Will the Federal Reserve end its rate hike cycle this week?

As expected, a data-light week saw muted moved among the major currencies, which almost all held to recent trading ranges.

A couple of notable exceptions were the Japanese yen, sent spiralling down by the Bank of Japan’s refusal to put an end to ultra-loose monetary policy, and the Brazilian real, which added to its rally so far this year and is now the second best performing major currency after the Mexican peso. Meanwhile, the Colombian peso reversed some of its recent gains, tanking amid uncertainty following a cabinet reshuffle. Among the G10 currencies, sterling ended atop of the performance tracker last week, partly due to continued hawkish comments from BoE members, while the euro finished largely unchanged.?

This week is shaping up to be perhaps the most decisive one of the year so far. In addition to the Federal Reserve meeting on Wednesday, followed by the ECB one on Thursday, we have a deluge of critical data, including the monthly US labour market report and both the quarterly survey of Eurozone bank lending and the Eurozone inflation number for April on Tuesday. This means that some Council members will wait until the last minute to decide between a 25bp and a 50bp move, adding to the uncertainty and potential for volatile trading this week.

GBP

We are pleased with the outperformance in sterling so far this year, since we had flagged the pound as one of the most undervalued major currencies at the start of 2023. The mere absence of negative newsflow out of the UK appears to have been enough to push it upwards last week, with the pound outperforming both the dollar and the euro. Recent communications from BoE members have alsop continued to strike a hawkish tone, and market participants appear increasingly confident that we could see UK rates top 5% later this year. The MPC won’t be meeting until next Thursday, so the business activity PMI data out this week could be important in guiding expectations for the decision.

We think that sticky inflation and rising wages will prevent the Bank of England from switching to a wait-and-see mode any time soon and, as the Fed approaches the end of the current hiking cycle, we expect sterling to remain well supported.

EUR

As this is written, markets seem to be leaning to a 25bp at the ECB meeting on Thursday. Recent Euro Area activity data, notably the PMIs, has been rather strong, while core inflation has proved sticky, so even in the event of a smaller hike we would expect a hawkish tone in the bank’s communications. We also do not entirely rule out a 50bp move, which would clearly be bullish for the common currency given current market pricing.?

However, with the quarterly bank lending survey and the April flash inflation report to be released soon before the event, anything can happen. Strategists are betting that we will see a slight pullback in the key core inflation data, but this has proven a stickier indicator in the Eurozone than in the US and market hopes have been disappointed before. Whatever the final decision, we expect communications to suggest that the Council decisions remain highly data dependent and that the hiking cycle in Europe will last for a few months longer.

USD

Macroeconomic news out of the US in the past week has been rather mixed. The first quarter GDP print was a clear disappointment, with growth slowing to just 1.1% annualised, almost half the consensus. More timely indicators of activity have painted a slightly more optimistic note, although signs of an easing in US inflation suggests that the Fed will likely deliver a final 25bp rate hike this Wednesday.?

As things stand, markets have not yet completely ruled out the possibility of another move in June, although the key for the dollar will be the communications accompanying this decision. On the one hand, prices and wages are far from consistent with a return to 2% inflation. On the other, while the bank crisis seems to have been contained, its impact on credit availability adds to the significant monetary tightening carried out by the Fed. Labour market indicators have suggested some slowdown recently, albeit from a very fast pace. We think the main hope for the dollar would come in the form of significant push back from the Fed against the cuts priced in by markets later this year and/or a stronger than expected nonfarm payrolls report on Friday.?

JPY

The Japanese yen was by far the worst performing currency in the G10 last week, crashing to its lowest level in a year against the dollar after the Bank of Japan stuck by its ultra-loose monetary policy stance. Friday's announcement following the BoJ meeting failed to deliver any change - the interest rate remained negative (-0.1%), while the tolerance range for 10-year Japanese bonds was kept intact, remaining at 50bps above/below zero. While no rate hike was anticipated, investors had pondered a scraping of the yield curve control policy in the face of still relatively strong price pressures (3.5% of core CPI inflation in Tokyo in April), hence the sharp sell-off in the yen.?

