Fed signals pause, dollar drops
As expected, the US Federal Reserve (Fed) raised the target range for the fed funds rate by 25 basis points yesterday to 5%-5.25%. The focus, however, was on the forward guidance in its post-meeting statement, which removed language that “some additional policy firming” may be warranted. Investors continue to price in a pivot rather than just a pause though, and the US dollar has come under renewed selling pressure as a result.
The Fed signalled that there will likely be a pause in June, but that it remains highly attentive to inflation and is data dependent. In other words, if there is any upside surprise to inflation, the central bank won’t hesitate to resume hiking interest rates (much like we saw from the Reserve Bank of Australia this week). That said, the stress in the banking system will do some of the heavy lifting for the Fed as a tightening in lending standards will weigh on economic activity in the second half of the year, which should also help ease inflationary pressures. Big US banks have so far been insulated from the turmoil, but regional banks continue to suffer, and this will most likely be the catalyst for the Fed to pivot its policy stance if the situation worsens. Just the collapse of Silicon Valley Bank in March added rate cutting bets worth 165 basis points to Fed pricing for the next 24 months. There is a significant amount of uncertainty regarding how much lending standards will tighten and whether there will be a credit crunch because of the stress in the US banking system. So, it’s important to keep an eye on bank deposits and lending data from here as well as economic data including the US jobs report tomorrow.
Where does this leave the US dollar and other currencies? This year’s dollar downtrend may gain traction if economic data continues to weaken, particularly if the labour market softens and disinflation gains momentum. EUR/USD could test $1.15 by late summer and GBP/USD could claw its way back towards $1.30. Such trends will also be supported by an extension of low volatility across financial markets. Moreover, if the banking turmoil remains confined to the US, this should hurt the dollar, but if it sparks contagion, risk aversion could support the US currency as well as traditional safe havens like that Japanese yen and Swiss franc.
Will the ECB give markets what they want?
The higher-than-expected inflation print in the Eurozone and Jerome Powell opening the door for a pause in the Fed’s rate hiking cycle have pushed the euro to a 13-month high. Now, it’s up to the European Central Bank (ECB) to confirm the markets view that two more rate increases will be delivered.
Economists are broadly expecting the ECB to increase interest rates by 25 basis points during today’s meeting of the Governing Council. While core inflation did fall for the first time in 10 months in April, headline inflation accelerated to 7% again. So far, tensions in the banking sector, especially in the US, have had a limited impact on the euro. The decoupling of banking stocks and EUR/USD seems to suggest, that the banking failures have been interpretated by markets as idiosyncratic events. However, with now the fourth major US bank under pressure – Pacwest stock falling 50% in a week – worries of a broader crisis are starting to grow.
The uncertainty surrounding the banking sector has been accompanied by speculations that the Fed will need to cut rates this year, which have shielded the euro from any capital flight. EUR/USD is trying to break the $1.10 level and is on track to appreciate the third day in a row.
Pound charges to 11-month high
The British pound is hovering just under $1.26 versus the US dollar – a fresh 11-month high – following the Fed’s signal that yesterday’s interest rate hike may be its last. After its weekly low of $1.2433, GBP/USD looks poised for a break higher, with its 100-week moving average, located at $1.2724, a possible upside target this month.
As we noted at the start of the week, the pound would be influenced by external factors like the Fed’s decision this week, hence it has capitalised on the weaker dollar in the wake of the dovish Fed decision. Against other currencies though, sterling remains mixed, trending lower against so-called riskier currencies like the AUD, NOK and ZAR and is still trading sideways against the euro ahead of the ECB’s announcement this afternoon. This is the next key risk event that could shake up markets today and steer GBP/EUR higher or lower. Next week, the Bank of England’s (BoE) meeting could be a tipping point for sterling. Economists expect just one more 25 basis point rate hike, taking the benchmark to 4.5%, even though inflation is stuck in double digits. That’s a sharp divergence from market expectations, which are leaning toward rates reaching 5% by September.
Despite the gloomy news flow in the UK recently, Britons might be surprised to learn that they are experiencing the greatest “hawkish surprise” out of many major economies. The worst inflation in the group is combined with GDP figures that were recently revised upward, which boosts the prospects for a hawkish BoE. Absent a dovish BoE surprise a week today, the pound may extend higher against most of its currency rivals.
Super sterling surges after flexible Fed
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 1-5
Have a question? [email protected]
*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.
