News & Analysis


Returning to the office after yet another bank holiday weekend, UK watchers will be glad of the light data calendar and modest price action in sterling, as anticipation builds for the upcoming Bank of England rate decision. Whetting the appetite this morning the only UK specific data point to drop was the release of BRC like-for-like sales data, which ticked up to 5.2% in April, from a March reading of 4.9%. Whilst on the face of it the increase in sales would suggest a robust British consumer, the April release coincided with a roughly 10% rise in the level of payments for most benefits. In the context of these newly flush UK households, this modest increase in the print is actually more suggestive of weakening consumer demand as increasingly tight monetary policy begins to bite. This is good news for the BoE, with the results of the next policy meeting set to be announced on Thursday, and who will be looking for signs for the effectiveness of prior policy tightening. Consensus expectations are for the MPC to raise Bank Rate by 25bps at the upcoming meeting, but with a divergence in expectations thereafter. Swap markets currently price a further 41bp of hiking following the May meeting, with economists in contrast broadly expecting the BoE to hold rates after this next hike. This divergence in expectations is unlikely to be resolved one way or the other by the BoE in their upcoming communications, instead we look for the Bank to signal a willingness to pause, whilst remaining open to further hiking if the data suggests it would be appropriate. This would be a continuation of the approach taken at the March meeting, and echoes the communications of the Fed last Wednesday, a fact that will likely make this message easier for markets to digest. However, the risk that the Bank of England does nail its colours to the mast one  way or the other remains. If it were to do so, then the current expectations gap would suggest that a bout of significant sterling volatility in the aftermath of the rate decision is a possible outcome, with an explicit pause in hiking more probable in our view, an announcement that would likely produce a sharp selloff in the pound.


The similarities in last week’s ECB and Fed decisions exposed the “divergence” trade that had benefited eurozone assets over the past two months. Specifically for the euro, it led to a re-widening in the spread between US and eurozone interest rates, the narrowing of which had been the main reason for EURUSD rallying to a one-year high. As a result, the euro has struggled to retrace to its one year peak and has instead traded in a relatively tight range. There has also been a pick up in speculation that the broad euro rally is coming to an end. While we are inclined to agree that the pace of euro appreciation is likely to slow from hereon in as the ECB takes on a more cautious tightening profile with interest rates approaching their terminal level, we think that at just 3.5% the market is underpricing the likely end point of the ECB’s hiking cycle. While another round of inflation data out of the eurozone is likely needed for money market traders to revise their expectations back up again, in the interim we expect to continue seeing support for a more extended hiking cycle than markets are pricing from ECB members. Most recently, this has come from the Chief Economist Philip Lane, who stressed upside risks to the inflation path given momentum in core inflation. With plenty of ECB speakers scheduled for today, this drum is likely to be beat again, especially by prominent ECB member Isabel Schabel given her consistently hawkish stance over the past six months. This could provide the euro with some support, but more than likely any volatility in the EURUSD pair will instead come from the US inflation data set for release tomorrow afternoon. In terms of our overarching view, the past week’s developments have done little to shift our medium-term view. We continue to forecast EURUSD trading at 1.10 and 1.12 over the 1-month and 3-month horizon.


After the Fed guided markets towards what is likely an end to its hiking cycle at last week’s meeting, all eyes were on the outcome of the Q1 Senior Loan Officers Opinion Survey (SLOOS) yesterday. Not only was the survey conducted in April, meaning the data would fully reflect the response by lenders to March’s regional banking crisis, but the results of the SLOOS were also available to all FOMC members ahead of last week’s decision. Shortly after the European close, the data validated concerns market participants had over credit conditions tightening in the wake of the March banking crisis, although it also vindicated the Fed’s caution in extrapolating too much on the economic passthrough this early on. While lending standards did tighten this quarter, this can be viewed as a natural extension of the previous trend. In fact, on a net basis, the number of lenders that had tightened standards didn’t increase as much as a regional banking crisis would suggest, with all indicators remaining far below their financial crisis peaks. For example, the most concerning lending category in terms of deterioration was commercial and industrial lending to large and medium sized borrowers. Although a net 46% of banks tightened standards, up from 44.8% recorded in the three months to January, this was well below the series peak of 83.6% in 2008. While the data plays into the hands of those sell-side economists still calling for a soft landing, it did little to completely dispel concerns over financial stability in the US. This was best observed by comments from Chicago Fed President Goolsbee, who said in an interview with Yahoo! Finance yesterday evening that he is “certainly getting vibes…that a credit crunch, or at least a credit squeeze, is beginning”. While the focus yesterday was on the Fed’s mandate to maintain financial stability, today the emphasis is likely to drift to its inflation target as April’s CPI data is released tomorrow at 13:30 BST. Expectations are for a continued moderation in the pace of core inflation. On both a month-on-month and annual basis, the median expectation is for core inflation to fall 0.1 percentage points from March to 0.3% and 5.5% respectively. While we believe the Fed is likely to pause its hiking cycle over the coming months, a hot inflation reading is likely to couple up with Friday’s positive surprise in April’s jobs figures to either increase the chances of another rate hike in June, or at the very least, reduce the probability of rate cuts this year. With 70bps of rate cuts priced in for the remainder of the year, we have long argued that the implied Fed funds path is more likely to flatten than invert further. If this takes place today, it will likely come as a support for the dollar.


On Monday, the Canadian dollar rose steadily until shortly after the North American open where it then reversed to close out flat on the day. The sharp turn in CAD coincided with similar moves in other high-beta commodity currencies such as AUD, NZD, and NOK, but the move did not time up well with commodity futures prices. Considering that no relevant news headlines nor data points were released at that time, the most plausible explanation is that non-speculative flows drove the turnaround, although the evidence is thin. It is worth noting that with the UK on holiday for the coronation, liquidity at the cross-over was thinner than usual. While not a driver of FX markets at the moment, the question of Chinese interference in Canadian politics has been a major news theme in the past weeks. The latest news: the government finally opted to expel Chinese diplomat Zhao Wei, whom CSIS said was involved in a plot to intimidate Conservative MP Michael Chong and his relatives in Hong Kong. The remainder of the week will still be light on Canadian data, with building permits on Wednesday being the only release of note.



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