Things have changed a lot since the FOMC meeting in April-except perhaps that US junk bond yields are still at record lows. However, the Fed may not react too strongly, and there may be no change in its statement, shifting the focus to any hawk hints around the reduction timetable. While this may spur a stronger dollar, 10-year Treasuries at around 1.50% show confidence in the Fed's framework, which Federal Reserve Chairman Colin Powell will want to keep.
Of course, the policy shift will not be easy. Given that non-farm payrolls grew by less than 600000 in April and May, the threshold for significant progress may not have been met. While the threshold for a shift to higher interest rates in 2023 is not high-because seven of the FOMC's 18 members already have this tendency and members are open to talking about loose subtractions, median tightening could raise credibility issues if the inflation outlook remains unchanged.
The fall in commodity prices has further limited the signal that stimulus measures will be scaled back immediately, with the narrative of "inflation is only temporary" gaining the upper hand. The Fed's preferred indicator of inflation expectations has fallen more than 20 basis points since mid-May, while 72 per cent of fund managers believe in the interim.
Against this backdrop, oil prices are still impressive, with Brent crude approaching $75 a barrel. That should boost European energy stocks and help the Stoxx 600 extend its longest winning streak since 1999. Unless the Fed's unexpected move took away the big wine glasses from the stock market party.
This article, excerpted from the Bloomberg Markets Live Review, represents only the author's personal views and does not constitute investment advice.