Head of FX Strategy
Summary: The news of the day was supposed to be the FOMC shocking us all with the first less-hawkish-than-expected performance in months last night, but the ensuing USD sell-off is already reversing sharply today. Instead, the focus ow shifts to sterling suffering a renewed beating in the wake of the Bank of England meeting today. Even as three dissenters voted for a larger hike, Governor Bailey is against them and the BoE is forecasting a recession starting in Q4. Ouch, sterling, ouch.
FX Trading focus: FOMC reaction fading fast. Bank of England ushers in renewed sterling pounding.
A very brief update today as I hosted an FX webinar today, starting just as the Bank of England decision was announced – find the replay here (scroll down to the “Previous Webinars” section).
The FOMC last night was a significant surprise in that Powell specifically seemed determined to take 75-basis point hikes off the table in specifically forecasting 50-bps hikes for coming meetings. As well, the Fed will only begin to shrink its balance sheet from June 1, only to reach its maximum pace of tightening ($95 billion/month) in three months. The result was a net “easing” relative to expectations, as the risk of a 75-basis point move was priced into June-July meeting expectations. Risk sentiment exploded higher on short covering and the US 2-year rate dropped some 15 basis points as the US dollar backed down sharply. Our view is that the Fed isn’t really in control of what it is eventually going to have to do in order to get ahead of inflation, but of course the market will react at the margin based on positioning and sentiment. Still, it is remarkable that the USD consolidation is reversing so quickly today. Part of that is down to the Bank of England uncorking an ugly economic forecast that is absolutely crushing sentiment in sterling as well as UK rates.
That of course takes us to the Bank of England meeting: three dissented to the decision to hike rates by 25-basis points, wanting a 50-basis point move. Interestingly, two members saw guidance for more hikes as “inappropriate”! In the economic forecasts, the bank is concerned about the “second-biggest drop in living standards since 1964”, sees unemployment rising throughout the forecast window, and a GDP contraction in Q4 and a 2023 GDP growth of -0.25%. The inflation forecast was raised to a blistering 10.25% for this year, but expected to drop to 3.5% in 2023 (!!). Governor Bailey said in the press conference that rate increases larger than 25 basis points are inappropriate, but I am more afraid that a vicious negative spiral in sterling could force the BoE to do more hiking than it wants to defend the currency and throw the economy under the bus. Finally, rather than starting “active QT” now (selling holdings outright rather than merely not replacing maturing bonds) as had been forecast once the BoE rate reached 1.00%, the bank now says it will not start doing so until August. This is almost an outright reneging on former guidance and is adding further to the pressure on sterling. Helmets on sterling traders – not sure that long term support at 1.2000 in GBPUSD is worth much if the USD is coming back full bore here – also note EURGBP thoughts below.
Chart: EURGBP
We focus on EURGBP here rather than GBPUSD because this is the a major technical break in the important measure of sterling’s relative strength. The brutal move higher could signal a move back into the heart of the pre-Brexit range, with resistance into the 0.8800+ area.
Table: FX Board of G10 and CNH trend evolution and strength.
Watching for a massive downdraft in GBP trend readings in coming days. Note the USD weakness on the back of the FOMC is fading fast….
Table: FX Board Trend Scoreboard for individual pairs.
EURGBP has triggered in a massive way to the upside on the chart – watching for follow through in the coming days. The AUDJPY is an interesting one to watch for the status after trying to move above resistance near 93.50, just as the CNHJPY status bears close watching.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
