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Market Briefing: Japanese Intervention and Fed Aftershocks Pummel Currency Markets

Global asset prices plunged and yield differentials tilted violently in the dollar’s favour yesterday after the Federal Reserve turned more hawkish than expected. The central bank hiked by 75 basis points for a third time, but the “dot plot” forecasts inflicted more damage on markets, showing that a solid majority of members expect to raise rates above 4.5 percent next year – even if this risks an economic downturn. Market-implied pricing shot up during the announcement and press conference, with the Federal Funds rate now expected to end the year around 4.4 percent, up from 4.2 percent yesterday morning.

The gap between two- and ten-year Treasury yields is the most inverted since 1981 as investors brace for a front-loaded tightening cycle that ultimately pushes the economy into recession.

The dollar weakened this morning as Japan intervened to support the yen for the first time since the late nineties after a widening in yield differentials triggered renewed currency weakness. The exchange rate fell into a tailspin after Bank of Japan Governor Haruhiko Kuroda said policymakers wouldn’t raise rates for “some time” and might leave forward guidance unchanged for two or three years – but then spiked upward after traders reported the central bank was actively buying in markets.

Unilateral intervention rarely succeeds in reversing longer-term trends, but the government’s efforts appear targeted at speculators building short positions against the yen. Masato Kanda, vice minister of finance for international affairs, said “The government is concerned about excessive moves in the foreign exchange markets, and we took decisive action just now… We’re seeing speculative moves behind the current sudden and one-sided moves in the foreign exchange market.”

The Bank of England raised rates by 50 basis points this morning, disappointing investors who had expected a larger move. Officials said “further, forceful” rate increases remained necessary, but the split on the committee – with the majority voting for a 50 basis point move – suggests policymakers will move cautiously in the months ahead as the government tries to shield businesses and households against skyrocketing energy prices. Updated staff projections show the economy remaining in contractionary territory in the third quarter, down from earlier estimates for a modest expansion. The pound is trading near its lowest levels since 1985 against the dollar.

Canada’s loonie briefly fell through another critical psychological barrier in the mid-1.30’s, but inched higher against the dollar this morning as oil prices firmed. The exchange rate remains vulnerable to downside as investors eye widening performance gaps between Canada and its less interest rate-sensitive southern neighbour. Rate differentials across the curve have widened in the greenback’s favour, with the Bank of Canada now expected tighten policy less aggressively – and begin loosening sooner – than the Fed.

The Banco Central do Brasil held its benchmark rate at 13.75 percent, bringing an end to one of the world’s most aggressive tightening cycles. In last night’s decision, policymakers led by Roberto Campos Neto noted growing global growth risks, declining commodity prices, and ongoing tax relief efforts in justifying a hold, but—in a hawkish surprise—vowed to “remain vigilant”, saying the central bank would “not hesitate to resume the tightening cycle if the disinflationary process does not proceed as expected”. The real gained altitude in thin trading conditions.

The Swiss National Bank lifted its benchmark lending rate above zero, bringing an end to negative rates in Europe. Swiss inflation levels are above the central bank’s target range, but remain very low relative to those seen in other economies.

Data out at 8:30 is expected to show roughly 215,000 jobless claims submitted last week, up from 213,000 the week before. Labour markets remain extremely tight, with no clear evidence of a policy-induced slowdown as of yet.

Karl Schamotta, Chief Market Strategist

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