Global Rates & FX Views: Central banks – the aftermath

Bank of Japan (BOJ) Meeting Outcomes

• Policy Communication: The BOJ's communication skewed hawkish, reinforcing that underlying inflation is no longer far from the 2% target, with some board members arguing it has already reached 2%.
• Risk Assessment: The July Outlook report explicitly added AI-related demand and FX developments to the list of upside inflation risks, alongside Middle East developments.
• Governor Uyeda's Stance: Governor Uyeda strengthened language on inflation proximity to the target but did not send a strong signal regarding a September rate hike.
• Hike Timing Baseline: The strategists' base case for the next hike remains October 2024, driven by the need for clearer data on price hikes in September/October and inflation expectations surveys.
• September Hike Contingency: A September hike remains a risk management option if yen weakness (triggered by US data) intensifies upside inflation risks before October.
• Exchange Rate Sensitivity: While the BOJ mandate is price stability, FX developments now have a larger impact on inflation assessments; the Ministry of Finance's intervention suggests a resistance level near USD/JPY 165.
• 2025–2027 Rate Path: The base case forecasts three additional hikes, targeting a policy rate of 1.75% by end-2027, with subsequent moves scheduled for March 2027 and October 2027.
• Political Constraints: Additional hikes beyond late 2027 face political headwinds from the spring 2025 BOJ leadership reshuffle and the summer upper house elections.
• Terminal Rate Risk: There is a risk the terminal rate exceeds 1.75% if the BOJ is forced to hike faster to contain inflation due to political timing constraints.

Bank of England (BOE) Meeting Outcomes

• Voting Split: The vote split was 6-3 to hold rates, slightly more hawkish than the strategists' base case of 7-2.
• Forward Guidance: The committee remained balanced, keeping the door open to hikes if second-round effects persist but explicitly stopping short of signaling an imminent hike.
• Market Reaction: The dovish outcome relative to expectations, combined with lower energy prices, triggered a sharp bull steepening in sterling rates.
• Committee Commentary: Governor Bailey and Governor Pill stated the committee is not getting closer to a hike, while hawkish member Lombardelli noted her vote to hold was not close.
• Quantitative Tightening (QT): Staff analysis suggests cumulative QT raised 10-year yields by 20–30 basis points (up from 15–25 bps previously).
• QT Pace Outlook: The report offered no decisive guidance on the QT pace between October 2026 and September 2027, with plausible outcomes ranging from an unchanged $70 billion pace to a slowdown to $50 billion.

US Federal Reserve (Fed) Meeting Outcomes

• Policy Decision: The Fed held rates unchanged, aligning with market pricing (65–70% likelihood) but diverging from investor expectations.
• Market Rationale: The back end of the curve sold off sharply while equities and the dollar weakened, driven by concerns over the Fed's lack of guidance and perceived "talk tough, act slow" messaging.
• Credibility Concerns: The reaction highlighted risks to Fed credibility for inflation fighting, as holding rates while emphasizing inflation risks creates a perception of being behind the curve.
• Repricing Dynamics: Market pricing for hikes by December dropped by roughly half (from 1.8 to 1.3 hikes), while the baseline probability for a September hike increased to 65%.
• Next Steps: The strategists view the next inflation prints as "enormously important" for determining if the September hike baseline holds.
• Inflation Framework: The Fed remains unconvinced that inflation warrants an immediate hike but continues to treat price stability as the dominant concern.

US 10-Year Yield Analysis

• Fair Value Discrepancy: Fundamental fair value for the 10-year yield is estimated at 4.15%–4.20%, whereas current levels stand at 4.7%, indicating a >2 sigma overvaluation signal.
• Model Validity: Strategists question whether calibration models remain valid in the current regime, suggesting the signal may indicate a breakdown in model assumptions rather than a mean-reversion opportunity.
• Reflation Outlook: The US economy is assessed to be peaking in a reflationary phase, with a likely fade of reflationary pressures over the next six to 12 months.