The market does not believe in the Fed's hawkish narrative

EUR/USD clearly above 1,0900. New historical highs for gold above USD 2200 per ounce and records on Wall Street at the S&P 500 index. This is the result of Wednesday's Fed decision on interest rates. The market reaction indicates at least very dovish rhetoric or even a reduction in interest rates. Nothing could be further from the truth! The Fed has been very neutral, if not slightly hawkish, but the market has its own opinion on the interest rate outlook. Discounts are coming!

Minor inflation revision

The Fed kept interest rates unchanged, as expected, but did not change the parameters of its balance sheet contraction program. The Fed did not change its forecast for interest rates this year and still sees three cuts, which could have been taken by the market as a good sign. On the other hand, the number of reductions for 3 and 2025 was reduced. At the same time, a slight revision of inflation for next year was made and a significant GDP forecasts were raised due to the strong labor market.

Powell sounded very neutral at the conference and said that the latest inflation readings were a surprise and did not make the Fed confident that inflation was heading towards its target. Despite this, the Fed was not hawkish. The announcement has not been changed, Powell confirmed that changes will be made soon changes in the pace of balance sheet reduction. The market basically saw only positives and still believes in the June interest rate cut. In fact, it looks like interest rates will be cut for the first time in June, with July at the latest if the Fed needs additional reassurance.

The market is very optimistic

But what if inflation goes in a different direction? Sam Powell said the recent bounce could be a "bump in the road" or more. If fuel prices, geopolitical tensions and a strong economy lead to a recovery in inflation, this could prove to be the case discounts won't appear that quickly. The market does not seem to notice this and remains very optimistic.

There is, of course, no reason to expect a worst-case scenario, but there will indeed be grounds for keeping interest rates unchanged for a longer period of time. Of course, inflation data and labor market data will remain under observation, but in addition, data on economic activity may prove crucial. If the Fed still wants a soft landing, it cannot overdo it by keeping interest rates high for too long.

Before 7 a.m EUR / USD was getting closer to the level of 1,0950, which means that since yesterday the upward movement was over 100 pips. A weak dollar means the return of a stronger zloty. We pay PLN 3,9449 for a dollar, PLN 4,3131 for a euro, PLN 5,0454 for a pound, and PLN 4,4544 for a franc.

Source: Michał Stajniak CFA, XTB