Early Morning Call: USD strengthens after Powell hints at another 50bp hike ahead of ECB rates

Fed rate decision

The USD edged higher on Wednesday after the Federal Reserve's (Fed) rate decision. As widely expected, the US Federal Reserve kept its rate target at 5%–5.25%, the first pause after 10 consecutive hikes that took rates 500 basis points higher. But the fight against inflation is not over yet. For Jerome Powell, US growth and the job market are holding up better than expected, giving room for the Fed to continue its campaign to limit price rises.

The Fed Chairman signaled that borrowing costs may still need to rise by as much as half a percentage point by the end of this year. An opinion shared with eight other officials, while three others feel borrowing costs need to go even higher. As for the market, the Chicago Mercantile Exchange (CME) Fed watch tool points to a 72% chance of a 25 basis-point hike next month, but contracts tied to the Fed's policy rate see the central bank delivering only one quarter-percentage-point increase by the end of the year.

The decision was accompanied by economic projections. The Federal Open Market Committee (FOMC) sees the unemployment rate rising by the end of 2023 to 4.1% from the current 3.7%, lower than the 4.6% jobless rate officials projected in March. The 2023 economic growth projection was raised to 1% from 0.4% in March. The Core Personal Consumption Expenditure Price Index (PCE) is seen dropping from the current 4.7% to 3.9% by the end of 2023. That is higher than the 3.6% projected in March.

The European Central Bank

This Thursday, the European Central Bank (ECB) is in the limelight. Christine Lagarde is expected to announce a 25-basis-point rate rise before another one in July. Then the ECB is believed to go into "wait-and-see mode" for the rest of the year. This is according to a poll conducted by Reuters, which indicated that economists believe inflation across the single currency economies remains elevated. After 375 basis points of hikes over the past year, economic activity across the region has slowed, sending the eurozone into a technical recession.

Macroeconomics

A set of macroeconomic indicators released this morning reinforced the case that more stimulus is needed in China, the world's second-largest economy. China's industrial output rose 3.5% in May from a year earlier, missing expectations and slower than the 5.6% expansion recorded in April. Ditto for retail sales, up 12.7%, missing forecasts of 13.6% growth and slowing from April's 18.4%. Investment in the property sector declined, accentuated in the first five months of the year, down 7.2%. Private fixed-asset investment shrank by 0.1% in the period. And if the jobless rate remained at 5.2% in May, youth unemployment would jump to a record 20.8%. Two days after cutting two key short-term policy rates, China's central bank cut the borrowing cost of its medium-term policy loans by 10 basis points to 2.65%.

The Reserve Bank of New Zealand

The New Zealand economy has slipped into a technical recession. Gross domestic product (GDP) matched analysts' expectations of a 0.1% contraction in the March quarter but was well below the Reserve Bank of New Zealand's forecast of 0.3% growth. Furthermore, fourth-quarter GDP was revised to a contraction of 0.7% from a decline of 0.6%. This cuts the risk of more rate hikes but creates a new headwind for the government's re-election hopes.

The Australian dollar overview

The AUD is one of the most enduring bull stories today. In Australia, the job market was stronger than thought in May. The unemployment rate unexpectedly fell to 3.6% when economists anticipated it to remain at 3.7%. Full-time employment rebounded by 61,700 from April, and part-time employment also rose. Last week, the Reserve Bank of Australia (RBA) unexpectedly raised interest rates to 4.1% and signaled that further tightening could still be required to tame inflation. The strength of the job report supports the RBA's case, as a tight labor market will contribute to stronger wage growth.