Wednesday was supposed to be the key day of the week in the financial markets. However, the weight of the Federal Reserve's change in macroeconomic projections in the context of interest rates could have its consequences in the weeks ahead as well.
The Fed left the target range for the federal funds rate unchanged at 0-0.25 percent, but policymakers signaled that they expect two hikes by the end of 2023. Bond repurchases will also remain at $120 billion per month.
GDP will accelerate, but so will inflation
Fed officials noted that progress in graft and strong support from a fiscal policy has led to increased economic activity and employment. New economic projections from the June projection showed GDP growing 7 percent in 2021. (above the 6.5 percent in the March projection). Growth in 2022 was left at 3.3 percent.
Unemployment this year is expected to be 4.5 percent, unchanged from the March projection, but inflation is expected to be much higher at 3.4 percent in 2021. (vs. 2.4 percent in March), though it is expected to slow to 2.1 percent in 2022. (vs. 2 percent in March). In the central bank's projection, 13 of 18 officials favored a rate hike in 2023 versus just 6 previously, with 7 pointing to the first move in 2022.
Dollar rally and implications for stocks, gold prices, and the Polish currency
Such a change seems to have triggered a long-awaited US dollar rally, as indicated by institutional investors' positioning based on the Commitments of Traders report we described earlier. EUR/USD plunged from the level of 1.21 to 1.1950. Currencies of developing countries, including the Polish zloty, are also significantly weaker. The USD/PLN exchange rate shot up to 3.78 and is at its highest level since the beginning of May. The strong dollar also affected gold quotations, whose price fell from over USD 1900 to USD 1807 per ounce.
Stock market indexes also seemed to react to the changes proposed by the Fed in its projections and fell slightly from record-high levels. Nevertheless, it is important to remember that the rate hike from 0.1 percent to 0.6 percent is an attempt to take the first step of normalizing monetary policy along with higher projections for economic growth. Companies should therefore be able to cope with a higher cost of capital going forward.
The end of June will tell if this is the end of the bull market
However, if someone is looking for negative signals for the markets, it is, for example, the flattener, i.e. the flattening of the yield curve in the US. This means that the interest rate on 2-year bonds has risen more than on 10-year or 30-year bonds. The flattening of the curve, in turn, may show that the market has fully discounted the improved outlook for economic growth and could now begin to discount a slowdown.
In such an environment, it is more difficult for equities to grow, but on the other hand we still have negative real interest rates, so it is equally difficult for capital to return to cash. The market will have to digest the new information in the coming days and it will probably be easier to determine at the end of June whether the bull market is coming to an end or whether we are observing only the beginning of a local correction.
Daniel Kostecki, Chief Analyst Conotoxia Ltd.
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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