Weak labour market data also failed to help the yen last week. The unemployment rate unexpectedly rose to 2.8%, versus the 2.5% consensus, and the jobs/job applicants ratio fell to its lowest level since August (1.32). That said, domestic demand remains robust, with retail sales increasing by 7.2% in March. The coming days do not promise to be as exciting - both Wednesday, Thursday and Friday are public holidays in Japan, with no new macroeconomic releases, thus the currency is likely to move in line with market sentiment.

CHF

The Swiss franc found itself in the bottom half of the G10 performance tracker and gave up some of its earlier gains against the euro last week. The move appears to be nothing more than a minor correction. Looking more broadly, the currency still holds the crown as one of the best-performing major currencies year-to-date.?

Last week’s economic releases from Switzerland were mixed. Trade data was positive, pointing to strong exports. Retail sales, however, slide, suggesting some weakness of consumer demand at the end of the first quarter. The forward-looking KOF index dropped as well, indicating a slightly weaker economic outlook in the next six months. This week will see a couple of SNB speeches and several economic releases. We’ll focus primarily on April inflation data and SNB president Jordan’s comments on Friday.?

AUD

AUD jumped across the board on Tuesday after the Reserve Bank of Australia unexpectedly delivered another 25bp rate hike, after investors had braced for no change. The bank’s communications were also on the hawkish side, with policymakers stating that "some further tightening" in policy could be warranted in order to return domestic inflation back towards the bank’s target within a reasonable timeframe. This marks a big shift in stance from the RBA, as it acknowledges a greater concern over sticky inflation than it had previously. The admission that the tightening cycle may not be over just yet is a particularly encouraging sign for the Aussie dollar, cementing our bullish view on the currency.??

Attention among investors this week will be on Wednesday’s retail sales and PMI data. Should we continue to see resilience in upcoming activity data, and a lack of a sustained downtrend in domestic inflation, then an additional hike, perhaps even a 15bp one, could be in the offing at upcoming RBA meetings.?

NZD

The New Zealand dollar posted modest gains against the US dollar towards the end of last week, though it has lagged behind its Australian counterpart following this week’s RBA announcement. No major newsflow out of New Zealand has led to relatively limited volatility in the NZD/USD pair. This is likely to change in the next few weeks, as investors eye a number of critical data points ahead of the next RBNZ meeting in a little under three weeks time. Tuesday’s labour report for Q1 will be particularly important - investors are expecting both a modest increase in employment and the jobless rate. As things stand, another 25bp hike from the RBNZ looks likely this month, and we favour possible additional action beyond then in light of this week’s hawkish surprise from the RBA.?

CAD

The USD/CAD pair ended last week almost unchanged amid relatively mixed macroeconomic news out of Canada. On the one hand, a very sizable government budget surplus in February (C$9.53 billion), the highest level in nearly 40 years, and a rebound in the manufacturing PMI, which returned back into growth territory (50.2 in April), may have helped maintain the Canadian dollar's position. Canadian GDP data for February came in positive, albeit below consensus (0.1% MoM), though this clearly runs on a lag. Global Brent Crude oil prices also remained almost unchanged last week (around $79 per barrel), which acted to limit volatility.?

This week's macroeconomic publications will be focused towards the end of the week. Among others, we will see the Ivey PMI (Thursday) and a set of data from the labour market (Friday). A speech by BoC chairman Tiff Macklem may also attract attention. That said, we expect trading in the Canadian dollar to be driven largely by external news, notably the announcement from the major central banks.

CNY

The yuan ended last week slightly lower against the US dollar. Recent economic news from China has not been particularly good. Industrial profits contracted by 19.2% year-on-year in March, underscoring the unevenness of the economic recovery. PMI data released on Sunday further emphasised this trend, showing somewhat disappointing activity in the non-manufacturing sector, accompanied by a slight downturn in manufacturing. The manufacturing PMI printed at 49.2, its lowest reading this year. The recovery in China’s economy is on track, but we could hope for more. China’s Politburo said on Friday that demand is ‘insufficient’, reaffirming that policy is set to remain supportive.

In the Labor Day ‘golden week’, we’ll continue to focus on the PMI data. The Caixin manufacturing PMI will be out on Thursday, followed by the services and composite PMIs on Friday.?