The Fed left its policy unchanged yesterday, but the updated forecasts and dot plot showed that the Central Bank does not believe in its own story about temporary high inflation. The reaction of the markets was acute and should not surprise, given the fact that in the past few months, the Fed’s policymakers worked hard to convince investors that high inflation will not last long, and therefore will not impact rate hike outlook. It turned out that this is far from the case.

Compared to the previous dot plot, there have been significant changes: 13 out of 18 officials expect a rate hike of at least 25 bp. in 2023. There were only 7 of them in March. As for 2022, 7 out of 18 officials expect at least one rate hike; in March, the hawk camp was less numerous - only 4 policymakers.

The forecast for GDP growth in 2021 was revised upward by 0.5% - from 6.5% to 7%. Inflation, according to the forecasts of the Central Bank, will rise to 3% by the end of the year and then begin to cool down. Notably, the growth forecast for 2022 remained unchanged, and for 2023 it was raised from 2.2% to 2.4%, probably reflecting optimism about the infrastructure initiatives of the Biden administration.

The sharp increase in the degree of optimism in the Fed forecasts brings forward the start of quantitative tightening (QT), which was clearly demonstrated by the bearish reaction in the Treasury market. The yield to maturity of longer-dated bonds, which are more sensitive to changes in interest rates or inflation, soared from 1.49% to 1.59% on Wednesday. Clearly, there was a massive sell-off of longer-maturity bonds which boosted demand for cash. The USD index soared from the level of 90.50 and continues to rally today fueled largely by the Euro weakness, as it now turns out that the ECB is noticeably lagging behind other Central Banks in developed countries in tightening credit conditions.

Formally, the details of the QE tapering will likely appear at the conference in Jackson Hole in August or at the meeting in September.

The risk of an early tightening of credit conditions in the US makes the dollar less attractive for carry trades, so investor focus is likely to shift to EUR and JPY, further weakening these currencies against the USD.

Technically, an interesting situation arose in the EURUSD and GBPUSD pairs, where yesterday's fall sent prices to the lower border of the medium-term uptrend:

Breakoutand consolidation below 1.1930 for EURUSD and 1.3890 for GBPUSD for severalsessions may mean that the medium-term uptrend in the pairs is broken and, atbest, we will see consolidation of EURUSD below 1.20 and GBPUSD below 1.40 withoccasional sales in this summer.