News & analysis

GBP

After a fairly indecisive European session for the pound, it was jolted back into life after the Federal Reserve cast a more dovish tone than markets were previously pricing. The move by the US central bank to temper expectations of normalisation weighed on the US dollar across FX markets as a whole, allowing sterling to climb 0.53% against the dollar, while a more aggressive reaction in EURUSD resulted in the pound sustaining losses against its European counterpart. Today, sterling trades flat even as markets continue to adjust post-FOMC with a mildly stronger dollar creeping back into the frame. The Bank of England is set to release its latest policy decision today after casting previously hawkish messages to markets about the natural tapering of the QE programme and a lack of concern regarding the Gilt curve. We anticipate that the BoE will adjust to the increasingly positive economic outlook. Since the January meeting, the BoE has witnessed faster vaccination roll-out, a roadmap to reopening the economy, and £65bn in additional fiscal spending. The improvement in the outlook is likely to be caveated with highlighting the downside risks that still remain, in an attempt to stop markets from running away with their expectations of policy normalisation. Beyond the 12:00 GMT release of the policy statement, the meeting minutes are going to be in focus to further gauge the divergences in MPC members’ outlooks on inflation and consumption. There will be no press conference at today’s meeting.

EUR

The euro found support in yesterday’s dovish Fed meeting but traded mixed against other G10 currencies as policy divergence between the Fed and ECB remains smaller than the Fed and more hawkish central banks, like the Norges Bank. EURNOK, therefore, traded lower yesterday evening, although this morning’s session saw a rebound in the cross as markets await the Norges Bank policy decision at 09:00 GMT where the NB is expected to signal tighter policy while keeping a dovish stance in the short term. In the Netherlands, exit polls suggest Mark Rutte’s Freedom Party (VVD) is due to increase its seats by three to 36 in parliament to contain a record 17 parties, while the pro-EU liberal democrat D66 party may have had the largest surprise gain in the elections, taking an additional eight seats to win a total of 27. D66 is the main pro-EU force to have served in the previous coalition and aims to allow more debate on European issues in the domestically focused campaign. For today, the euro may take cues from the updated guidance on the AstraZeneca vaccine by the European Medicines Agency, who will issue a formal assessment today. The EMA is expected to give a positive recommendation on the vaccine after the World Health Organization stated yesterday the benefits of the vaccine outweigh any risks. A green light from the EMA should give large eurozone governments like France and Germany the confidence to resume the use of the Astra shot, but the suspension of the vaccine may have already undermined public confidence.

USD

In the first battle of markets vs the Fed since the pandemic, the Fed under-delivered with a dovish dot plot that broadly weighed on the US dollar while yields dropped across the whole curve. This morning, the dollar index recovered only modestly, indicating that markets buy the idea of a weaker dollar going forward. In the buildup to the Fed event, market pricing was tilted towards the hawkish side, with a rise in both nominal and real yields indicating that markets priced increased inflation and policy expectations. If history is any guide, however, the Fed shrugs its shoulders at markets who try to second guess their reactive function – at least in the beginning. The FOMC did acknowledge the improved economic outlook since its January meeting, as the rapid vaccine rollout in the US and the $1.9trn fiscal stimulus bill have changed the US economic landscape since then, and placed its 2021 inflation forecast at 2.4%. The longer-term inflation outlook is of more importance here however, as markets by now understand the 2021 inflation figures will be abnormally elevated due to base effects. Forecasted inflation for 2023 was placed modestly above the Fed’s 2% target at 2.1%. Under the Fed’s previous reaction function, above target inflation would have been any reason for a rate hike over the forecasting period, but under the current Average Inflation Target (AIT) regime, it simply means the Fed aims to keep policy accommodative. The dot plot confirmed this, with only 2 additional FOMC members pricing in a rate hike before the end of the forecasting period, putting the total at 7. This pushed back market expectations of policy normalisation, especially with Fed Chair Powell reiterating in the press conference that now is not the time to talk about QE tapering. Overall, markets took last night’s message as highly dovish, which brings us back to Q4 2020 when expectations of a dovish divergence between the Fed and other major central banks were expected to dominate FX markets. It remains unclear how long the Fed can persist in maintaining its dovish stance in an improving economic environment, but for now, divergences in central bank reaction functions are likely to continue driving yield spreads and thus FX price action, placing the emphasis on hawkish banks like the Norges Bank and Bank of England who are due to release their latest policy decisions today.

CAD

The Canadian dollar welcomed the Federal Reserve’s decision yesterday with open arms as it drove to carve out fresh 3-year highs. The loonie is currently trading at levels not seen since early-2018 as policy divergences between the US central bank and the Bank of Canada are widening, as reflected in front-end yield spreads. Many analysts expect the BoC to taper its QE programme at the April meeting, a sign that policy normalisation is occurring and rate hikes are on the horizon. Meanwhile, the Federal Reserve beat back such expectations last night, signalling a positive yield spread is likely to remain in the loonie’s favour for some time. The focus now rests solely on fixed income market developments as the USD firms up again after sustaining losses yesterday. A recovery in the US yield curve and a steeping of the back-end is placing pressure again on the G10 currency space. With little in the calendar specifically for the loonie today, focus on fixed income and equity market dynamics once US markets open will be key for today’s USDCAD price action.

 

 

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