Opinions

We believe the ECB will leave rates unchanged at its 23 July meeting, despite the reescalation of the US-Iran war since 7 July. We continue to believe that ECB will hike by 25 bps in Sep meeting and be done with the rate hike cycle. Markets currently price around 45bp of cumulative hikes in H2 2026; assuming a similar amount is priced going into the July meeting, we would expect marginally less to be priced by the end of the press conference. Recent ECB speak is supportive of a July hold in rates, even by the hawks. We believe that ECB market pricing at any time remains an oil trade. So, if oil continues to trade north of $85-90 levels on Brent in REMCY26, we can’t completely rule out Dec hike. But that is not our base case as of now. We believe Mme Lagarde will urge caution and underscore that uncertainty is elevated, indicating the impact on the Euro area economy depends entirely on the duration and intensity of the conflict, neither of which are clear at this stage. Mme Lagarde will likely want to deliver as neutral a message as possible. We do not have any strong views on Euro as of now but might like to receive 2 yr ESTR around 2.75 levels if available just before the policy event on 23rd July.

The “hall of mirrors” is a well documented problem in central bank communications. Rather than providing an independent signal about what a central bank should do, market pricing reflects a complicated feedback loop between central bank communications and economic fundamentals. The more the central bank tries to communicate how its reaction function depends on near-term developments, the more markets interpret these developments through the lens of that central bank’s reaction function. Financial markets perform best when they react to incoming data & they work less efficiently when they ask a question: How will the Federal Reserve react to that incoming information? Financial market prices are probably the most important source of information to guide central bankers. But when all the financial markets are doing is reflecting back what central bankers have said, then central bankers are blind to the most important set of information i.e true market information. Warsh believes in breaking this hall of mirrors. We believe Warsh might provide NIL forward guidance, might ensure DOTS go away while SEPs remain, post FOMC press cons to continue but far lesser content and that too on long term trends rather short term view & continuation of a more streamlined Fed speak. From a market perspective, with less forward guidance, term premiums go up and IVs remain elevated across asset classes.

At the monetary policy meeting held on 15-16 June, the BoJ raised the policy rate from 0.75% to 1%, the highest level since 1995, as expected. In its interim assessment of QT, it also decided to halt reductions to its JGB purchases from FY27 onward, after which monthly purchases will be maintained at around JPY2trn. This can be seen as a balanced choice vis-à-vis the Takaichi administration, which is reluctant to raise rates and concerned about a surge in long-term yields. Markets are currently pricing in a 92% chance of a 25 bps hike by Dec'26. We believe there is a significant risk of the next hike being in October itself. Governor Uchida characterized the current rate hikes as “policy adjustments toward a neutral level”, while adding that “it is not clear at what point we can judge the stance to be neutral; we won’t know until we reach it”. This likely implies that, although the policy rate has now reached the lower bound of the BoJ’s published estimates of the neutral rate, that fact does not mean the Bank will become materially more cautious about further rate hikes. As the situation in the Middle East seems to be stabilising, we believe uncertainty over the economy should recede, and the BoJ should ideally become even more focused on upside risks to inflation. In recent years, firms have become more accustomed to passing higher costs on to prices, and the BoJ should be strongly alert to the possibility that the mechanism through which higher crude oil prices lead to higher inflation has strengthened compared with the past. However, the rate-hike path could be affected by domestic and overseas political developments. In particular, if BoJ leadership proposes additional rate hikes going forward, we believe dissenting votes are likely to rise to four out of nine by July 2027, assuming PM Takaichi nominates doves to replace the Policy Board members whose terms expire on her watch. At the time of the September monetary policy meeting the BOJ will only have lending data for August, the first month when a June rate hike will start to be reflected in market interest rates and will not have any results from a Tankan survey carried out after the rate hike. As of September, the BOJ is unlikely to have enough data to assess financial conditions following a June rate hike. At the October meeting, however, when it will have access to lending data for several months following a June rate hike as well as to the results of the September Tankan survey, it will probably be able to conclude that funding conditions remain accommodative. But historically BOJ had decided not to hike rates in October 2025 or April 2026, we think it will be fairly difficult for the current leadership team to: (1) justify a rate hike after a shorter interval than before (2) without being able to confirm employers' stance on wage hikes. Hence, our main scenario for the next rate hike following a hike in June is a hike in December, while our risk scenario is a hike in October.

