A hawkish Fed meeting saw the US dollar reconnect with higher Treasury market yields as a key driver this week. The DXY lifted more than 1% to close at highs since late July above the 100 level. The Treasury curve flattened as yields at the front end lifted in anticipation of a Fed hiking cycle while yields at the longer end drew confidence that steps were being taken to address elevated inflation. While the Fed set the tone, other central banks were also hawkish, including the BoE and RBA. Meanwhile, the BoJ hiked rates, but the market reaction indicated developments fell short of reinforcing the hawkish expectations priced going into the meeting.
A highly telegraphed rate hike from the Fed lifted the benchmark rate by 25bps to 3.75-4% in a unanimous decision by the FOMC. Chairman Warsh described the move as taking away 'a dose of accommodation' after saying he was 'hard pressed' to conclude financial conditions were restrictive enough to deal with inflation at his speech in Jackson Hole. History suggests once the Fed hikes more hikes follow. That is the scenario factored into the market curve, which discounts 3 more hikes coming through by mid next year. Updated projections from Fed members imply only at least 1 additional hike this year as officials also lifted their outlook for growth and inflation. However, that is still much more hawkish than its previous path for steady rates in 2026 ahead of a cut in 2027.
The Bank of England left its key rate 3.75% this week as the MPC again returned a 6-3 vote. However, this decision was more hawkish than at the previous meeting after the committee highlighted rising risks to inflation, with Governor Bailey and other MPC members indicating that energy prices would need to fall to keep policy tightening at bay. That is not the BoE's base case as the central bank now expects that energy price rises will drive inflation to a slightly higher peak above 4% by early next year.
The BoE also announced an overhaul of its balance sheet reduction plans, aiming to limit its involvement in the gilt market. The plans put a pause on active sales until at least April next year as the BoE explores options to sell holdings back to the government instead of the market, purchases that would be funded with new issuance. The BoE intends to restrict any such sales to maturities between 2035 and 2049, leaving aside its longest dated holdings (around £120bn) to back current and future banknotes. The balance sheet under these plans would run off in the background by £46bn annually, down from previous annual targets of £70bn and £100bn.
RBA officials further reinforced market pricing for a rate hike at the September meeting following a parliamentary testimony hearing this week. Governor Bullock said some of the upside risks to inflation 'appear to be materialising' and the key question for the Board was whether policy was restrictive enough to deal with that. While growth has slowed and labour market conditions had eased, Bullock reiterated that capacity pressures remained after years of weak productivity growth had constrained the supply side of the economy.
