Sovereign International Daily Market Report
Federal Reserve set to end ultra-aggressive hiking cycle
Activity in the FX market has been relatively light on the ground in the past week, with most major currencies trading within relatively narrow ranges ahead of a busy period of central bank meetings.
First up will be this evening’s Federal Open Market Committee meeting. Market participants are overwhelmingly expecting another 25bp rate increase from the Fed this week, although it looks highly likely to be the last in the current cycle. At the last FOMC meeting in March, chair Powell noted that there was a ‘very strong consensus’ in favour of another hike, with the meeting minutes continuing to stress that US inflation remained much too high, and that ‘some additional policy firming’ may be appropriate. Since then, inflationary pressures have continued to ease, and we are beginning to see signs of a loosening in labour market conditions and another flare up in the troubles faced by US regional banks - shares in both PacWest and Western Alliance both plunged by more than 25% on Tuesday.
Investors are pricing in a non-negligible possibility (almost one-in-three) of another hike beyond this month’s meeting, but we see this as unlikely. That said, we do not expect the Fed to explicitly state that the hiking cycle is over on Wednesday, though chair Powell is likely to hint at it during his press conference. We would also not be surprised to see a slight softening in the forward guidance, that both leaves the door open to another hike if warranted, while suggesting that one is unlikely to be needed. We think that it is far too soon for the Fed to begin telegraphing rate cuts, which we still contest is not on the cards for some time. At present, futures are pricing in around 50bps of cuts by year-end, which we see as excessive.
Attention on Thursday will quickly turn to the European Central Bank meeting. In our view, yesterday’s Euro Area inflation data is not likely to have influenced the decision making among the council too much. While we saw a modest uptick in the headline inflation rate to 7.0% (from 6.9%), the core print actually fell short of expectations to 5.6% (from 5.7%). A smaller, 25bp hike now seems like a done deal, although a larger 50bp move is not entirely out of the question. In the event of a 25bp hike, we expect the bank’s communications to remain hawkish, though president Lagarde is once again unlikely to deliver explicit forward guidance. We think the council will instead hint that additional hikes are on the way, though these will continue to remain ‘data dependent’.
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As mentioned yesterday, this week will also be a busy one in terms of major macroeconomic data releases. This afternoon will see the release of the latest business activity PMI numbers out of the US. We will be paying closest attention the services index from ISM, which is expected to remain in expansionary territory. The UK composite PMI on Thursday will also be worth keeping tabs on ahead of the big one - the monthly US payrolls report for April on Friday. While this will clearly be released after this month’s FOMC meeting, the strength of both wages and employment growth could be key in guiding expectations for the strength of the US economy, and the dollar.
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