There were widespread expectations in the market that over time we would see meaningful changes to Fed communications, including around the meeting. And Kevin Warsh didn’t disappoint. We saw very, very significant changes to the range of communications at Chair Warsh's first meeting. We saw the statement completely trimmed down. And at least on the question of tone, it seemed like he very much leaned more towards the older version of Kevin Warsh when he was at the Board of Governors, where he seemed to be more focused on inflation and somewhat more hawkish signals from him. But we don’t know yet if this was just a role play to get in to the good books of FOMC members considering the baggage he comes with considering Trump’s rate cut ambitions. From a market perspective, market focus is shifting to US Fed reaction to elevated inflation than the Iran deal. The shift higher in economic forecasts and in the “dot plot” projections for the Fed funds rate this year were at the more hawkish end of expectations. While Warsh tried to downplay these somewhat in his press conference, the market has leaned into pricing hikes to materialise sooner, with USD rallying after the decision. The lack of forward guidance offered in either the Fed statement or by Warsh himself appears to be the new state of affairs and could create more room for front-end rates and FX volatility in the months ahead. Warsh had also announced the establishment of task forces focusing on five areas: Fed communication, balance sheet policy, the use of and reliance on existing data sources, productivity and jobs, and inflation frameworks. Although inflation risks are at the centre of discussion on the Committee, one of the above task forces is aimed at reviewing how the Fed should gauge inflation, suggesting that the bar to a hike might be higher until those task forces provide concrete policy proposals later this year. Summary: We still believe Fed is likely to remain on a long pause till Dec’26. But we don’t want to express this view yet via rates unless economic data starts changing. We do not see the current strength in NFPs fading at least till Aug NFP. Hence, we remain guarded on any strong rate views. But we remain bullish on DXY and expect it to go to 102 levels by July end from the current 100.85 levels. Also, if the 1yr-1yr US SOFR inches up to 4.10-4.15 levels from CMP of 4.03 levels, we like to receive half risk at these levels & another half at 4.25. Stop to this view is 4.35 and TP is 3.80.

We expect the BOJ to raise its policy rate (uncollateralized overnight call rate) from 0.75% to 1.00% at its Monetary Policy Meeting (MPM) on 15–16 June. We expect the BOJ to maintain its stance of continuing with rate hikes on the view that real interest rates are very low even as they approach the lower bound of the estimated neutral interest rate range. Given the rise in breakeven inflation (BEI) and persistent downward pressure on the yen, we think the BOJ might add a phrase emphasizing its commitment to price stability in a bid to win the market over. W.r.t Governor Ueda's press conference, we do not expect Governor Ueda to provide any specific views on the pace or conclusion of rate hikes (including the terminal rate). With the policy rate following the prospective rate hike (1.00%) close to the lower bound of the BOJ's estimated neutral rate range (1.1-2.5%), it will be interesting to see whether the BOJ maintains its view that real interest rates are very low. We think the BOJ is likely to announce at the June MPM that it will maintain its current plan for reducing JGB purchases (so-called tapering) through FY26 but stop tapering from April 2027 and leave monthly purchases unchanged at ¥2.1trn. From a market perspective, this week’s BOJ’s 25bps hike may not be hawkish enough for JPY. A stronger anti-inflation message could support JPY, while insufficient hawkishness would leave intervention risk around the 160–163 area in focus. We believe that Ueda might find it difficult to sound hawkish and hence JPY should test the June’24 highs of 162.25. USD/JPY also appears to have recently regained its correlation with the US-Japan 5yr interest rate differential, showing the significance of this week’s BOJ & FOMC decisions. Any MoF intervention might wait till 163-165 levels.

We expect a status quo in 17th June FOMC meeting with a hawkish FOMC statement. New Fed Chair Kevin Warsh might try to tone down the hawkishness of the FOMC statement but without supporting data, he too might not want to commit too much himself. We expect the Committee to remove an easing bias from the policy statement with unanimous support. The median projections for the federal funds rate are likely to show no changes for 2026 and 2027, followed by one rate cut in 2028. We expect the median longer-run projection to be revised slightly higher. Chair Warsh is unlikely to submit his own economic and policy projections, consistent with his past criticism of forward guidance. In his press conference, we expect he will acknowledge the current hawkish macroeconomic environment but will likely make a case for policy easing in the medium term. Since the April FOMC, US economy has shown consistent trends of strong employment with elevated inflation. Although core CPI inflation slowed to 0.208% m-o-m in May, we expect May core PCE inflation rebounded to 0.34%, driven by PCE components derived from PPI data. On a y-o-y basis, core PCE inflation likely inched higher to 3.426% in May, the highest since October 2023. Fed Speak since the April FOMC has been hawkish. Several FOMC participants explicitly discussed the possibility of a rate hike. But there is still a dovish fraction at FOMC consisting of NY Fed President Williams, Governor Bowman & SF Fed President Daly. Based on recent Feds Speak, we expect the median dots for 2026 and 2027 will rise to 3.625%, indicating no changes from the current rate level for the next one and a half years. In the long run, many policymakers will likely maintain their long-term disinflation scenario as their base case, and we expect the median 2028 dot to be 3.375%, consistent with one rate cut. We expect the longer-run median dot (a proxy of the neutral rate of interest), will be revised up slightly to 3.250% from 3.125%. Since the March FOMC meeting, inflation data have been stronger than the March median projection implied. As a result, we expect the median inflation projection for both the headline PCE and core PCE price indices will rise over the near term Markets are pricing in a 80% probability of 25 bps hike by Dec’26 and some more by mid CY27. We expect short end pricing to remain around current levels varying between 50-100% of a rate hike by Dec'26.