Hawkish Fed Leaves Markets Recalibrating
The Federal Reserve delivered its widely anticipated 25 basis point rate hike this week, lifting the funds rate to a 3.75–4.00% target range. What caught markets off guard was the more overtly hawkish message that accompanied the decision. The updated Dot Plot projections now point to at least one further increase before year-end as the most likely path, shifting expectations away from any lingering “one-and-done” hopes.
Whether hiking rates is the optimal response to what remains primarily an oil-driven inflation shock is still debatable. Yet Chair Kevin Warsh was clear in pointing to a resilient US economy, persistently elevated inflation, and ongoing geopolitical risks, particularly those feeding into higher energy prices, as the Board’s rationale. The 12-0 unanimous vote itself came as a surprise. Several members had struck more dovish notes in the lead-up to the blackout period, yet the hawks ultimately carried the day and brought their colleagues onside. One wonders about the level of buyer’s remorse President Trump may be feeling over his latest Fed Chair selection, with a rate hike now delivered ahead of the midterm elections and the prospect of further tightening still on the table by December.
In the immediate aftermath, the Treasury market showed a flattening of the yield curve. Short-term rates, which are most sensitive to Fed policy shifts, rose more sharply than longer-dated yields, including the key 10-year note. Overall, however, yields found support, which in turn underpinned a firmer US Dollar. The Dollar Index climbed back above the 100 level for the first time since July, while USDJPY pushed above 156. Attention now turns to Friday’s Bank of Japan meeting. A 25 basis point hike is widely expected, but the real intrigue will centre on the BoJ’s forward guidance, specifically whether officials signal an accelerated tightening timeline compared with the gradual pace markets have grown accustomed to.
Oil prices have been the other dominant force this week. The shutdown of Saudi Arabia’s East-West pipeline following drone strikes has injected fresh supply concerns into the market. US Energy Secretary Chris Wright has sought to soothe nerves by suggesting the disruption will prove short-lived. Even so, both WTI and Brent remain above $100 a barrel, and the threat of further attacks on pumping stations or other Gulf energy infrastructure is keeping an upside bias firmly in place. Any meaningful steps toward de-escalation could quickly reopen the door to sub-$100 levels, but for now the risk premium remains embedded.
Gold continues to struggle under the weight of elevated yields, a reinvigorated Dollar, and the renewed climb in oil. These three forces have combined to leave the precious metal on the back foot. Dip-buying interest is still expected on approaches toward $4,200 and $4,000, yet the broader expectation of higher global interest rates, driven in large part by the energy price spike, is currently denting gold’s appeal as a non-yielding asset. Technical levels to watch include support at $4,235 and $4,170, while resistance sits at $4,395 and $4,435.
Risk assets are likely to spend the coming sessions digesting the Fed’s inflation-fighting stance. The question is whether equities can continue to grind higher while both bond yields and oil prices remain elevated. At least one of those two pressures will probably need to ease for stocks to find a clearer growth path forward. Friday’s BoJ decision adds another layer of uncertainty. Should the Japanese central bank deliver an oversized dose of hawkishness in the same vein as the Fed, markets could face a fresh bout of volatility just as they are still adjusting to the new US rate outlook. With the Fed meeting done, its now time for the BoJ to take centre stage.
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