Sovereign International Daily Market Report
Dollar crashes to April 2022 lows as markets eye end to Fed hikes
The dollar remained under pressure against its major peers on Thursday, languishing at its weakest position in over a year, as markets grew increasingly confident that the Federal Reserve’s rate hike cycle may soon by nearing an end.
Since last Friday’s nonfarm payrolls report, the US Dollar Index has now lost almost 3% of its value, accelerating its downward trend on Wednesday after the June CPI report missed economists’ estimates. Headline inflation eased sharply in the US last month, falling to its lowest level in more than two years, while the critical core index also unexpectedly dropped below 5% for the first time since November 2021 - somewhat of a watershed moment. The retreat in the sticky core inflation measure will be particularly welcome news for the Fed, as it suggests that the bank’s ultra-aggressive tightening cycle is finally bearing fruit. There remains a long way to go before underlying price pressures return to target, though the notion that almost all metrics of US inflation are trending in the right direction will be highly comforting for FOMC officials.
The Fed appears to have backed itself into somewhat of a corner, having suggested in its June ‘dot plot’ that two more rate hikes may be on the way in the US during the remainder of the year. While recent hawkish rhetoric suggests that another 25bp rate increase remains likely later this month, markets are now highly doubtful that a second will follow, with futures assigning little more than a 1-in-7 chance of one by November. Indeed, we are now increasingly confident in our call that the July hike will be the last in the current cycle, before rate cuts commence at some point in H1 2024. This shift in the market’s expectations has hammered the dollar in the past week, to the extent that it has underperformed almost every other currency in the world in that time.
Some of the moves that we’ve seen among the G10 currencies in the past week have been rather remarkable, perhaps partly due to thinner liquidity during the typically subdued summer months. The Norwegian krone (NOK) and Swedish krona (SEK), two of the big underperformers of late, have both rallied by more than 5% a piece against the greenback in the past seven days, with the Japanese yen (JPY) not too far behind. Interestingly enough, the moves that we’ve witnessed in the euro and sterling have been relatively subdued compared to some of the other major currencies, which can again perhaps be explained by valuation as both currencies have performed very well since the beginning of the year.
All news this week has pointed towards a higher rate in GBP/USD. On the one hand, the Fed looks likely to soon call time on its tightening cycle, while on the other, both UK wage growth and GDP data has come in above economists’ expectations. Data out on Thursday morning showed that the UK economy contracted by 0.1% MoM in May, albeit this was more mild than the 0.3% downturn anticipated. All subsectors of GDP shrank, aside from Britain’s dominant services sector, the crown jewel of the UK economy, which unexpectedly posted flat growth. The resilience in the UK’s crucial services sector should provide reason to cheer, while worker strikes are becoming less onerous, as the 128k worker days lost in May was the lowest since July 2022. Once again, Britain’s economy appears on track to defy expectations, and avoid a full quarter contraction in Q2 though, as mentioned earlier in the week, we do not rule out a technical recession in H1 2024.
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As far as the euro is concerned, the lack of major economic news out of the common bloc has arguably been good news. We did see a mild miss in industrial production numbers on Thursday, though this was largely overlooked by markets. We view yesterday’s ECB meeting accounts as hawkish, as they noted that the bank was open to more hikes beyond July and that market pricing for rates at the time of the meeting ‘could be judged as insufficient to bring inflation back’ to 2%. Focus in markets is likely to shift back to the Euro Area next week with the release of the June inflation figures on Wednesday. Another upside here could extend the EUR/USD rally to fresh highs.
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