Cable rose yesterday as markets geared up for the latest Fed meeting, rising seven tenths over the session, a trend that continued this morning as markets continued to digest the fall out from last night’s news. Whilst the UK is set to receive the outturns of some third tier data releases today, it is likely the actions of the Fed last night and the ECB later today that will hold the most weight for FX markets. The Fed in particular, having at least hinted in the direction of pausing rates following this latest meeting, has opened the door for other central banks that would like to do the same. In our view, the BoE, which meets next week on May 11th, falls into this camp. Despite market expectations for a one or two further rate hikes following the upcoming BoE meeting, economist consensus anticipate a policy rate increase on May 11th likely being the last of this cycle. For the BoE, this means that expectations management is likely to be pivotal, and the Fed just provided a playbook on how to do this without causing significant volatility in markets. As such, Governor Bailey and Co. will likely be looking to the Fed for a few pointers this morning on how to lay out their next steps. For Sterling, if the BoE can pull off a repeat of last night’s Fed meeting, it would likely suggest the currency is currently around the top of its range, with rate expectations moderating over coming weeks. If they cannot, and markets are forced to readjust expectations quickly in the aftermath of an announcement, then volatility and downside pressure could be on the cards in the immediate aftermath. In our view, with the Fed now having beaten a path for other central banks to follow, the BoE’s jobs probably just got a little easier, and we expect a similar hint towards a hawkish pause at the upcoming meeting.
With the Fed having had its turn yesterday evening, the ECB is up next as the central bank with a big policy rate decision to make, with a rate announcement expected at 13:15 BST today, and a press conference taking place soon after. For the ECB, unlike the Fed, we think today’s decision should be somewhat easier. Markets already expect a 25bp rate hike and communications from ECB speakers in recent weeks point towards this being a majority opinion amongst voting members following the downturn in last week’s inflation numbers. More important will be any guidance they provide on further rate hikes later in the year. On this point, with the ECB still some way from terminal, it should be sufficient for the ECB to simply guide markets that interest rates will continue to rise in coming months. This would be consistent with our view and that of markets, that the ECB still has some way to go in cooling an inflationary process that whilst showing a slight decline in the core measure in the most recent release, still remains elevated. Most importantly for FX markets therefore will be the tone with which President Lagarde chooses to communicate these policy steps. With the euro rising half a percent yesterday against the dollar as traders priced in the expected Fed actions, a rate hike and hawkish guidance should see further support for this trend. A dovish surprise however, either guiding to a low terminal rate or perhaps signalling rate cuts prematurely could see some of yesterday’s moves reverse and cannot be ruled out as a possibility.
Price action in the dollar was a little strange yesterday: the broad dollar index fell by -0.7% on the day, but it was a steady and controlled decline. One might think a packed calendar with plenty of event risk would have dialled up the usual volatility, but yesterday did not fit the typical mould. Given the controlled decline and subdued reactions to the calendar events, the most likely explanation for this dynamic is that it was simply driven by negative risk sentiment and a slow positioning shift ahead of the Fed meeting. Banking troubles have been resurfacing this week after a month of relative calm post-SVB, and the Fed was widely expected to tone down its level of hawkishness. While ADP employment came in twice as high as expected, at 296k new jobs in April, the reaction in the dollar was hardly distinguishable. The ISM composite index met expectations, and didn’t change much either. The main event, of course, was the Fed’s decision to hike 25bps, which came to the surprise of no one. This hike had been teed up months ago, and intermeeting communications all but confirmed it.
The Fed’s big policy change was to remove a bit of forward guidance that took future interest rate hikes for granted. The new rate statement said nothing about where rates would go next, but kept in the bit about future hikes remaining a possibility if warranted by the data. The Fed’s key message on virtually everything was, “we don’t know.” Credit standards have tightened, but we don’t know how much more we will get. Credit tightening can substitute for rate hikes, but we don’t know by how much. Policy is close to where it needs to be, but we still can’t be sure. Chair Powell did say, however, that in a few months’ time, he would have more confidence. The ironic bit: during the press conference, Powell did not seem too fazed about recent bank failures, expressing confidence in the system’s resilience. But before most traders had even gone home for the evening, PacWest became the next bank on the firing line. Shares plummeted by 50% after it was reported that the bank was looking to broker a potential sale, a development that continues to weigh on the dollar in early trading this morning.
The Canadian dollar was close to flat on Wednesday, with no Canadian risk events on the data calendar. While the broad dollar decline, which we discuss in the USD section, benefited pretty well every G10 currency, a continued sell-off in crude oil provided the counterweight to keep the loonie in line with the dollar. The oil selloff has been quite sharp in the last several days, briefly making a new low of $63.64 per barrel, the lowest price in a year and five months. Oil analysts point to disappointing industrial data out of China and souring US growth expectations as reasons for the latest move.