Fed focus – Don’t spook the market

It’s hard to overstate just how pivotal this week could be for Chairman Jerome Powell and his team of central bankers at the Federal Reserve. Inflation in the States is at a near 40-year high, while the credibility of the Fed to achieve its mandate is undoubtedly in question. The Fed’s forward guidance at this week’s meeting will need to be more artistic than scientific in calming markets easily spooked by abrupt policy changes. Nevertheless, Powell and his team will need to ‘cautiously’ telegraph a March rate hike of up to 50bps. Not easy.

Still, it almost defies belief that the same officials who got the ‘transitory’ inflation call so wrong will maintain crisis-era support for the US economy. Nevertheless, this meeting of the Federal Open Market Committee will likely be a light touch on the accelerator before speeding towards a rate hike at every meeting until inflation begins to moderate. Meanwhile, Fed officials also need to decide how quickly to shrink its $9tn bond portfolio, another tool for tighter policy. Asset purchases probably should end this month but will likely end in March before the Fed decides the rate at which to shrink its balance sheet in the coming months.

Bottom line: US stocks are off to their worst start since 2016 on rate hike expectations, while bond traders are looking towards a flattening of the yield curve on faster monetary policy adjustments. In FX, we’ve seen this play out in a broad strengthening US Dollar, although this has been counteracted by a shift in forward points against the Greenback. Since October, Sterling/Dollar one-year forward points have gone from -75 to -22 at the interbank level.

The week ahead
 

GBP 

Sterling weakened last week, falling 0.30% against the Euro and 0.90% against the US Dollar amid the backdrop of a global stock market sell-off. UK Prime Minister Boris Johnson faces an important week for his leadership with the findings of the Sue Gray investigation into ‘partygate’ to be released, which could result in a confidence vote. There’s little significant data due out between now and the next Bank of England meeting, with markets pricing in a 90.00% chance of an interest rate hike in February. Elsewhere, fresh Brexit data has shown that imports from Great Britain to the Republic of Ireland between January and November last year were down 21.00% compared to 2020 as the transition period came to an end.

  • UK flash Manufacturing and Services PMIs were released this morning at 56.9 (est. 57.7) and 53.3 (est. 53.9).
  • Public Sector Net Borrowing is forecast to have fallen in December to £17bn versus £17.4bn in November.
  • The Confederation of British Industry’s Industrial Order Expectations is due on Tuesday, with manufacturers expecting less order volume this month at 22 following the December reading of 24.
  • The CBI will also publish Realised Sales on Thursday. Analysts are expecting a print of 4 compared to last month’s 8.

 

EUR

EUR/USD has drifted lower at the start of this week, following on from the European Central Bank President Christine Lagarde’s comments at the World Economic Forum on Friday. Lagarde restated the central bank’s position on inflation—in that prices will begin to fall this year—while emphasising that European economies are lagging behind that of the US. Concerns are growing on the governing council, with some warning of higher inflation for longer as a result of monetary policy inaction. The World Health Organisation has issued warnings suggesting the pandemic is far from over as case counts in Europe continue to hit record highs.

  • German flash Manufacturing and Services PMIs were published this morning, coming in at 60.5 (est. 56.9) and 52.2 (est. 47.9), respectively.
  • Euro Area flash Manufacturing and Service PMIs were also released today, reading 59.0 (est. 57.6) and 51.2 (est. 51.9).
  • The German ifo Business Climate print is due on Tuesday, with analysts expecting a 94.1 print versus 94.7 in December.
  • Preliminary Q4 2021 Gross Domestic Product data is projected to read 0.5% for France (Q3. 3.0%) and -0.2% for Germany (Q3. 1.7%).

 

USD

The US Dollar Index has continued its climb in early trade, up 0.65% since the start of last week. Stock markets sustained their downward trend with the S&P 500 and Nasdaq down 8.30% and 12.50%, respectively, since the turn of the year. The Federal Reserve will be the focus for markets this week, with Goldman Sachs expecting tightening measures to be implemented at every meeting until meaningful changes in inflation are realised. Four rate interest rate hikes are all but priced in for this year, with the chances of a fifth touching 60.00%. US Chief Medical Adviser Anthony Fauci has provided some encouragement, stating that signs are emerging that the Omicron wave is peaking.

  • Flash US Manufacturing and Services PMIs are due later today and are forecast to come in at 56.9 and 54.9, respectively.
  • The Federal Reserve will provide its latest Monetary Policy update on Wednesday at 7PM.
  • Preliminary US GDP for Q4 2021 is expected to read 5.30% versus a 2.30% gain in Q3.
  • Finally, to bookend the week, the Core Personal Consumption Expenditure Price Index m/m will be published with analysts expecting a 0.50% gain in December, the same as November.

 

If you'd like to discuss your foreign exchange requirements with one of our currency specialists, call us on +44 (0)20 3465 8200.