Weekly Brief

‘Will the Fed go for 100bps now?’

GBP

The ongoing battle to become the next Tory party leader and de facto prime minister, after Boris Johnson’s resignation this time last week, had been whittled down to just 5 as of Thursday afternoon. Leading the pack is ex-Chancellor Rishi Sunak, with Penny Mordaunt close enough to make it still too tough a call, to call. This is especially the case given that Ms Mordaunt is the current betting favourite, after a poll of Tory MPs placed her in first place in the final run-off. The remaining 5 will now take part in the first of a series of televised live debates today (Friday) and then again on Sunday, before the next round of voting takes place on Monday, when the weakest link will leave the building.

There was a surprising pop higher in the latest UK growth figures, when they were released a little earlier in the week. GDP increased by 0.5% (MoM/May), up from -0.3% previously. A slew of travel bookings appears to be the main culprit, even if everyone is stuck at the airports, for the most part.  At the same time, Industrial Production increased by 0.9% (MoM/May), and there was also a strong rebound in Manufacturing Production by 1.4% (MoM/May), from -0.6%. If anything, the data puts the BoE in a bit more of a pickle, with a slightly better economic backdrop, it will be tantalising for the BoE to go down the path of most central banks just now, and press the ‘big hike’ button at the next MPC meeting. However, with those much-publicised increases to the cost-of-living, plus government borrowing costs already ballooning at an alarming rate, the BoE look damned if they do, and damned if they don’t.  

As for the pound, it really depends on which lens you look at it through. GBP/USD succumbed to the super-strong greenback, and broke to a new cycle low under 1.1800 for a spell. Against the single currency, it has been a slightly different story, at one point challenging the 1.1900 region, before slipping back 100 pips by yesterday’s close of play.

It is a big week for UK data next week, with the latest inflation and Labour market reports due. Headline inflation is expected to increase from 9.1% to around 9.6%, which will give the BoE even more of a headache if achieved. Interestingly enough, with much talk around tax cuts from the prospective new Tory leaders, that could further increase headline inflation down the road. Yuck.

EUR

Currency markets have dominated the front pages this week, as the pair with the most liquidity and depth, EUR/USD, faced the ‘battle of parity’. The combination of an ever-increasing interest rate differential between the U.S and EZ, and the dollar continually benefitting from regular bouts of market nervousness, leading to broad risk aversion, has seen EUR/USD succumb to selling pressure over the past few weeks, leading us to this key and magical threshold.

In the end, the single currency finally gave way on Thursday, with the pair properly moving below parity and quickly moving 50pips down to a low some place near 0.9950. As we have said regularly during our daily updates, parity matters not only for the likes of Bloomberg and the financial press, but especially so for markets and option traders. Hence when it finally broke, it broke with some momentum and gusto, as a slew of stop-loss sellers were forced out of their positions. It looks a bit like a herd of wildebeest all trying to get out of a small gate at the same time.

Notwithstanding the fanfare around key levels in currency pairs, key EZ data in the shape of the latest German and Spanish inflation data were released a little earlier in the week. Whilst Spanish inflation remains above 10%, and German inflation remains at 8.2%, there were no material changes, which may give the ECB a small crumb of comfort as we approach the big rate decision meeting next week.

Christine Lagarde has said on many occasions that the ECB will hike by 25bps in July, which if followed through, will mark the first rate hike from the ECB since 2011. Given that borrowing costs have risen sharply for much the of the region, it really does seem as though the ECB will err on the side of caution and keep with 25bps, despite that surging inflation. This is especially so given the delicate political backdrop in Italy just now. Indeed, with recession risks mounting in the region, recent market-implied expectations for future rate hikes have also diminished of late. The latest pricing expects around 180bps worth of hikes next year, down from 195bps. Next week promises to be fun.

USD

Just 24 hours after the BoC shocked markets with their 100bps move, Fed governor, Christopher Waller, left the door firmly open for the Fed to hike rates by a similar size at this month’s meeting, if it was warranted by incoming data.

Whilst Waller did say that his ‘base case for July depends on incoming data’, and that ‘we have important Retail Sales and Housing data’ due out before the July meeting, you have to wonder whether this may be the beginning of another round of hawkish comments from Fed officials, with the potential for another timely leak to confirm that the Fed have upped their game from 75bps to 100bps for July. Apparently forward guidance comes in the shape of leaks in these fast-moving times.

The case for a bolder hike becomes ever-more convincing when you take into account the most recent Inflation and labor data, with the former jumping as high as 9.1% (YoY), driven by accelerating gasoline and food price increases, and another solid 372k gains on the headline Nonfarm Payrolls.

As for the dollar, well the strong move higher moved up a notch through this week. The broad dollar index moved as high as 109.00, which was impacted in part by the big move lower in EUR/USD (see EUR). However, the dollar’s strength has been witnessed across the board, with most major currencies marking sharp declines. Aside from views of what the Fed might do on rates, a big portion of the dollar’s gains has been driven by risk aversion in markets, with most major indexes stuttering through the week, as worries over a global recession intensify.

As Mr Waller highlighted, the big data to watch over the coming week is housing data and today’s Retail Sales. This is one area where the consumer might have a larger say on things.

CAD

The Bank of Canada had everyone grabbing their record books this week, after out-hiking even the Fed, with a whopping 1% move, taking Canadian rates up to 2.5% in the process. Whilst the BoC did say that they were looking to ‘front-load’ their rate hikes leading them to the surprising move this week, they also highlighted that they would be prepared to move again if data warranted such measures down the road.

As with everywhere else, Inflation is key, and whilst at just under 8%, it is not as bad as some major economies just now, the BoC highlighted that inflation is higher and more persistent than they had expected in their most recent Monetary Report (in April). The BoC fully expect inflation to remain at these elevated levels for the next few months, and given that there is obvious spare capacity within the Canadian economy, the time to go bold was now.

Oddly enough, just 24 hours after the move, USD/CAD was trading up beyond 1.3100. but that is all about the USD and risk aversion, rather than any fallout from the BoC move. GBP/CAD and EUR/CAD are perhaps much better thermometers to measure the temperature of the Loonie just now, and both have remained weak, suggesting relative Loonie outperformance.

Next week sees the release of the latest Canadian inflation figures, and that headline reading is forecast to jump well beyond the BoC’s 8% reference point, even if you take food and energy out, and annual inflation may well move from 6.1% to around 6.7%. No wonder the BoC raised rates so much this week.

AUD & NZD

The RBNZ did exactly what they said that they would do, and raised NZ rates by 50bps to 2.5% this week. The move represented the sixth straight meeting in which the RBNZ have hiked rates, and rates are now at levels not seen for around six years. Furthermore, the RBNZ also said that they remained comfortable with their path to try to combat surging New Zealand inflation.

Interestingly enough, as well as referencing higher inflation, the RBNZ did mention that there are emerging signs of medium-term downside risks to economic activity. Despite this, further hikes still look likely over the coming months.

NZD/USD was unable to benefit from the move by the RBNZ, with the pair slipping back under 0.6100 for a spell yesterday. Similarly, despite the lowest level of Unemployment in Australia for nearly 50 years, AUD/USD also fell victim to the greenback, moving back under 0.6700 briefly yesterday, before staging a modest pullback. 

 

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