A surprising reversal
The Federal Reserve’s Federal Open Market Committee meets a minimum of eight times per year to make decisions on monetary policy and provide guidance on the evolution outlook for the economy. In the previous April meeting, the FOMC had struck an uncertain tone about the rebound of economic prospects and whether they would lead to a sustained increase in inflation. In last week’s press conference, we appear to have witnessed the Fed acknowledge higher inflation, because policymakers now expect to raise rates in 2023, which is sooner than anticipated.
Although it has been retracing somewhat in today's trading session, the initial market reaction was dramatic. Commodity and equity prices have fallen in anticipation of the tighter funding environment, sending the Dollar rallying to March 21 highs.
The Euro—which had been a primary beneficiary of Dollar weakness over the past quarter—experienced a resulting sell-off. More generally, this shift in rate expectations has caused a reversal of risk appetite, not just in the EU. Whether it remains will be dependent on a continuation of the inflation surge narrative.
Bottom line: The question that both markets and policymakers face is whether inflationary pressures will manifest in other geographies as well or whether vaccination efforts remain a barrier to recovery. If demand did spike elsewhere, there would be a solid basis to foresee an even stronger bias for rate hikes from the Fed. The international connectivity of markets implies that the more places experience demand surges, the greater the effect for everyone. National compartmentalisation under Covid has in some ways reduced this effect by reducing the movement of labour, but a lifting of lockdown measures means this transmission of demand is likely to come back into focus.
The week ahead
Cable suffered its most significant weekly fall since September 2020 last week as Dollar strength weighed heavily on the pair. The focus will be on the Bank of England this week after UK year-on-year inflation for May came in at 2.1%, the highest level for almost two years. This could pose the question of whether the central bank will consider an early hike in interest rates, much like the Federal Reserve. UK Coronavirus restrictions look set to remain in force until the 19th of July, despite some vaccine experts hinting that high levels of vaccinations in the country could lead to an early relaxation of restrictions on July 5th.
- Rightmove HPI m/m fell to 0.8% this month compared with 1.8% in May.
- Flash Manufacturing and Services PMI’s are due out on Wednesday, with Manufacturing expected to read 64.1 vs 65.6 last month, and Services to remain unchanged at 62.9.
- The Bank of England’s Monetary Policy Committee will meet this Thursday and provide an interest rate decision and any asset purchase facility changes.
- The Gfk Consumer Confidence index will be released on Friday, forecast to show a -7 reading vs -9 last month, indicating an uptick in confidence.
EUR/USD has faced similar selling pressure to Cable over the last week, with the pair trading below $1.19 in early trading. The European Central Bank is currently more dovish than the hawkish Fed, with markets anticipating the US will be around two interest rate hikes ahead of the EU by 2023. ECB President Christine Lagarde will be speaking throughout the week, which will be the closest we'll get for any formal indication of interest rates. There is a busy week for data with PMI’s out mid-way through the week, along with sentiment stats that could push the inflation narrative and the need for tighter monetary policy.
- The European Central Bank President Christine Lagarde will be speaking today and on Wednesday at 5:00PM.
- German flash Manufacturing PMI is forecast to read 63.0 vs 64.4 last month, while Services look set to climb to 55.4 vs 52.8 last month.
- French flash Manufacturing PMI is expected to be little changed at 59.0 vs 59.4 last month. Services appear to be on the rise to 59.6 vs 56.6 last month.
- The German ifo Business Climate is anticipated to rise to 100.5 vs 99.2 last month as positive sentiment continues to build.
Last week, the Greenback had its best weekly performance in over a year after the Federal Reserve announced two possible interest rate hikes between now and the end of 2023. Short term government bond yields managed to perform well on the back of this announcement, with the two-year yield rising to its highest level for around 15 months, currently trading at 0.26%. Longer-term yields have since seen a fall with the expectation of these interest rate increases. Elsewhere, the Nasdaq has climbed 4.15% this month and continued to diverge from the S&P 500 and Dow Jones last week, with both major indexes suffering further losses.
- The Federal Reserve Chairman Jerome Powell is due to testify on the Fed’s emergency lending programmes and current Coronavirus pandemic policies on Tuesday.
- Flash Manufacturing PMI is forecast at 61.5 vs 62.1 last month, while the flash Services PMI is anticipated to read 70.0 vs 70.4 last month.
- Final GDP q/q looks set to remain unchanged at 6.4% for Q1 2021.
- The Core PCE Price Index m/m is projected to read 0.6% in May vs 0.7% in April.
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