European markets and US markets fell back sharply yesterday as bond yields in the US, as well as across Europe, hit their highest levels in over 10 years in anticipation of further aggressive interest rate rises from central banks over the next few weeks.

The slide in US markets which saw the S&P500 close at a one-month low looks set to see markets in Europe continue with the negative theme, and another weak open as we look ahead to today’s Federal Reserve rate decision.

With a mini budget set to be outlined later this week, and the government borrowing more than expected in July, pressure will increase on new PM Liz Truss and Chancellor Kwasi Kwarteng on how they intend to fund the latest energy price cap fiscal package. In July, the government borrowed £4.9bn and this is expected to rise to £8.2bn in August as higher rates put upward pressure on debt payments. 

Yesterday the Swedish Riksbank surprised markets by hiking its headline rate by 100bps, more than had been expected, pushing it from 0.75% to 1.75%, with the prospect of more to come.

The aggressive nature of the move raised concerns that we might well see the Federal Reserve follow suit later today, followed by the Bank of England and Swiss National Bank tomorrow, with yields pushing higher across the board,

The main question today is whether we see the Fed move by 75bps today, or by 100bps which some started to call for in the middle of last week, after US core prices turned out to be much stickier than expected. This shift in the market thinking probably has more to do with what happened the last time we got a hotter than expected rise in US CPI during a blackout period, which prompted the Fed to shift to a much more aggressive hike by way of leaking to friendly journalists over the weekend in a move that saw the Fed come under heavy criticism. This begs the question as to whether they would go down this route again and hike by 100bps instead of 75bps.

This still seems an outlier especially as rates are much higher now than they were then, along with the lack of any briefing to the contrary over the weekend.

There is no question that the change of tone by Fed chair Jay Powell since Jackson Hole has shifted the dial when it comes to the idea of a pivot, or rather how unlikely the prospect of such an outcome currently is.

We also have the consensus from various Fed policymakers that the Fed will continue hiking until the job is done. When you have the likes of a typical Fed dove like Minneapolis Fed President Neel Kashkari talk about the unlikely prospect of rate cuts in 2023, it’s hard to envisage a scenario of anything other than a 75bps rate hike today, as the Fed continues to insist that their priority is to keep going on rates until the job is done.

This also ties in with several FOMC members indicating they expect to see the Fed Funds rate at between 3.5% and 4% by year end, and possibly higher.

With US economic data continuing to look resilient and several US policymakers talking about front loading rate hikes you have to think that after last week’s CPI numbers, and the jump in core CPI, that the Fed will do another 75bps rate hike at the very least this week, as well as signalling further big hikes in November and December. The dot plots should also be instructive in this regard.

While the softer option of a 50bps rate move is also very much off the table, there are some voices calling for 100bps, however this could well come across as knee jerk and suggest that the Fed is panicking and could send completely the wrong message to markets.

The Fed needs to show it is in control of events and raise rates by 75bps but also indicate that further substantial rate rises would be forthcoming until there is clear evidence that inflation is starting to come down at a sustainable rate.

EUR/USD – still in the downtrend from the highs this year with trend line resistance from the highs this year, now at around 1.0180. A break through 1.0200 is needed to signal further gains. The bias remains towards the previous lows at 0.9865, and the 0.9620 area.

GBP/USD – found support at 1.1350 but still looks weak with little indication of a turnaround. We have minor resistance at 1.1500, which if broken could see 1.1750.  Bias remains for a move towards 1.1000 area, while below 1.1800. 

EUR/GBP – found support at the 0.8720/30 level, yesterday, with the potential for a move towards 0.8800. A break below 0.8720 opens up 0.8670.  

USD/JPY – still have resistance at the 115.00 area, with not much in the way of a dip. We need to see a move below 141.00 to delay a move towards the 1998 highs at 147.70. A move below 141.00 could signal further declines towards 139.80.  

FTSE100 is expected to open 6 points lower at 7,186

DAX is expected to open 40 points lower at 12,630

CAC40 is expected to open 30 points lower at 5,949