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Markets soften on hawkish Fed messaging

As had been clearly telegraphed and widely anticipated, the Federal Reserve opted to hold interest rates at yesterday’s meeting. Officials said “Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy,” and Jerome Powell avoided committing to any further moves, instead saying the July meeting would be “live” and dependent on incoming data.

More unexpectedly, new projections showed policymakers expect to deliver two additional hikes by year end. But the “dot plot”, as the Summary of Economic Projections is colloquially known, has evolved into a strange hybrid between a forecast update and a communications tool – it tells us what Fed officials think, but also reflects what they want markets to think. Policymakers could be working to avoid a premature easing in financial conditions by convincing investors that more tightening is on the way – but may not intend to fully follow through in delivering both hikes.

Markets are on the defensive, with equity futures, commodities, and risk-sensitive currencies retreating as rate cut expectations are pushed farther into the future. The yield curve is moving deeper into inversion on a rise in recession bets, suggesting that the Fed’s “hike until something breaks” messaging is coming through.

The Chinese yuan is weaker after the central bank slashed the interest rate on its medium-term lending facility, signalling growing distress among policymakers as they try to prop up an ailing economy. The cut marked the third major reduction in interest rates this week, and came after a raft of data showed growth slowing from early-year levels as a rebound from zero-covid lockdowns fizzled out. Retail sales grew 0.2 percent in May relative to the prior month, industrial production was up 0.6 percent, and the youth unemployment rate (which is not directly comparable to similar numbers in the West) climbed to 20.8 percent. Fixed asset investment slowed in the first five months of the year, with a boost in government-sponsored infrastructure spending offsetting a -0.1-percent decline in private sector investment. Investment in real estate dropped -7.2 percent year over year, and the number of new construction starts fell -22.6 percent relative to the same period in 2022.

In the day ahead, the European Central Bank is expected to deliver its second-to-last rate hike, along with updated forecasts that should show both growth and inflation rates coming down. US retail sales are seen falling -0.2 percent in May from the prior month after gasoline prices tumbled and consumer spending continued to shift toward intangibles. Import costs should exhibit a similar pattern, dropping -0.5 percent month-over-month in May on falling volumes and an easing in supply chain issues. The number of jobless claims is expected to fall to 245,000 in the week ended June 10, down slightly from 261,000 in the prior week. And the Bank of Japan is likely to remain on hold this evening, leaving all of its major policy settings unchanged as policymakers await a decline in inflation pressures.

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