News & Analysis

GBP

After rallying over a percentage point in yesterday’s session post-Fed decision, the pound is one of the early losers in the G10 space this morning as it trades 0.7% lower against the dollar and nearly half a percentage point lower against the euro. Sterling’s weakness is likely due to traders reducing their positions ahead of today’s Bank of England meeting, which is set to see policymakers substantially under-deliver on money market expectations. At 12:00 BST, the BoE is likely to raise rates by 25 basis points to 1%, a move that is largely expected by economists. However, the accompanying documentation, such as the meeting minutes and the Q2 Monetary Policy Report (MPR) is set to outline the precarious growth backdrop the Bank currently faces, which suggests a more cautious policy stance ahead. This suggests a year-end rate this year of around 1.25-1.5%, with risks that a higher Bank Rate will tip the economy into recession or deepen the economic contraction already underway due to the cost-of-living crisis. This will undershoot money market expectations substantially, with swaps currently implying 125bp of tightening by September. We have long argued that a dovish money market repricing is unlikely to dent GBP too significantly as GBP traders have factored in a weaker growth outlook more accurately than swap traders over the past month, however, the move is likely to cause some GBP volatility at a minimum. After the documentation is released, Governor Bailey and his deputies are set to speak to the press at 12:30 BST.

EUR

Along with JPY, the low-yielding euro benefitted substantially from the more dovish tone taken by Fed Chair Powell at yesterday’s meeting. EURUSD rallied near a percent in the aftermath of the Fed decision as US Treasury yields dropped and the rate differential between the continent and the US narrowed. While the euro’s performance wasn’t spectacular in the grand scheme of the G10 move, it came as a relief to ECB members as it lifted the currency from recent multi-year lows against the dollar at a time when energy imports priced in USD are already having a significant impact on eurozone inflation. On the ECB, Governing Council member Madis Muller reiterated Isobel Schnabel’s comment that a rate hike in July is likely despite ongoing growth concerns. This morning, Executive Board member Fabio Panetta highlighted the weakening in growth conditions, stating that the eurozone “is de facto stagnating”. Regardless of public concerns around growth conditions, the single currency is trading stronger against most of the G10 currency board excluding USD as FX traders buy the dip in the broad dollar overnight in the APAC session as Treasury yields also trim losses.

USD

After trading tentatively lower in the run-up to the May Fed meeting, dollar downside was consolidated after Fed Chair Powell took the prospect of a 75 basis point hike off the table while also eluding to a more conservative rate path to neutral territory than markets had previously been pricing. The dovish repricing came despite the Fed hiking rates by 50 basis points for the first time since May 2000 and outlining their plans to “phase in” the maximum quantitative tightening plans by allowing $30bn in maturing US Treasuries to roll-off of the balance sheet until that is raised to $60bn in September. The dollar’s downside was most visible in risk sensitive currency pairs, such as AUD, NOK, ZAR and MXN. All of which posted gains in excess of a percentage point in yesterday’s session. This morning, US Treasury yields are reflating somewhat, but still trade substantially off of yesterday’s highs. This has provided the dollar with a modicum of strength as it retraces part of yesterday’s move. However, we expect USD downside to become more visible in the coming days unless regional Fed speakers or Friday’s nonfarm payrolls provides enough for markets to turn more hawkish on the US central bank again.

CAD

The loonie rallied three quarters of a percent on Wednesday after the Federal Reserve’s interest rate decision; the biggest sign of CAD strength in two weeks. The gain was smaller than the degree of appreciation seen in most other G10 currencies, however, which is a bit surprising given the risk-on moves in other markets. The price of crude oil, which is empirically a supportive influence on the Canadian dollar, rose 5% on the day, nearly a two-standard deviation move. In the meantime, US equities rose 3%, the biggest one-day gain in two years. The developments in crude and equity markets should theoretically have generated even more CAD strength than they did. However, the smaller gain is partially explained by Canadian bond yields, which fell along with their US counterparts. This meant the US-Canada yield differential didn’t narrow as much as other currency pairs. Also, markets could have dismissed the supportive CAD developments because the Canadian and US economies are highly interconnected. As a result, the Fed’s pushback on a 75bp move would have been viewed as also signalling a lower chance of 75bps from the Bank of Canada, evidenced by the 6% decrease in implied money market pricing for the BoC’s next meeting on June 1. Today, the calendar is light for the loonie, with just BoC Deputy Schembri speaking on the Bank’s journey to contribute to the reconciliation with indigenous peoples. In lieu of any market moving economic events, the loonie will likely continue to trade in line with the broader market fallout from yesterday’s Fed meeting.

FX Elsewhere

Members of the central bank of Brazil’s monetary policy committee (COPOM) likely sighed a breath of relief after yesterday’s Federal Reserve meeting led to broad USD weakness. After spending $2.1bn defending the Brazilian real since mid-April, the weakening in the dollar coincides with the central bank’s efforts to support the real, despite it being the best performing currency year-to-date. In combination with its efforts to promote a stronger currency in an attempt to bring inflation down, the BCB hiked rates by 100 basis points, a move that was largely expected by markets. With the Selic rate now at its highest level in five years and 7% above inflation expected 12-months ahead, the central bank is expected to slow its tightening cycle at June’s meeting, barring any upside surprises to inflation, a further deanchoring of inflation expectations, and BRL depreciation.

 

 

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