Fed hikes as expected while strong data supports Asian currencies

The FOMC raised the target fed funds rate 25bps to 1.25%, and continued to say that it can remove policy accommodation at a pace likely to be "measured." That was expected. Overall, the statement was mildly dovish on inflation. The FOMC said that the recent inflation data have been somewhat "elevated" but a portion of that appears due to transitory factors. It also said that underlying inflation is expected to be relatively low. Consistent with recent statements from Fed Chair Greenspan, the statement also read that the FOMC would respond to changes in economic prospects as needed to fulfil its obligation to maintain price stability. This reinforces the importance for the markets in monitoring unit labour costs as the Fed has made clear this is the key source of inflation pressures in the economy.

The statement was bullish for assets as it implies that the FOMC would only raise rates 25bps at most at the next meeting (August 10). The Treasury curve steepened on the FOMC announcement while the S&P ended the session up 0.4%. The fact that the FOMC left their options open in the event that they appear to be falling behind the curve may have taken some of the steam out of the Treasury rally, though currency markets took it as a USD negative statement.

This was reinforced by Japan's Q2 Tankan survey which came out above expectations, with a reading of 22 for large manufacturers and 9 for non-manufacturers. The reading for small manufacturers, an important sector for the Japanese economy was 2, which was the first positive reading since 1991. The continued out performance of the Japanese economy gives more support to the view that the authorities can allow the JPY to strengthen without damaging the recovery. We expect USD/JPY to reach 98 by year end.