US credit conditions cushion dollar
The Federal Reserve’s (Fed) quarterly Senior Loan Officer Opinion Survey (SLOOS), published yesterday, showed US credit conditions were less gloomy than expected. Although credit conditions for US business and households continued to tighten at the start of 2023, it was likely due to the impact of the Fed’s aggressive rate hikes rather than severe banking sector stress. For now, the risk of a credit crunch has eased, and this has cushioned the US dollar’s recent decline.
The closely watched survey was among the first measures of sentiment on the banking sector since the recent run of bank failures and showed the proportion of US banks tightening terms on commercial and industrial loans for medium and large businesses rose to 46%, up from 44.8% in the fourth quarter of 2022. The report also showed much weaker demand for credit. Although not as gloomy as expected, whether you analyse the loan supply or loan demand, the overall picture continues to remain bleak and banks’ willingness to lend to consumers dropped to the third lowest level since the 1980s, indicating a worsening outlook for the consumer, labour market and therefore GDP for the second half of 2023. As Fed Chair Jerome Powell stated last week, this could limit how much higher interest rates will need to go to bring inflation back to the Fed’s 2% target. Consequently, the case for a weaker US dollar through the remainder of this year is building.
Are markets overpricing the possibility of the Fed cutting interest rates this year though? This is the major risk that could upend the weak dollar narrative. That’s why tomorrow’s US inflation print will also be closely watched following the stronger-than-expected US labour market report last Friday.
Sterling lingers near 1-year high
The British pound is holding firm above the $1.26 mark against the US dollar and just shy of €1.15 against the euro as UK markets reopen from the coronation long weekend. Data this morning showed UK retail sales rose 5.2% in April from a year ago, but persistently high inflation meant consumers are getting less for their money. The key risk event from the UK and for sterling this week is the Bank of England’s (BoE) policy decision on Thursday.
The BoE is widely expected to raise its key interest rate to 4.5% but many economists think it is close to ending its run of rate hikes dating back to December 2021. However, headline inflation is still in double digits and core inflation is proving sticky, whilst accelerating wage growth could keep services inflation elevated too, which puts the BoE in a precarious position. Financial markets are split 50-50 about whether UK interest rates will peak at 4.75% or 5% later this year. For the past 18 months, predictions that the UK economy will buckle under the BoE’s run of aggressive hikes have failed to materialise and instead, the UK has seen the largest amount of hawkish economic data surprises out of other major economies. Nevertheless, the BoE’s recent emphasis on the lagged impact of past tightening suggests it may remain non-committal on its next policy steps after hiking on Thursday.
GBP/USD has benefited from narrowing US-UK rate differentials thanks to markets pricing in rate cuts by the Fed later this year and unless there is a sharp repricing of the monetary outlook by the either the BoE or Fed, this dynamic should keep the currency pair on track to test its 100-week moving average just above $1.27. Against the euro though, gains may be limited as the European Central Bank (ECB) could out-hike the BoE for the remainder of 2023.
German macro data disappoints
Markets expect the ECB to continue its fight against inflation, despite macro data coming in weak. Dutch central bank chief Klaas Knot and other policy makers had expressed concerns over the stickiness of inflation, while chief economist Philip Lane sees momentum in core inflation.
Macro data out of Germany has been disappointing. Inflation adjusted retail sales fell 8.6% during the last twelve months, recording the steepest decline since 1952. Factory orders for German goods have fallen 10% in March, with industrial production cooling 3.4%. The deterioration of hard data increases the likelihood of a downward revision of German GDP for Q1, while soft data continues to point to a broader economic outlook in the second half of the year.
The euro has fallen slightly below the $1.10 mark at the beginning of the week and is searching for new catalysts to support any upward momentum. Economic data out of Europe is scattered and scarce, which will mean that US and UK data will be the dominant FX drivers. The winter rebound has most likely run its course for now as markets assess how large the divergence between the ECB and Fed is going to be. With three rate cuts expected in the US and none in Europe, risks are skewed to the downside for EUR/USD for now.
GBP/USD up 1% from last week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 8-12
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
