Currency traders are battening the hatches ahead of a week in which the world’s three most powerful central banks will deliver rate decisions and a series of critical data updates will be published, potentially shaping the monetary policy outlook.
Economists think tomorrow’s data will show US headline inflation slowing to 4.1 percent year-over-year in May, down from 4.9 percent in the prior month as gas prices continue their decline.Underlying consumer prices should also cool, with ebbing goods demand and an easing in rental costs driving the month-over-month change in the core measure down to 0.3 percent from April’s 0.4 percent.
After a weeks-long communications effort from increasingly-cautious Fed officials, the CME’s Fedwatch tool shows markets assigning 77-percent odds to a “skip” at the central bank’s Wednesday meeting.With evidence of an incoming slowdown beginning to accumulate, policymakers are widely seen buying time to understand how economic activity and credit conditions are evolving. But the probability of a move in July is holding near 65 percent, and median projections included in the so-called “dot plot” are expected to show officials supporting at least one more quarter-point move this year. We aren’t convinced rates will inevitably go higher – recent surprises in Canada and Australia are hardly meaningful for the vastly larger and more diverse US economy – but we remain deeply skeptical of the “pivot” narrative, and suspect officials will use forward guidance tools to pour cold water on the idea that rate cuts will come later in the year.
The greenback is weaker against all of its major rivals, exhibiting typical “dollar smile” dynamics as volatility expectations keep ratcheting lower. Yields are essentially flat across the curve, and equity futures are setting up for a slightly more constructive open.
The British pound is outperforming against the greenback, flirting with the 1.26 mark on fading recession fears and rising rate expectations. Two of the UK’s biggest business organizations – the Confederation of British Industry and the British Chambers of Commerce – have updated their forecasts to show the country narrowing skirting a contraction this year, aligning with the Bank of England’s own projections, which suggest that rates have room to push higher without triggering a downturn. Tomorrow’s jobs data – which are expected to show a modest cooling in employment levels and an acceleration in private sector pay growth – could raise the likelihood of further rate hikes beyond an almost-certain move in June, but an all-important US inflation print is likely to overshadow any domestic developments in driving exchange rate dynamics.
We also note that Boris Johnson’s surprise resignation from Parliament has raised speculation around the possibility of an earlier election – one which current polling suggests the governing Tories would lose by a wide margin. But the scale of the rebellion – just two other Tories resigned in sympathy with Johnson – suggests that this remains relatively unlikely, minimizing the political risk-related impact on the pound.
The euro is holding its ground ahead of Thursday’s European Central Bank meeting – which isn’t expected to deliver major surprises. Policymakers have clearly committed to delivering at least one more hike, and the odds on one additional move at the July meeting remain high. After a raft of easing activity indicators and a decline in core price growth during the month of May, growth and inflation forecasts are both likely to see downward revision, helping to keep September expectations anchored near current levels.
Japan’s yen is back on the defensive. With inflation running above the Bank of Japan’s target for more than a year, market participants have long thought Governor Kazuo Ueda would eventually act to tighten monetary policy settings, but recent softness in wage gains, coupled with a lot of dovish rhetoric from officials, has helped put pressure on yields and the yen. Thursday’s rate decision is not expected to result in any major policy adjustments.
Lastly, the Canadian dollar is pushing toward key resistance levels on a softer greenback. Last week’s Bank of Canada-driven improvement in yield differentials is helping underpin the currency’s gains, but uncertainty surrounding tomorrow’s US inflation numbers and Wednesday’s Federal Open Market Committee meeting look set to prevent a stronger topside breakout for now. And crude prices are lending no support: both global benchmarks remain sharply weaker after last week’s data showing a collapse in Chinese export growth, paired with a sharp drop in producer prices – factors which point to a weakening in demand across both the global and domestic economies.