CAPITALDIGEST MARKET REVIEW, 08/5/2023

DOLLAR HOLDS LOSSES AFTER FED HIKES, SIGNALS PAUSE The dollar fell on Wednesday after the Federal Reserve raised interest rates by a quarter of a percentage point and signaled it may pause further increases. In an overt shift, the central bank no longer said it “anticipates” further rates will be needed, only that it will watch incoming data to determine if more hikes “may be appropriate.” The pause would give officials time to assess the fallout from recent bank failures, wait on the resolution of a political standoff over the U.S. debt ceiling, and monitor the course of inflation. The Fed did not explicitly commit to ending its hiking cycle, helping to lift the dollar off session lows reached immediately after the central bank released its meeting statement. “Some people might have been expecting some sort of explicit pause. I don’t think that was realistic but this is what a pause sounds like in reality,” said Adam Button, chief currency analyst at ForexLive in Toronto. “The name of the game now is watching economic data and trying to find signs of weakness in the U.S. economy or stubborn strength.” The dollar index was last down 0.42% on the day at 101.42, after hitting 101.05, the lowest since April 26. The euro gained 0.46% at $1.1047 after reaching $1.1093. It is holding just below a 13-month high of $1.1096 reached last week. The dollar also fell 1.02% against the Japanese yen to 135.15. The April jobs report due on Friday is this week’s main economic focus. The dollar briefly bounced after data earlier on Wednesday showed U.S. private employers boosted hiring in April with strong demand in the leisure and hospitality industry, though wage growth slowed. Other data on Wednesday showed the U.S. services sector maintained steady growth in April as new orders increased amid a surge in exports, but businesses continued to face higher prices for inputs, indicating that inflation could remain elevated. Consumer price inflation due next week will also offer fresh clues on whether inflation is continuing to ease. “The Fed continues to walk the tight rope, and that is they’re trying to strike a balance between their inflation fighting credibility while trying to engineer a soft landing,” said Michael Arone, chief investment strategist at State Street Global Advisors in Boston. STERLING GAINS VERSUS DOLLAR AHEAD OF FED RATE DECISION The pound gained versus the dollar and held steady against the euro on Wednesday ahead of an expected U.S. Federal Reserve rate hike later in the day and Thursday’s European Central Bank meeting. The pound rose 0.37% to $1.2515, not far from last week’s 10-month peak of $1.25835 as markets waited for the Fed to wrap up its latest policy meeting. The dollar traded lower against most major currencies as a combination of gloomy U.S. jobs data, a standoff in Washington over the debt ceiling and nervousness following banking collapses made investors jittery and supported market pricing that Wednesday’s expected 25 basis point Fed rate hike will be the last in its current tightening cycle. This advertisement has not loaded yet, but your article continues below. Article content Market pricing for the Bank of England in contrast indicates a rate hike next week and a reasonable chance of one more increase in June. “Stronger data support the hiking cause,” said Nomura in a note. The bank expects the BoE to hike rates by 25 bps in both May and June. “Most notable releases include the upside surprise to March core inflation, a strong pick-up in underlying wage momentum, generally ongoing strength in labor market activity, a rise in consumer confidence, and a more resilient looking housing market.” European Central Bank rate setters take center stage on Thursday and money markets show a roughly 85% chance they will also raise rates by 25 bps, with a 15% chance of a 50 bp move, with more hikes in the months to come. The pound was a touch firmer against the euro with the single currency down 0.07% at 88.15 pence. The pound has performed particularly strongly against the Australian dollar and Japanese yen in recent weeks, though it dipped 0.37% against the Japanese currency on Wednesday to 169.7 yen, moving away from its seven-year top of 172.08 hit in the previous session The pound firmed 0.33% against the Aussie dollar to A$1.8766, heading back towards Friday’s one year high of A$1.9035. DOLLAR UNDER PRESSURE AFTER FED, EYES ON ECB The dollar remained pressured against most majors on Thursday, helping Sterling to its strongest in 11 months, after the Federal Reserve hinted at pausing its aggressive tightening cycle, and ahead of a significant European Central Bank meeting. Markets were also buffeted by risk aversion amid a rout in regional U.S. bank shares, which further supported market expectations of rate cuts later in the year. The euro EUR=EBS was last down slightly on the day at $1.1044, having jumped 0.57% on Wednesday. The pound was last flat at $1.2566 GBP=D3, but in Asia trade hit $1.2595, its highest since June 2022, and the Swiss franc reached 0.88215 per dollar, its strongest since January 2021, before softening. CHF=EBS The narrowing rate differentials between the U.S. and Europe, as markets price in more European rate increases than in the U.S., has been boosting European currencies in recent months. The Fed on Wednesday raised its benchmark overnight interest rate by a quarter of a percentage point, as expected, but dropped from its policy statement language that it “anticipates” further rate increases would be needed. “If this does prove to be the last hike of the cycle, the next big question for FX markets will be: how long will rates remain at these levels?” said HSBC analysts in a note. The Fed has guided markets away from the possibility of rate cuts this year, though markets are pricing them in nonetheless. “If the Fed is proved right over the course of 2023, then it will make it harder for the USD decline to extend later in the year.” “But for the time being, the market is likely to run with the theme of a peak in Fed rates justifying a clear peak in the USD and an ongoing