Europe in Anticipation and Gold Holding Steady

European markets were mixed early on Wednesday ahead of the Federal Reserve interest rate decision later today. The FTSE 100 jumped as sterling weakened on falling UK inflation, the DAX rose a third of a percent and the CAC was flat. China left rates on hold and UK inflation fell, pushing yields down along with sterling, whilst oil dropped sharply off 10-month highs struck in yesterday’s session. Gold was steady just below the 50-day SMA at $1,928.

BoE's Inflation Surprise Party: What's Next on the Rate Hike Road?

UK inflation fell, unexpectedly giving the Bank of England a bit of a gift ahead of its policy decision tomorrow. It will drive some debate about the variable and lagged effects of rate hikes – should the MPC really take rates a little higher tomorrow? I think they do – inflation is still x3 where it ought to be and the BoE would crash what’s left of their credibility by hanging a pause on this one data point. What it does support is the recent market pricing favouring a one-and-done hike in September and no more thereafter. With the Fed about to pause and the ECB signalling it thinks it is done with hiking, the BoE won’t want to be the outlier.

Whether it does hike or not tomorrow, as per our Fed preview, central banks including the BoE are into a new phase where the focus is not so much on how high they go with rates but how long they keep them restrictive.

UK inflation slipped to 6.7% from 6.8% in July, defying expectations that higher petrol prices would see the headline CPI rise to 7.1% in August. More encouragingly, core inflation slid to 6.2% from 6.9% and the all-important services CPI declined to 6.8% from 7.4% in the prior month. The decline is services inflation is the most important. Of course rising oil prices are a headache but likely not going to last forever and not so critical to how the CBs react for now.

FTSE's Morning Cheer & Sterling's Slippery Slope

FTSE futures rallied on the update, with the FTSE 100 seen opening up around 30pts higher at 7,690, and European equity index futures were similarly trading firmer.

Sterling fell sharply, with GBPUSD slumping to take out new cycle lows at 1.2330, the weakest since May. Looking to see if we test that 1.230 round number from May now as bears retain control since the 200-day line crack.

Yield Peaks and Oil Retreats

Elsewhere, Treasury yields are higher at fresh 16-year highs with the 10yr up to 4.372% and the 2yr to 5.11% ahead of the Fed meeting. Yields have just come off a bit this morning following the UK inflation print. Wall Street closed down yesterday as yields rose. The PBOC left its loan prime rates at record lows.

Oil prices retreated to the lowest in 5 days after spiking sharply higher as US markets opened yesterday to take out a new 10-month high. Extreme backwardation in the forward curve and large speccie net long move is bullish...the spike and sharp retreat may have been about a scramble for barrels before the futures expiry.

Fed's Dot Plot Drama

And heads up on the Federal Reserve later today

• FOMC expected to leave rates on hold
• A pause but rates may not have peaked
• Focus on the dots and the language from Powell
• Higher for longer but this is the moment to shift focus from higher to longer

The Fed is a certainty to pause – 99% implied by fed funds futures. The main question overhanging the meeting is on the dot plot, whether policymakers think they have hit the peak in rates and the big question over duration. With the latest round of economic projections due we will see whether policymakers still see one more hike this year, and their outlook for the key argument over duration. If the dots are the same as June, markets could move to price in a higher likelihood the Fed hikes in November – currently one in three - and push back on when they think the Fed starts to cut. If the median dot is lower than the 5.6% forecast in June, then it could be the signal to the market that the Fed is done, with the current target rate at 5.25-5.50%. This may be taken as a dovish signal so Powell would need to sound hawkish in the presser to counter. My preference is for dots in 2023 to be unchanged – even if the Fed does not actually hike again this year - and higher in 2024 and 2025 as the Fed lays the groundwork for keeping policy rates at this level all next year. To borrow a phrase from a while back, the Fed isn’t even thinking about thinking about cutting rates. We may see the median 2024 dot raised to close to 5% from 4.6% in June. Growth rates for this year and next should also rise and provide counterbalance to maintaining rates, which would suggest the Fed is minded to believe the US economy has ‘got this’. In terms of the statement, I’d expect the Fed to stick to the view that ongoing hikes “may be appropriate”  as opposed to “data dependent” – the latter would be seen as a signal that the Fed thinks it has peaked.