CAPITALDIGEST MARKET REVIEW, 7/11/2022

U.S. DOLLAR RISES AS FED LIKELY DOING ANOTHER BIG HIKE; STERLING SINKS The dollar gained across the board on Monday, regaining some of the luster it lost earlier in the month, bolstered by expectations of another supersized rate increase at this week’s Federal Reserve monetary policy meeting. That said, the dollar’s gains could be limited if the Fed signals on Wednesday that the pace of rate hikes will slow as it assesses the impact so far of its policy tightening. Sterling, on the other hand, was on the defensive against the dollar and the euro, despite market forecasts of another 75 basis-point rate hike by the Bank of England later this week as well. The Fed is widely expected to raise its benchmark overnight interest rate by 75 basis points (bps) to a range of 3.75% to 4.00%, its fourth such increase in a row. But for the December meeting, fed funds futures have priced in on Monday a 55% chance of a 50-bps rate increase, down from about 67% last Friday. In afternoon trading, the dollar rose 0.8% against the struggling yen to 148.62 yen JPY=EBS . For the month of October, the dollar was up 2.7%, on track to post its third monthly gain versus the Japanese currency. “I think the dollar in general is consolidating. A lot of the news has already been priced into the dollar,” said Amo Sahota, executive director at FX consulting firm Klarity FX in San Francisco. “If the dollar is to make new gains, I think it would be relatively marginal. Generally, the dollar is somewhere in the bend – trying to establish a high, but has not generally done so. STERLING DROPS AS BOE HIKES INTEREST RATES BUT DIVERGES FROM FED Sterling fell sharply on Thursday as the Bank of England (BoE) raised interest rates by 75 basis points, a day after the Federal Reserve hiked borrowing costs by the same amount. The BoE’s rate hike was its biggest in three decades and took the main rate to 3%. It came a day after the Fed hiked by 75 basis points (bps) and signalled rates were likely to rise more than anticipated to crush inflation, driving U.S. bond yields and the dollar sharply higher. In contrast, the BoE’s monetary policy committee (MPC) said borrowing costs were unlikely to rise as high as markets expected before its meeting, in unusually specific guidance. Sterling fell sharply after the BoE decision, dropping as much as 1.7% to $1.1197. It then recouped some losses and was last down 1.5% to $1.1219. The euro rallied against the pound, rising 0.91% to 86.95 pence. “What caught my eye is that while some central banks are saying they don’t know how high rates will go, the BoE is saying the peak is lower than what the market is pricing,” said Jan von Gerich, chief economist at Nordea. “Sterling could face some pressure against the dollar at least.” The BoE was widely expected to raise borrowing costs by 75 bps on Thursday, although some analysts thought a 50 bps increase was a possibility. DOLLAR RALLIES AFTER HAWKISH FED; POUND SLIDES AS BOE WARNS OF ‘VERY  CHALLENGING’ OUTLOOK THE US dollar strengthened on Thursday (Nov 3), after the Federal Reserve signalled US interest rates will likely peak at a higher rate than markets had expected, while the pound fell after the Bank of England (BOE) raised rates but warned of a “very challenging outlook”. The BOE lifted UK interest rates to 3 per cent from 2.25 per cent in its largest single increase since 1989, as it battles the twin forces of a slowing economy and red-hot inflation. The central bank forecasts inflation will hit a 40-year high of around 11 per cent during the current quarter, but it pushed back against expectations for further steep rate hikes, saying Britain has already entered a recession that could potentially last two years – longer than during the 2008 to 2009 financial crisis. The pound initially slid by as much as 1.7 per cent against the US dollar after the BOE’s statement, and dropped against the euro before recovering some ground. “The pound has been slipping against the resurgent US dollar all morning, but notably it has fallen against the euro also, following the BOE announcement and the perception that this was a dovish hike,” Jane Foley, head of FX strategy at Rabobank, said. Thursday’s decision – the biggest rate rise in 33 years apart from a failed attempt to support the pound on Black Wednesday in 1992 – was in line with economists’ expectations in a Reuters poll, but was not unanimous. DOLLAR SOFTENS ON CHINA REOPENING HOPES, U.S. JOBS DATA IN FOCUS The euro and pound regained some ground on Friday, but were still set for their biggest weekly losses since September, ahead of U.S. jobs data that could underscore the hawkish message Fed chair Jerome Powell delivered this week boosting the dollar. Helping drive the gains was improved investor sentiment following reports China may relax its strict anti-COVID measures, which also caused China’s yuan to strengthen sharply. The euro was last up 0.24% at $0.9772, having earlier traded around 0.54% higher. Sterling was up 0.6% at $1.1228, also having pared gains from the Asian session. Nonetheless, the European common currency was still set for a 1.9% drop on the week and sterling a 3.4% decline, both their largest since the third week of September, when Britain’s then finance minister Kwasi Kwarteng sent markets spinning with a now withdrawn set of fiscal policies. The dollar strengthened across the board this week after Federal Reserve chair Jerome Powell on Wednesday said the central bank could continue to increase interest rates if inflation doesn’t slow, causing markets to price in 52 a higher peak for U.S. rates. In contrast, markets read a dovish message into authorities’ remarks around the Bank of England rate increase on Thursday and European Central Bank’s last week, while Norway, Canada and Australia’s central banks have also recently surprised on the dovish side. DOLLAR RISES AS CHINA DEFENDS STRINGENT COVID POLICY, DAMPENING RISK SENTIMENT The dollar firmed on Monday as sentiment soured after China said it is sticking with its strict COVID restrictions, quashing hopes of an imminent reopening in the world’s second-largest economy which had earlier fired a broad rally in riskier assets. China said over the weekend that it will persevere with its “dynamic-clearing” approach to COVID-19 cases as soon as they emerge, giving little indication it would ease its outlier zero-COVID strategy nearly three years into the pandemic. The dollar gained 0.55% on the Chinese offshore yuan to 7.2141, while the risk-sensitive Australian and New Zealand dollars were also among the biggest losers, both falling nearly 1% in early Asia trade. The Aussie was last down 0.7% at $0.6426, while the kiwi fell 0.6% to $0.5893. The two currencies were huge beneficiaries of a broad rally on Friday – rising nearly 3% – as speculation that China could soon end its COVID restrictions gathered pace and buoyed risk appetite. “People are kind of thinking there’s going to be an eventual opening … but it’s not obvious to me that there’s an imminent reopening due, and I think it’s kind of premature,” said Alvin Tan, head of Asia FX strategy at RBC Capital Markets. The economic impact of China’s zero-COVID policy was again highlighted in trade figures released on Monday, which showed exports and imports unexpectedly contracted in October, the first simultaneous slump since May 2020. Elsewhere, sterling edged 0.3% lower to $1.1340, while the euro slipped 0.1% to $0.9949, erasing some of their roughly 2% jump on Friday.