Time will tell
View from the Trading Desk
Since June of last year, the Greenback’s valuation has been one-way traffic, with the US Dollar’s trade-weighted index climbing by almost 7% in the period. Of course, global events like the Covid-19 pandemic and, more recently, Russia’s invasion of Ukraine have helped to support demand for the safe-haven US Dollar. However, market expectations of Federal Reserve policy action have really propelled the Greenback to current levels. In a similar fashion, continued US Dollar appreciation to the pre-Covid trend channel (below) will hinge on the Fed meeting market expectations that have become increasingly aggressive.
Almost ten months ago, on June 16th, the Federal Open Market Committee changed tact and forecast two interest-rate hikes, up from zero, by the end of 2023. Fast-forward to today, and markets have priced in a further nine 25bps increases to the 0.5% headline interest rate, all by the end of 2022! It’s certainly a dramatic shift in such a short period of time, and with the global growth backdrop still rather perilous, it could mean that the Fed will struggle to meet expectations.
For the Greenback, we don’t see signs of near-term strength abating, however, this is likely to play out more against currencies with central banks that are less likely to tighten policy in the short-term—think Euro, Yen, and Yuan—than those more aligned with the Fed—think Pound, Canadian Dollar, and Nordics.
Bottom line: Over the weekend, Bloomberg published an interesting piece on the path to neutral interest rates—i.e. the rate that neither restricts nor spurs economic growth—and why that particular rate is so hard to pin down. In short, the level of uncertainty around inflation and tighter financial conditions, combined with a market hooked on ultra-easy monetary policy has some economists predicting that a US recession could be on the horizon. This could spell trouble for the lofty Greenback if slowdown indicators, like Friday’s ISM Manufacturing Purchasing Managers’ Index read, become more prevalent.
The week ahead
Sterling fell against most G10 currencies last week, dropping 0.5% against the US Dollar and 1.0% against the Euro. Bank of England Deputy Governor Ben Broadbent issued a caution to BOE policymakers, warning that forward guidance provided by the central bank is driving aggressive market pricing. According to Broadbent, there should be greater dependence on economic data to form expectations rather than making plans for monetary policy that affect demand today. Five 25 basis-point interest rate hikes are priced in between May and November, with UK inflation set to peak at 8.0% in the next few months. Energy rationing in the UK has been ruled out by Transport Secretary Grant Shapps as European countries look to contain rising energy prices.
- Monetary Policy Committee members Jon Cunliffe and Huw Pill will be speaking today and Thursday, respectively.
- The UK final Services PMI for March will be released today and is expected to remain unchanged at 61.0.
- The UK Construction PMI for March will be released this Wednesday, with analysts forecasting a 58.0 reading versus 59.1 in February.
- On Thursday, the Halifax House Price Index m/m is due to be published for March. Estimates are for a 0.9% print.
The Euro retraced 0.3% this morning, holding above the $1.10 handle against the US Dollar following a 50 basis-point move to the upside last week. Eurozone inflation hit 7.5% year-over-year in March, with European Central Bank President Christine Lagarde expecting inflation to continue higher against a backdrop of war in Ukraine, rising energy prices, and supply chain bottlenecks. Markets are pricing in 60 basis-points worth of rate hikes for the rest of the year as bets for more hawkish monetary policy action ramp up and help to keep the common currency afloat amid turbulent market conditions. European markets have opened broadly higher this morning; the Euro Stoxx 600 is up 0.5% so far today.
- French Industrial Production m/m for February is projected to read -0.1% versus 1.6% in January.
- The Economic and Financial Affairs Council (ECOFIN) is due to meet on Tuesday, with meetings taking place throughout the day.
- Eurozone Producer Price Index m/m is due to be released on Wednesday. Current estimates indicate a reading of 1.2%, compared to January’s 5.2% reading.
- The European Central Bank Monetary Policy Meeting Accounts will be released this Thursday at 12:30PM.
The US Dollar Index is trading 0.2% higher this morning as markets ramp up bets of a 50 basis-point interest rate hike following further robust jobs data. The US economy added 431,000 jobs in March—lower than expectations, but still a strong print in what is a tight labour market. Government bonds continue their sell-off, with the spread between the two and ten-year Treasury yields turning negative and widening. Elsewhere, the US has planned to release 180 million barrels of crude oil from the Strategic Petroleum Reserve as supply disruptions persist following the Russian invasion of Ukraine; WTI was holding below $100 per barrel in early trading. US futures markets are pointing higher, with the S&P 500 up 20 basis points to start the week.
- The ISM Services PMI will be published this Tuesday. Markets are expecting a 58.6 print in March versus the February reading of 56.5.
- Federal Open Market Committee (FOMC) members Lael Brainard, John Williams, and James Bullard will be speaking during the week.
- The latest FOMC Meeting Minutes from the Federal Reserves’ last two-day meeting in March will be published on Wednesday.
- US Unemployment Claims for the week ending the 2nd of April are due for release on Thursday. Forecasts indicate a 201K reading, suggesting little change from the week prior.
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