reduction in the greenback’s residual overvaluation,” said HSBC. Money markets are now pricing in a slightly more than 10% chance the Fed will begin cutting rates in June, and expect roughly 80 basis points of rate cuts through to the end of the year. FEDWATCH The European Central Bank announces its rate decision later in the day. Market positioning is for a 25 basis point increase, though it reflects a chance of a larger 50 bp increase. Traders will also be closely watching the ECB statement and governor Christine Lagarde’s press conference for indications about the central bank’s future rate path, with expectations being the ECB has not finished raising rates. Adding to expectations the Fed will soon have to begin easing monetary conditions were lingering fears of banking sector turmoil, intensified by news that PacWest Bancorp PACW.O is exploring strategic options. DOLLAR JUMPS AS U.S. JOB GAINS, WAGE GROWTH BEAT EXPECTATIONS The dollar jumped on Friday after data showed jobs growth beat expectations in February, backing up the view of Federal Reserve officials who have said that a recent rise in U.S. government bond yields is justified by an improving economic outlook.The jobs improvement came amid falling new COVID-19 cases, quickening vaccination rates and additional pandemic relief money from the government, putting the labor market recovery back on firmer footing and on course for further gains in the months ahead.Nonfarm payrolls surged by 379,000 jobs last month, after rising 166,000 in January. In December, payrolls fell for the first time in eight months. Economists polled by Reuters had forecast February payrolls increasing by 182,000 jobs. “This is a rather impressive nonfarm payroll report,” said Edward Moya, senior market analyst at OANDA in New York. “There’s momentum in the labor market and what that’s doing is providing I think more optimism that the growth picture is looking even better.” A rollout of COVID-19 vaccines and impending U.S. fiscal stimulus have boosted confidence in an economic recovery, adding fuel to expectations of higher inflation. The dollar index jumped as high as 92.201, the highest since Nov. 25, before retracing back to 91.906, still up 0.30% on the day. The euro fell as low as $1.1892, the lowest since Nov. 26, before bouncing back to $1.1924, down 0.40% on the day. Benchmark 10-year Treasury yields hit a one-year high of 1.625%, and were last at 1.599%. The jobs data comes after Fed Chairman Jerome Powell on Thursday disappointed investors who were expecting him to express concerns about rising bond yields. Powell stuck to his stance of keeping interest rates low until the economy has recovered, adding that the sell-off in Treasuries was not “disorderly”. “The U.S. dollar rose sharply higher post-Powell comments (as) many in the market I sense were looking for stronger rhetoric from the Fed to put a break on further rallies in yields,” said Neil Jones, head of FX sales at Mizuho Bank. The Swiss franc and Japanese yen continued to weaken against the greenback on Friday on expectations that global growth will lag that of the United States. The Swiss franc fell to a seven-month low of 0.9310 francs per dollar, before rebounding to 0.9283. STERLING HITS ONE-YEAR HIGH AS BANK OF ENGLAND DECISION NEARS The pound rose to just shy of a one-year high against the dollar on Friday, and to a one-month high against the euro, as traders eyed the Bank of England’s interest rate decision next week. Sterling GBP=D3 was up 0.21% at $1.26 on Friday, after reaching $1.263 earlier in the session, the highest since late May last year. The euro EURGBP=D3 was down 0.14% against the pound at 87.49 pence, after earlier falling to 87.42 pence, the lowest since April 6. The pound has received a boost from the U.S. Federal Reserve meeting this week, analysts said, when the central bank raised rates by 25 basis points but signalled that it may stop there. U.S. employment data, out at 1230 GMT on Friday, will provide clues as to the Fed’s likely next move. By contrast, many analysts think the Bank of England will have to keep raising rates, given that inflation is much stronger in Britain – running at 10.1% year-on-year in March, compared with 5% in the United States. “The Fed dropping some of the hawkish language from its statement this week allowed markets to solidify their view that this is the end of the hiking cycle in the U.S.,” said Joe Tuckey, head of FX analysis at broker Argentenx. “Sterling has been able to capitalise on this.”When interest rates look like they’re going to rise in one country but stay flat in another, it can make investments in the former country look more attractive, potentially boosting the currency. A stronger-than-expected, although still lacklustre, economy has also supported the pound. Economists have been on recession watch, but one is yet to materialise, in part because of a drop in energy prices. Meanwhile, a rapid slowdown in U.S. inflation and the Fed approaching the end of its hiking cycle has sent the dollar down against a range of currencies. The dollar index =USD, which measures the U.S. currency against its major peers, was down slightly on Friday and was 0.34% lower for the week. Sterling’s perkiness against the euro can also partly be explained by the outlook for central banks, said Chris Turner, global head of markets at ING. The European Central Bank on Thursday raised rates by 25 bps, a step down in the pace of monetary tightening. Euro zone inflation has also cooled quicker than Britain’s. “Sterling is doing better. Part of that owes to the ECB, which was less hawkish than expected and that took some of the steam of the euro,” Turner said. Traders broadly expect the Bank of England to raise rates by 25 basis points to 4.5% on Thursday next week, according to pricing in derivatives markets. They then see rates climbing to a peak of around 4.8% later in the year. Dominic Bunning, head of European FX research at HSBC, said the pound could rise to around $1.30 later in the year.”This is not a story of an absolute positivity,” he said. “We’re not looking for much, much bigger gains here.”