Whilst the UK will have to wait until next week to hear from the Bank of England and if it will choose to follow in the steps of counterparts at the Fed and ECB, the big news today is likely to be the results of local elections that took place yesterday. Results so far appear to confirm what many had expected, losses for the ruling Conservative party and gains for both Labour and the Liberal Democrats. This trend is hardly unsurprising given the massive lead the Labour party currently holds in opinion polling, but the focus will be on the extent to which this translates into victory at the ballot box, which should become clear over the course of today. Barring any shocks from today’s vote counting, sterling appears to be benefiting from a period of relative quiet in the UK news and data landscape, rising against both the euro and dollar in early trading, as markets continue to digest yet another round of policy rate tightening. Whether that continues, however, will depend on how markets view the upcoming rate decision from the BoE next week. With a large gap in expectations opening up between markets and economists, the possibility for a sharp fall in the pound following the decision remains a risk for markets.
With the Fed having raised hiked rates on Wednesday, Thursday’s big news came from the other side of the Atlantic, where it was the turn of the ECB to announce a policy decision. Moving in line with both economist and market expectation, the ECB stepped down the size of interest rate hikes, opting to raise policy rates by 25bp. Despite doing little to surprise markets, the euro fell around seven tenths against the dollar between the time of the initial announcement and the end of President Lagarde’s press conference, having since retraced some of these losses. This move reflected market sentiment that was not buying Lagarde’s message, that the ECB had “more ground to cover” in tackling inflation, with expectations for the ECB terminal rate being trimmed by more than 10bps in response. This latest move highlights the communication difficulties that the ECB is likely to have in guiding markets over coming months as it approaches a terminal level of policy tightening. In our view, the ECB is still likely to hike rates several more times, with a terminal rate of 3.75% the most likely outcome. Assuming this view is shared by ECB policy makers, then communications over coming days are likely to guid in this direction, a move that we would expect to be supportive for the euro in coming weeks.
The market spent much of yesterday’s session continuing to digest the FOMC’s latest policy rate announcement. Whilst the initial reaction of FX markets to Wednesday’s decision was relatively muted, the same cannot be said for regional banking stocks, some of which took a hammering in post-market trading, a development that did not reverse over the course of yesterday’s session. PacWest and Western Alliance in particular saw dramatic falls, which leading into the end of the week raises the prospect of whether yet another bank resolution will have to be worked out before markets reopen on Monday. Worryingly, these falls occurred despite broad consensus that the Fed is likely to pause rate hikes in June, suggesting that additional pressure on these banks is unlikely to come from tightening monetary policy. Perhaps more pertinently from an FX perspective, the emphasis seems to be shifting from concerns over deposit flight to worries about the long run profitability of the business models for many US regional banks, with the FOMC policy rate bank now standing at 5.00% – 5.25%, and likely to stay there for some time. With concerns lingering over financial stability, and credit conditions beginning to tighten as a result, today’s labour market data should give some indication of the extent to which banking concerns are weighing on the broader economy. Nonfarm Payrolls are expected to show a decline from last month’s reading of 236k, dropping to 185k according to economist estimates. Whilst this would still be marginally above the pre-covid norm, it would also continue the downwards trend in jobs added since the start of the year, indicating a US economy that is slowing in response to tighter monetary policy and higher borrowing costs. With no signs that the US economy is likely to experience anything other than a growth slump as opposed to a deeper downturn at this point, the cocktail of US specific financial risks and weak growth is likely to continue weighing on the dollar.
The loonie traded out of line with its cross-asset drivers on Thursday, rising by 0.6% alongside most other G10 currencies against the US dollar. Government yield spreads narrowed in Canada’s favour, crude oil held flat at $68 per barrel, $5 higher than yesterday’s intraday low, while the S&P 500 slumped by -0.7%. Even a large surprise on fresh trade balance data resulted in a fairly small move that quickly reversed. The data showed that Canada’s trade surplus widened to $1bn in March from $0.4bn, despite expectations that it would halve. Mid-afternoon in Toronto, Governor Macklem delivered his latest speech, which repeated the same core message from months of communications that he is determined to get inflation all the way back to 2%. While it mostly rehashed old topics, the message was a bit contradictory. On the one hand, Macklem reiterated that it was far too early to cut rates, and that the BoC may hike again if needed. But on the other, he highlighted that renewed financial system stress could alter the rate path, and that bank stresses were a reminder that instability can strike quickly. The subtext from the latter comment is that a bank crisis could easily lead to rate cuts, despite what he said about cuts being too early. Really, the best way to view this is that nobody knows how bad the regional banking troubles in the US will become, and policymakers are fumbling in the dark. If the banks are fine and inflation gets worse, we could see more hikes. If the banks are fine and inflation keeps slowing, the conditional pause will remain in place. And if troubles in the banking system begin to rapidly accelerate, well, rate cuts are highly likely. As much as we would like to say otherwise, anything can happen. Today, we will be getting Canadian jobs data at the same time as the US jobs report, so expect any move in USDCAD to be dominated by the US figure. That said, economists are looking for a smaller gain of 20k in April, compared to March’s 34.7k.