Macro/FX Watch: Previewing the Fed and BOE meetings
Stratégiste des Marchés
Résumé: Central bank meetings will dominate the agenda this week. While a Fed pause is priced in by the markets, commentary will get a bigger emphasis especially with energy prices complicating the outlook. Dollar could still stay strong on the US exceptionalism story. Bank of England decision is due on Thursday and a 25bps rate hike is mostly priced in, although dovish hints are likely and could undermine sterling.
FOMC meeting: Dollar strength could stay
The decision for the Fed looks relatively straight forward for this week. Economists and markets are aligned to expect no rate hike, but for the Fed to keep its door open for further tightening later in the year. That base case expectation of a hawkish pause gets further weight due to the recent trajectory of oil prices that continue to complicate the inflation as well as growth picture picture. While most commentaries would centre around oil prices impact inflation expectations, it is worth noting that high oil prices will also act as a key growth headwind as businesses and consumers have to divert more of their household budgets towards energy and electricity costs. That may warranty a pause, and Fed is expected to keep rates unchanged at 5.25-5.50%.
Markets will likely focus on the Fed’s growth and inflation projections, as well as the expected path of Fed funds rate from here. Dot plot showing another rate hike for 2023 remains on the cards may not spook markets as it is about 50% priced in. But whether the dot plot supports the case for about four 25bps rate cuts priced in for 2024, or provides some pushback on that to support their higher-for-longer message, will be key for markets. June’s dot plot showed 2024 terminal rate at 4.6%, while the market is currently pricing in 4.5%. If that 2024 Fed funds rate dot moves higher to 4.8-4.9%, that will prompt the markets to push out some rate cut pricing for 2024 and this could bring a further bid higher for the US dollar.
On the growth front, everything appears to be going well on the surface with headline growth strong and labor market showing only some very minor cracks. However, many forward-looking indicators are flashing concerning signs on the US economy for the fourth quarter after the Swiftonomics of Q3. Banks continue to tighten lending standards, corporate refinancing risks are rising and consumer are starting to pull the purse strings as pandemic savings get exhausted. This could mean we get a more balanced message from Powell, and data-dependency could remain the weapon of choice. US dollar could still remain supported unless we get a clear dovish message from JPow on Wednesday (Thursday morning in Asia) which moves the pricing of rate cuts to early 2024.
Also worth noting would be any messages on the long-run neutral rate or the long-term Fed funds target rate which is at 2.5%. Fiscal policy has been loosened significantly under the Trump and Biden administrations, which means inflation could settle higher than the 2% target and monetary policy will need to be more restrictive in order to keep inflation under control. Demographics, geopolitics and green transformation have brought structural upside to inflation. While this remains a low-probability message, but it will have higher implications.
Market Takeaway: The case for an upside in the dollar index remains despite the FOMC event risk, although technical suggest that a correction to 104.45 could be seen before resuming uptrend.
BOE meeting: Not an easy choice between hawkish pause and dovish hike
The outlook for the BOE is relatively less clear than the Fed going into this week’s meeting. The central bank will need to choose between the ECB strategy of a dovish hike or the Fed’s strategy of hawkish pauses to stretch out the tightening cycle. Wage pressure and service inflation trends continue to point towards the need for more rate hikes, and justifies the over 80% odds priced in for a rate hike this week.
However, services disinflation should become more pronounced later in the year, and recent labor market report also showed some early signs of cracks. Meanwhile, UK’s confidence in BOE has slipped to record lows amid high inflation and cost of living crisis, and that has potentially prompted a shift in rhetoric from some of the central bank officials lately with Governor Bailey and Chief Economist Huw Pill talking about the end of the tightening cycle. This suggests markets may be under-pricing the risk of a pause from BOE and GBP may be exposed to that. To be fair, GBP has suffered recently due to dovish re-pricing of the BOE as terminal rate projections came down from 6.5% to 5.6% currently. But a pause, even if it is accompanied by hawkish commentary, will be taken as an end of the BOE’s tightening cycle and leaves room for further dovish re-pricing. Meanwhile, reaction from the sterling may be underwhelming if a hike or hawkish commentary is seen as markets will look through to the growth headwinds and the incoming turn in policy stance.