Central Bank Bonanza
As expected, the markets trod water last week ahead of the central bank bonanza that we are looking forward to enjoying this week. There is also the little matter of the release of February’s non-farm payroll data on Friday. Over the week, the dollar ebbed and flowed as the euro flirted with its best levels for over six months, whilst sterling continued to feel giddy once it got above 1.2425. Friday’s PCE data from the States showed that, indeed, inflation is moderating and other news from across the pond was pretty positive, with GDP a little stronger than expected and the weekly employment data held up well. Can the Fed navigate a soft landing for the economy? At first sight, the chances look good; however, there are some signs just below the surface that all is not well, with consumer expenditure retreating and retail sales starting to fall off a cliff.
The week ahead really looks like it’s going to be a week full of volatility with plenty of price traps for the unwary. The three major events most likely to move currencies are the outcomes of the central bank meetings, which will be announced on Wednesday and Thursday. Chronologically first and also probably first in terms of importance, the US Federal Reserve will reveal the outcome of their two-day meeting on Wednesday evening. As we mentioned earlier, there are some signs that the economy is starting to slow, and inflation is starting to subside back towards the Fed’s target level of 2%. Indeed, there have been clear hints in the recent Fedspeak that they are moderating their hawkishness, and the currency markets are now generally expecting a 25bp rise in the Fed Funds rate. Alongside the rise, we expect a warning that inflation isn’t defeated and that rates are still likely to rise higher and stay at these levels for longer. There is, however, a slight chance that with financial conditions still relatively benign that the Fed wants to give markets a jolt and raises by 50bp; if they do this, we will see the dollar appreciate rapidly and stock markets firmly in reverse gear. With the markets trying to pick the top of the current tightening cycle and sitting with hair triggers waiting to react, Wednesday evening should be exciting for dollar watchers.
Out of the big three central banks, the ECB looks the easiest to read, with nearly all the prominent council members, including Christine Lagarde stating that they will move rates higher by 50bp at their meeting on Thursday. The eurozone economy certainly appears more resilient than many, including your humble scribe, expected, and the inflation outlook has, without a doubt, been helped by the, so far, mild winter weather. The unanimity of the council member’s recent speeches will no doubt hold, and the main interest will probably centre around not the rise but expectations of when rates will start to fall. With the war in Ukraine entering a new, possibly more dangerous phase, we expect that President Lagarde will push firmly back on market expectations of rate cuts next year. Whether today’s confidence indicators, the eurozone inflation figures, released on Wednesday or S&P’s Purchasing Managers Indexes influence their decision is hard to tell, but both could be used in the short term by the markets to push the euro ahead of the announcement.
Last but never least, let us turn to the Old Lady of Threadneedle Street. The Bank of England is probably the hardest to call out of the three major central bank meetings. Inflation is certainly here in the UK and making its presence felt, as we can all testify when we do our weekly shops or pay our household bills. The derivative markets are looking for the Bank to start cutting rates in August, which considering that they haven’t finished hiking them yet, shows a distinct lack of faith in the resilience of the economy in the face of recession or perhaps putting a positive spin on things a rapid drop in inflation. Indeed, the Producer Price Index is showing signs of falling. This data may encourage the doves on the Monetary Policy Committee to vote for just a 25bp increase in Base Rate, whilst many think that 50bp would be more appropriate. Either way, the Bank is undoubtedly heading towards the end of its current rate tightening cycle, and there is some speculation that it may follow the Bank of Canada and admit to this. Also of interest will be the division of votes in the MPC after last month’s division. With the jury out on the size of the hike, sterling will be in for a volatile week with the short-term direction decided by this decision; although we feel that the general trend is lower, a temporary spike could occur if rates do indeed move by 50bp. Have a good week, and make sure you are doubly careful if you are looking to execute a trade this week.