Weekly Brief

The race to the top

GBP

We ventured into the latest BoE meeting this week with some serious doubts as to the eventual outcome. On the one hand, the surging inflation in the UK – which is amongst the highest of the economies that we track, would argue for a bold move from the BoE. However, recent growth figures, amongst other weaker data suggest that the UK economy is already showing signs of contraction. There appears to be a recession in the UK in all but name, and hiking rates into a weakening economy never ended particularly well.

In the end, the BoE erred on the side of caution, opting to raise UK rates by just 25bps (to 1.25%), but reminding everyone that they are prepared to ‘act forcefully’ on inflation if needs be. Quite what inflation has to get to in order for these acts of forcefulness to be triggered is up for debate, but that hawkish tilt in their statement, at least gave a modicum of comfort to those who had been seeking a bolder hike on the day. All said and done, we think that the BoE got it right.

The pound initially took the news poorly, but that was as much to do with frustration from the 50bps camp. However, GBP/USD found its mojo again and rallied back over 1.2320 through the day, as a short-covering rally ensued. GBP/EUR followed suit and moved back over 1.1700.

Looking into next week, and the latest CPI inflation print will give markets some idea as to whether the BoE were correct in their thinking, or not. However, the latest estimates do not bode well, predicting a headline jump from 9% to 9.8% (YoY/May), creeping ever-closer to that rather unwelcome 10% level. Stiff upper lip time.

EUR

Just a week since the latest ECB meeting, after which they said that they would be hiking rates by 0.25% in July, and an emergency meeting is called by the ECB. Emergency meeting, what is that all about? Markets were awash with multiple outcomes, from rate hikes to extensive programmes that might help take the pressure off the bonds of the more indebted nations. In the end, the announcement was a complete damp squib. The ECB have agreed to work on a ‘new anti-fragmentation instrument’. Whatever that is.

How do you explain market frustration? Well, imagine it is Christmas day, and you get to the big present right at the end. You know, the one with the bow on, and fancy paper. Excitedly, you unwrap the gift and inside is that gleaming iPad box you have wanted all year. Except, when you open the box, it is not an iPad inside, but some chocolates. On Wednesday, the market got chocolates from the ECB. Given that markets had given the central bank community a green card to hike at their will this week, the ECB really did miss a window of opportunity.

The single currency got caught up in the crossfires, with EUR/USD initially rallying strongly on the rumour express, moving back to just over 1.0500. However, the markets instant frustration was taken out on the single currency, swiftly moving back under 1.0400, and was perhaps only saved on the day by the outcome from the Fed meeting. Looking ahead, today’s HICP inflation will be closely monitored, with the pick of the bunch next week being the Euro area PMI readings next Thursday.

USD

Something changed over at the Fed over the past week that prompted their decision to raise U.S rates by 75bps, instead of the previously flagged 50bps hike, on Wednesday. Many would argue that last Friday’s higher than expected inflation reading was the straw that broke the Chairman’s back, so to speak. This is especially true, given that we were finally expected to see a slight softening (of inflation), and the market fallout from that particular number had been fairly spectacular. However, it may well have been consumer inflation expectations, and consumer sentiment falling to a record low, from the Michigan Confidence Survey that really changed thinking at the Fed. Whatever the weather, the Fed opted to go bold now, also indicating that they are likely to make a similar (75bps) hike at their next meeting in July.

Markets rallied on the news initially, as the hope of some larger hikes now could see a quicker end to the process, as the Fed may be encouraged to pause sooner. Powell said as much. However, by the time markets rolled over to Asia and the European morning, sentiment had turned sour, and by the end of yesterday all of the previous day’s gains had been eroded.

With Powell suggesting that he would like to see at least 125bps worth of rate hikes from the Fed before the end of this year, after next month’s 75bps move, we should see the hiking size, if not regularity, decline come September. The current ‘dot plots’, which highlight cumulative future rate expectations/guesstimations from Fed members, suggests that the policy rate might get to around 4% by the end of next year. Of course, for that to happen the U.S economy will need to play ball, and that is by no means guaranteed, given that we have already seen signs of consumer weakness, which was highlighted by the recent slowdown in Retail Sales. The housing market looks particularly vulnerable, and is showing a marked correction.

The greenback has had a particularly choppy week. Having marked a cycle high over 105.00 in the middle of the week, the dollar index slipped back under 104.00 by yesterday. USD/JPY has had a big move, slipping from 135.00 to under 132.00 and the jumping back over 134.50 in the space of 24 hours, as a risk-off market dominated, before further inaction from the BoJ stirred the turnaround overnight. Interestingly enough, the BoJ may have kept policy unchanged (again), but for the first time in a while they mentioned readiness to watch FX, in their accompanying statement.

USD/CHF needs a mention too. The surprising 50bps hike by the SNB (yes SNB!), which raised Swiss rates from -0.75 to -0.25%, coupled with the weaker greenback, and broad risk-aversion all in the same day, resulted in a rather spectacular move from over 1.0050 to 0.9664 in USD/CHF. We nearly chocked on our Lindt’s.

It is fairly quiet on the U.S front next week, but Chairman Powell will be speaking later today, and given the proximity to the FOMC, it would be a bold call to suggest that he might give us any new Powell’s of wisdom.

CAD

Having benefitted from higher energy prices and a robust economy of late, the Loonie has had a rather disappointing time of it over the past week or so. USD/CAD rallied from just over 1.2500 to just under 1.3000 during this time. However, with the greenback stuttering, and a slew of keynote Canadian data due over next week, these factors could have a major impact on the landscape going forward.

In particular, next Tuesday’s Retail Sales (MoM/Apr) will be key. With a 1.8% increase through the month expected, up from a flat reading previously, we could see further signs of the strength in the Canadian economy. The next day’s inflation print could see inflation tapping 6% (YoY/May), which would give markets confidence that the BoC are likely to make another big hike at their next meeting. Will they follow the Fed’s lead, and go beyond 50bps? Time will tell.

AUD & NZD

Having slipped from a near 0.7300 high, AUD/USD moved all of the way down to under 0.6900 by the middle of the week. That tide turned around in conjunction with the other dollar crosses, and the Aussie has staged a meaningful recovery. Helping the cause has been the latest Australian employment report, which was much better than expected, with 61k new job gains over the past month, well ahead of the 25k expected. Unemployment remains tagged to 3.9%.

As it stands, and assuming that there are no bumps in the road beforehand, expectations remain high that the RBA will hike Australian interest rates by a further 50bps next month. In the meantime, next week sees the release of the minutes from the latest RBA meeting. Whilst somewhat backward looking, the decision to raise rates by 50bps completely blindsided markets, so the text from the RBA around the reasoning behind the move is meaningful.

The move by the kiwi has replicated that of the Aussie, with NZD/USD quickly regaining lost ground after finding support at 0.6200. Given that the latest New Zealand GDP report missed expectations, dropping by 0.2% (QoQ/Q1), versus estimates of a 0.6% gain, the rebound for the Kiwi is all the more impressive. Point to point, it probably out-rallied the Aussie on the day, which was likely short-covering given the weaker data.

 

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