and again, he proved that in the press conference yesterday, so.
And I think, you know, what we've got is a situation where the Fed has missed its inflation target for a number of years, and he recognizes that that is causing a credibility problem, and he wants to stamp his authority and say, look, no, we are going to deal with this now.
It may turn out to be that the Fed didn't need to be as hawkish in terms of the dot plots that we got yesterday because we think there are a number of reasons why.
Inflation could actually move lower quite quickly through the second half of this year.
So yep, uh, presentage presentation style was great, a clear message to the markets that we've got this sorted and we will make sure that inflation returns to its target.
Yes, and let's talk about expectations, especially on the heels of US and Iran assigning that MOU.
So markets may be quickly pricing and rate hikes for this year, but I understand your team at ING is calling for a 12 month pause.
So how confident are you that the central bank's barking louder than it will actually bite?
Yeah, well, I, I think it does come back to the point that they have missed their target so long, for so long and so badly, um, that there is this, you know, new leader, new statement of intent, just to get the markets on side, uh, because we did have that lingering uncertainty about what, uh, a wash, uh, Fed would mean.
That's, that's, that's sorted now.
Uh, but in terms of where we go from here, um, yep, you know, we've seen energy fall substantially.
We're pro we're gonna, we've seen gasoline prices go from $4.60 a gallon nationally.
Down to below $4 a gallon yesterday, and we think with the latest oil moves we'd be down at $375 by this time next week.
Um, so that is going to mean that actual month to month changes in consumer prices falls in June, and we could get another fall in July as well.
So that's a big helpful story.
But also remember, as he said yesterday, uh, monetary policy does appear to be restrictive around the housing market, and what is the biggest component of the US inflation basket?
It's housing.
And we know that house prices are rising barely 1%.
We know from the likes of Zillow and Realtor.com and Apartments.com that monthly rents are actually now falling outright.
So those two stories should imply that the biggest components of inflation should start to be dampened through the second half of this year.
Then remember too that what's the biggest cost of US corporates?
It's not tariffs, it's not gasoline, it's not chip microchips, it's the cost of you and I, it's the cost of the worker.
And unfortunately for us, wage growth is slowing quite quickly right now.
We're down, getting close to 3%.
We think we'll fall perhaps even below 3% wage growth this year.
And then on top of that, of course, also remember tariffs.
Tariffs were a big story for Last year, uh, that one-off step change is not going to be repeated this year, and in fact, as a result, the year on year rates should push lower.
So I think there's 4 really important stories there, lower energy costs, the tariff side of things, um, we've got the wage side of things, and of course we've got housing as well.
So, I'm still leaning in the direction that the Fed doesn't need to hike rates, and indeed it will be a prolonged pause.
Yes, and James, finally, before I let you go, I do want to get your take on what we're seeing in global bonds as well as the FX market.
We did see the Treasury curve flatten yesterday, but given the fact that we're keeping a close eye on both currency pairs, in particular the US dollar, as well as the 10 year yield and 2 year yield, what is that signaling to you right now?
Yeah, well, we've got an environment where the ECB is hiking rates.
The Bank of Japan is also hiking rates as well.
So, you've got these higher yields starting to come through elsewhere, and that, for me, is, is quite an interesting environment that's, in terms of the treasury market, we have got yields having pushed higher, particularly at the short end yesterday.
I think that's probably a little bit overdone, but also at the long end, we are still a little bit more cautious than the market.
The market's still looking, or, or economists are still looking for 10-year yields to drop, perhaps drop down to 4.25% by the end of this year.
We think they could just stay that little bit more elevated because Kevin Walsh himself wants to see a smaller Fed balance sheet, so the Fed are not going to be buying bonds in an environment where we've got the US government continuing to borrow huge amounts of money, 6.5% of GDP for each year for the next 3 or 4 years at least is what we're expecting.
So that's supply in an environment where the Fed's not buying and where also the foreigners who own a third of the bond market have more options.
It was fine when Japanese JGB yields were yielding 0%.
They're now at 2.5%.
Likewise, UK gilts, when they were 2% less attractive, much more attractive now at.
5.5%.
So there's more options for global investors as well.
So I just think that that could keep US 10 year yield a little bit more elevated.
So we've had a bit of bond, uh, flattening, bond yield curve flattening of recent days.
We think we could return to a more steeper yield curve on a 12 month view.
Well, James, a lot to keep our eyes on, so I appreciate your time.
Thank you so much for joining us the day after the Fed.
Thanks a lot.
