Dow Falls Amid Rising Treasury Yields, Dollar Surges After Fed Decision; Bank of England Faces Tough Rate Decision | Daily Market Analysis

Key events:

• New Zealand - GDP (QoQ) (Q2)
• Switzerland - SNB Interest Rate Decision (Q3)
• UK - BoE Interest Rate Decision (Sep)
• USA - Initial Jobless Claims
• USA - Philadelphia Fed Manufacturing Index (Sep)
• USA - Existing Home Sales (Aug)

On Wednesday, the Dow concluded the day with a decline, primarily due to the surge in Treasury yields, which pressured the technology sector. This movement came in the wake of the Federal Reserve's decision to maintain interest rates at their current levels while embracing a stance of prolonged higher rates.

The Dow Jones Industrial Average dipped by 0.2%, equivalent to a 76-point drop, while the Nasdaq experienced a more significant decrease of 1.5%. The S&P 500 also registered a decline, falling by 0.9%.

The Federal Open Market Committee (FOMC) opted to keep interest rates unchanged, with the Federal funds rate remaining within the 5.25-5.50% range. Although this decision had been widely anticipated, the economic projections presented some surprises that triggered a strengthening of the US dollar, causing the EUR/USD pair to drop approximately 0.5%.

While the median forecast for the end of 2023 still anticipates an additional 25 basis points of tightening, the new outlook for 2024 suggests a 50 basis point reduction in rates over the course of the year. Notably, the dot-plot, a key component of the forecasts, displayed a more hawkish revision, with the consensus projecting one more 25 basis point rate hike for the remainder of 2023, followed by a 50 basis point reduction. Chairman Powell remained cautious in his statements, recognizing that financial markets closely scrutinize every word from the head of the Federal Reserve in an attempt to forecast future decisions.

It is worth noting that while some other central banks are grappling with the challenge of managing inflation effectively, the Federal Reserve has generally made substantial progress in achieving its objectives. However, its current focus lies in preventing any inadvertent reversal of the progress made thus far.

Most economists maintain their conviction that the Bank of England will proceed with an interest rate hike in the UK, taking rates from 5.25% to 5.5% in today's Monetary Policy Committee (MPC) meeting scheduled for 12 noon. This would mark the fifteenth consecutive interest rate hike, propelling rates to their highest levels since early 2008. However, recent events, including a positive inflation surprise, have introduced some uncertainty regarding the future steps for UK interest rates.

UK inflation continues to outpace that of most other G7 nations, posing a tangible threat to the country's economic growth. The accelerated cooling of core prices in recent data releases gives the Bank of England reason to pause and contemplate its next move.

The Bank of England now confronts a challenging decision. Should they persist with rate hikes to further quell UK inflation, or should they temporarily halt interest rate increases to observe the direction of economic data in the coming months? This decision is far from straightforward because the data clearly indicates that UK inflation remains elevated.

As the European trading session commences, the British pound has displayed consistent weakness, primarily in response to the disappointing UK Consumer Price Index (CPI) report for August. This depreciation of the pound has pushed the EUR/GBP currency pair toward the upper boundary of the trading range between 0.8500 and 0.8700, a range that has been in place since May. Meanwhile, the GBP/USD exchange rate has fallen below the 1.2350 mark.

On Thursday, the US dollar reached a six-month peak against a basket of currencies, while US Treasury yields surged to multi-year highs following the Federal Reserve's decision.

Both the dollar index and dollar index futures experienced a gain of approximately 0.5% each during Asian trading hours, reaching their highest levels since early March. This rally came in response to comments by Fed Chair Jerome Powell, who indicated the likelihood of at least one more interest rate hike later this year.

The Japanese yen faced pressure after the Fed meeting, with its value hovering around 148.39 per dollar, having touched a nearly ten-month low of 148.47 earlier on Thursday. Despite the dollar/yen pair approaching levels last seen at the end of the previous year, the chances of the Bank of Japan tightening its policy in Friday's meeting remain slim.

Although Japan's Chief Cabinet Secretary Hirokazu Matsuno issued further warnings on Thursday, emphasizing that authorities wouldn't rule out any measures to address excessive volatility in currency markets, the risk of actual intervention appears to be limited to verbal statements at this point.