Mixed labor market enough for the Fed to skip?
For the first time since commencing its tightening cycle more than one year ago, the Federal Reserve is expected to hold interest rates constant at the next meeting on Wednesday. The communication of various policymakers in advance of this important meeting and current market pricing suggest that the decision to not raise interest rates should be considered a skip and not a pause in terms of its meaning for the broader tightening cycle.
Last week’s surprise rate increases by the Bank of Canada and Reserve Bank of Australia did make markets a little bit more uncertain though, with fed funds futures still pricing in a one-in-three chance of another 25 basis point hike on Wednesday. However, the consensus remains centered around the idea of a skip in June, followed by a final hike in July, which would conclude the tightening cycle at an end rate of 5.25 – 5.50%. The Fed could follow market pricing and cement this idea into its dot-plot (rate projection), showing one more hike to come. Leaving open the possibility of further tightening under the condition that inflation remains sticky could satisfy the hawks within the Fed to consent to not raising rates now.
Markets have completely priced out any rate cuts by the Fed for this year as well, even against the backdrop of a weakening labor market. In addition to the latest rise of the unemployment rate from 3.4% to 3.7%, metrics like initial jobless claims, job openings, the quits rate and hours worked have been moving against the overall strong jobs growth number. This mixed picture should be enough for the Fed to not hike on Wednesday, giving policymakers time to evaluate the impact of tighter monetary policy on inflation and the broader economy. Going forward, the labor market will shape how the Fed will behave once peak rates have been reached. Historically, cutting cycles in an environment when the labor market is tight tended to be more shallow than when it’s soft.
ECB’s June hike a done deal, but what comes next?
The European Central Bank is stuck in a slightly less favorable position than its US counterpart. Having started its tightening cycle four months later than the Federal Reserve, policymakers in Europe have some more work to do in bringing down inflation. While core inflation rates are near identical in both regions at around 5.5%, underlying inflation dynamics and historic precedence are the main reasons for why markets continue to price in more hikes and fewer cuts by the ECB vs. the Fed.
However, investors began questioning this narrative some months ago, as the priced in hawkish outperformance of the ECB over the next 12 and 24 months started to vain. The main reason for this repricing has been weaker macro data coming out of Europe and investors reducing bets on rate cuts by the Fed. The Eurozone officially fell into a mild recession, following two consecutive quarters of negative growth. The broader Eurozone fell by 0.1% in Q4 and Q1 in what can be described as the mildest recession possible. And while this does not provide enough reason for the ECB to follow the Fed in potentially pausing its tightening cycle, it does raise questions on how long policymakers can go without cutting rates in 2024 again.
As for the meeting on Thursday, economists and markets are broadly aligned in forecasting a 25 basis point hike by the ECB. The expected divergence in policy rates between the ECB and Fed might be a positive factor for the Euro going into the week. However, the largest catalysts will be the post rate decision speeches by Jerome Powell and Christine Lagarde, during which expectations for the meetings in July might be set. EUR/USD has crossed the $1.07 mark after Thursday’s disappointing initial jobless claims. Now, it will be up to the plethora of upcoming data releases and both rate decisions to decide if the pair can hold on to these gains.
UK data might be overshadowed by ECB, Fed
The Euro has not been the only currency benefiting from a mixed labor market picture in the US. 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%. The pound has performed particularly well against the Euro recently and has successfully appreciated for eight consecutive weeks, rising by 3.5% to an eight-month-high. The upward move saw GBP/USD break above a key resistance level of $1.2545 as well, with volumes in the currency pair surged, indicating a desire to push the pound towards fresh 2023 peaks.
It can be argued that economic data, apart from inflation, has neither helped nor weakened the bullish case for the pound in recent weeks. The latest property market report from mortgage lender Halifax did confirm, that British home prices dropped in May for the first time in 11 years on an annual basis. However, the market reaction following the headline has been muted, suggesting that only a continued stream of weaker than expected data would come with serious monetary policy and therefore market implications.
Given this week’s rate decisions in the US, Eurozone and Japan, economic data out of the United Kingdom will most likely be less market moving. This does not mean that British macro releases can just be ignored. The labor market report on Tuesday and GDP and industrial production on Wednesday will be closely watched by investors as well. As has the narrative surrounding the hawkish outperformance of the ECB vs. the Fed weakened recently, so too can the same happen to the BoE.
Pound at the top of its 7-day trading ranges
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 12- June 16
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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.
