One-in-three chance of another Fed hike
The newly released forecasts from the OECD see the global economy growing by 2.7% this year, followed by a marginal pickup to 2.9% in 2024. The recession of the global manufacturing sector, fading reopening momentum from China and the still negative credit impulse remain headwinds for the world economy. The outlook for next year will therefore mostly depend on how much the positive factors (rising real incomes, bottoming credit impulse) can outweigh the negative ones (lagged effects of rate hikes, rising unemployment rates).
The outcome of this field of tension will impact currency markets via growth differentials and global risk sentiment as well. The US dollar’s broader downward trend that started in September last year remains in place, despite the US Dollar Index rising by 2.8% in the last four weeks. The Greenback is currently in its second attempt at breaking the negative bias, as the breakout in early March was hindered by the collapse of Silicon Valley Bank.
This week’s surprise rate increases by the Bank of Canada and Reserve Bank of Australia have made markets a little bit more uncertain about the Fed’s meeting next week, with fed funds futures now pricing in a one-in-three chance of another 25 basis point hike. This has further converged the rate expectations differential between the ECB and Fed and has pushed the Euro below $1.07 once again.
Peaking inflation not enough for the ECB
arkets have been carried away pricing in rate cuts for this year, it seemed, and have been forced to reprice their expectations given the economic data and continued hawkish talk from central banks. However, it is not like the global economy isn’t facing any major downside risks. Procyclical and export oriented countries like Sweden, Germany and South Korea have seen their PMI’s and other leading indicators tumble in recent weeks, with their manufacturing sector already well into recessionary territory. New orders around the world are falling, while inventories are starting to rise again due to weaker demand.
And while German industrial production did manage to growth in April, the 0.3% expansion was less exciting than what economists had expected (0.6%). The economic slowdown has not convinced the European Central Bank to signal an end to its tightening cycle. Dutch central bank president Klaas Knot just yesterday told journalists how inflation could well remain too high for a long time and how further rate hikes will be necessary. Governing council member Isabel Schnabel said that while peaking core inflation is welcomed, it does not constitute a sufficient conditions to stop raising rates.
Currencies have been fairly range bound given the anticipation ahead of the G3 central bank decisions next week. EUR/USD has been moving around the $1.07 mark for seven consecutive days without a clear breakout in either direction. This lack of conviction might continue into the rate decisions as investors parse through economic data without setting out a path for the currency pair before the Fed and ECB meet. On a side note, the Chinese yuan has been moving down significantly against the euro, pound and dollar with EUR/CNY close to reaching the highest level since July 2021.
BoE may have no choice
It’s been a quiet week for the pound, taking cues mostly from global risk sentiment and external data as opposed to domestic factors. Before paring gains against the US dollar yesterday, GBP/USD climbed towards $1.25 after the Bank of Canada surprisingly delivered a hawkish rate hike, prompting calls that the Bank of England (BoE) will have no choice but to jump on the hawkish train too.
In the wave of this week’s interest rate hikes in Australia and Canada, and continued hawkish comments made by European Central Bank policymakers, sterling has retained its status as the best performing G7 currency year-to-date on anticipation that the BoE will have to keep raising interest rates given the UK has the highest G7 inflation rate at 8.7%. Market pricing is important for currency pairs, and 100 basis points of hikes by the BoE relative to the Federal Reserve’s 25 basis points by year-end means converging interest rate differentials could be a boon for the pound. Barring the market turmoil following proposed tax cuts by Liz Truss last September, the 2-year yield spread between the UK and US currently resides near its highest in around 16 months.
It could be argued that markets are over-egging the prospects of BoE rate hikes though, as stated by BlackRock this week ditching a long-held underweight position in gilts, saying market expectations for more BoE interest-rate hikes are overdone. This puts the pound in a vulnerable position, especially if the current hawkish bets unwind amid growing recession, housing, and credit crunch concerns.
FX volatility subdued ahead of G3 meetings
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 05- June 09
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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.
