The Federal Reserve increased the Federal Funds Rate (FFR) by 75 bps as expected, the largest single increase since 1994, to a range of 1.5% - 1.75%, while leaving the door open to a similar move in the next meeting (July 27th).
The Federal Reserve now points to an FFR of 3.4% by end-2022 (median projection) instead of 1.9% in March’s projections, suggesting a fast entry in restrictive territory (range of FOMC’s estimates for the longer-run FFR: 2.0% – 3.0%), broadly aligning with markets’ expectations for a range of 3.5% - 3.75%.
The Bank of England (BoE), increased the Bank Rate for a 5th consecutive meeting, as expected, by 25 bps to 1.25%, with a vote majority of 6 versus 3 who opted for a 50 bps hike. Markets price-in the Bank Rate to reach 3.5% in the next 12 months.
The European Central Bank announced, as expected, the end of net asset purchases as of July 1st, as well as its intention to increase the key policy interest rates by 25 bps in the July 21st meeting. The ECB left the door wide open for larger hike increments afterwards, supporting the view for a +50 bps to come on September 8th and indicated that hikes will continue after September. In all, markets price-in cumulative increase of circa 250 basis points over the next 12 months.
To stem market fragmentation risks, apart from the “total” flexibility in PEPP re-investments across time and jurisdictions, the ECB held an ad hoc meeting on June 15th, pledging the immediate commencement of designing a new instrument. Euro area periphery spreads broke their rising trend following ECB’s announcement.
The Bank of Japan (BoJ) maintained its ultra-accommodative stance and showed no intention to deviate from it. The forward guidance “policy interest rates are expected to remain at their present or lower levels” was unchanged. Monetary policy divergence with major peers led to a sharp depreciation for the Yen following BoJ’s meeting, -2.1% on Friday versus the US dollar to \135.30, the weakest since October 1998.
Discounting rising probabilities that major central banks’ aggressive monetary tightening could lead to a “hard landing”, the S&P500 declined by 5.8% in the past week, recording losses in 10 of the past 11 weeks. US large-cap equities have declined by -23% since January 2022 high (4797).
Similarly, the Eurostoxx ended the week down by 4.6%, standing 21% below its November 2021 high (488), with both indices dipping into “bear market” territory. Following the recent sell-off, equities attracted buying interest in the start of the current week.
Valuations have reverted rapidly below their long-term means. Indeed, the 12-month forward Price to Earnings ratio for the S&P500 has retreated to 15.5x, falling below its 20-year average of 15.8x, for the first time since April 2020. Compared to the pre-pandemic levels, the ratio is 2.5 points lower than in January 2020. Regarding the Eurostoxx, the ratio stands at 11.9x, significantly below its 20-year average (13.3x) and its January 2020 level (15.0x).