Sterling weakness was rather contained yesterday despite the continued headlines from the Bank of England signalling concern about the current mix of inflation and growth conditions. First up from the BoE yesterday was Catherine Mann. When asked whether the BoE should hike by 25bp or more, Mann stated that it largely depends on whether inflation expectations remain anchored and the expected consumption drag, which could short-circuit the expectations-formation circuit. In essence, Mann stated that her decision was largely data-dependent, with the data of concern being that of forward-looking inflation expectations indices. Today’s retail sales data, which showed headline sales volumes contract by 1.4% MoM in March, will likely bode well for Mann’s thesis that declining consumption levels should moderate the abilities of firms to raise prices too aggressively, thus containing the peak in inflation. The half a percentage point drop in GBPUSD this morning is reflective of this and the likely repricing that will occur in UK rates markets, which is already showing in two-year Gilt yields this morning as they fall by 2.5 basis points after the cash open. In addition to Mann, Governor Bailey also stressed the precarious position the UK economy finds itself in, stating that BoE policy is walking a “very tight line between tackling inflation and the output effects of the real income shock”. With recession indicators starting to flash amber across European and US rates markets, rising expectations of policy tightening, especially in the UK, isn’t likely to benefit the pound until there are signs of improving growth conditions. While overnight index swaps are pricing in at least one 50bp hike in the UK by August– in three meetings time– we think the growth outlook remains too precarious for this to be as certain as OIS pricing suggests.
More hawkish European Central Bank members have been speaking up to media about the possibility of a July rate hike, which was only mildly beneficial for the euro in recent trading sessions as it didn’t signal an overall shift in ECB commentary. Yesterday, however, leaning dove Luis de Guindos joined the party and stated a July hike is not off the table. Markets reacted more strongly to his comments, as it was somewhat out of kilter with his usual stick-to-the-party line commentary. However, he also stated that while lift-off in July is possible, so is September, which suggests markets may be reading too much into his comments. Halfway through yesterday’s session, EURUSD pared back all of its gains as hawkish rhetoric from the Fed drove rate expectations for the US higher, while at the same time, Lagarde suggested in a discussion panel the ECB’s approach will be less aggressive than the Fed’s due to idiosyncratic growth risks for the eurozone. Later this morning, focus will shift to eurozone Purchasing Managers’ Index releases from Germany, France and the eurozone.
The bounce in global bonds on Wednesday seems to have been a ruse by fixed income traders as yesterday’s session saw bond prices plummet again, leading to higher yields across the board. Early signs from Asia and the start of the European session this morning suggest that today’s session will be dominated again by higher yields. At just above 2.7%, the US two-year yield continues to drive to fresh highs, with current levels last seen in 2018. However, expectations of a more aggressive period of policy tightening in the US are still seen to bring down inflation over the longer-term, as highlighted by the re-flattening of the US Treasury curve as 10-year yields continue to trade below 3%. Economic events were dominated by monetary policy headlines, with both San Francisco Fed President Mary Daly and Fed Chair Powell both hitting the wires. Daly said on Thursday that the Fed “will likely be taking a 50 basis-point increase in a couple of the meetings, also starting our balance-sheet reduction program.” Given that most of the discussion of a 50bp hike has been focused myopically on the next meeting, Daly’s comments provided colour on the likely policy actions taken in successive meetings. This resulted in money markets now pricing in three successive 50bp hikes in overnight index swaps. Meanwhile, Fed Chair Powell continued to reiterate that the likeliest option at the next meeting is 50bp as he showed increased concern over inflation expectations. With this already priced in, sell-side analysts are now wondering if James Bullard is taking the right stance. The St Louis Fed President has been suggesting the Fed could move in 75bp increments in coming meetings, and some sell-side institutions such as Nomura are starting to support the idea. Data from the Philadelphia Fed outlook survey for April showed concerning signs of slowing growth, however. The 6-month forecast of new orders fell to a decade low, suggesting growth conditions are set to deteriorate sharply in the US amid the latest inflation shock.
The loonie fell half a percent against the greenback on Thursday amid few possible news or data catalysts. The drop was mostly driven by movements in the broad US dollar, which received some safe-haven demand after equity markets and risk sentiment tanked amid rapidly rising yields. The Canadian dollar received a bit of support from crude oil markets, which were up 1-2% on the day, but this didn’t offset the pressure from the yield space. Canadian bond yields rose by about 6-7bps through the curve but fell behind the surge in US and European yields. The loonie this morning has extended its losses, wiping out all of the gains posted on Wednesday after a bumper CPI report was released.