CAPITALDIGEST MARKET REVIEW, 15/5/2023

DOLLAR IN HOLDING PATTERN, INFLATION DATA PROVIDES LITTLE CLARITY ON RATES The dollar remained stable against a basket of currencies on Wednesday as data showed inflation slowed slightly more than expected last month but gave traders little clarity on the U.S. monetary policy outlook. A U.S. Labor Department report on Wednesday showed the annual increase in consumer prices dipped below 5 per cent in April for the first time in two years. An inflation measure closely watched by the Federal Reserve also subsided, which could provide incentive for the central bank to pause further interest rate hikes next month. But with inflation still above the Fed’s 2 per cent target, rates may need to stay high for some time to tame it. “The market is of the view that the Fed will be cutting rates sooner and faster than most other central banks. The data are showing some tentative signs of validating those expectations of divergence, but are not clear in suggesting that even faster or deeper cuts are needed,” said Alvise Marino, macro trading strategist at Credit Suisse in New York. “When markets are looking for big things to happen, and the actual outcomes are not as shocking, expectation of future volatility tends to fall.” The dollar index in afternoon trading was at 101.48, up 0.1 per cent after hitting a low of 101.21 earlier. The euro was trading 0.15 per cent higher at $1.0979 while sterling was flat at $1.2624 against the greenback. The Japanese yen held to gains and was last seen at 134.25 as the dollar slipped 0.73 per cent. Fed funds futures traders are pricing in a pause before expected rate cuts in September. The Fed’s target range stands at 5 per cent to 5.25 per cent. But Amo Sahota, director at Klarity FX in San Francisco, believes the near 80-basis-point cut that markets are pricing in by the end of this year “looks a little aggressive”. “I think what the data does say is the Fed can afford to be on pause and not have to raise interest rates. I don’t think this is giving us the real green light to say that there will be aggressive rate cuts. We’ve got another inflation read before the next Fed meeting in June. POUND HOLDS LOWER VS DOLLAR AFTER BOE RATE RISE The British pound trimmed some losses but remained lower against the dollar on Thursday after the Bank of England raised interest rates for the 12th consecutive meeting in its attempt to fight surging inflation. As expected, the BoE raised rates by a quarter of a percentage point to 4.5%, taking borrowing costs to their highest level since 2008, and said it now expects inflation to fall more slowly than previously hoped. The central bank also said it no longer predicts a recession after revising up its growth forecasts from gloomy projections in February, the biggest improvement since it began publishing forecasts in 1997.Sterling GBP=D3, which had been around 0.5% lower against the dollar prior to the decision, was last down 0.3% at $1.2590. On Wednesday, it hit its highest level in over a year at $1.2679. “Sterling should continue its rally against the U.S. dollar for as long as the consensus holds for higher UK rates, along with the prediction that the U.S. Federal Reserve will pause their programme of rate hikes,” said David Morrison, senior market analyst at Trade Nation. In the post-announcement press conference, BoE Governor Andrew Bailey said the bank will “stay the course” to ensure inflation falls back towards target, but that the impact of prior rate hikes will weigh more on the economy in coming quarters. “The BoE kept its forward guidance, which suggests that the door is very much open for further increases at the coming meetings,” said Mohit Kumar, chief European economist at Jefferies. Traders see interest rates peaking at around 4.87% in November, reflecting very little change on what had been priced earlier in the day. 0#BOEWATCH The euro earlier fell to a five-month low against the pound at 86.62 pence but was last down just 0.2% at 86.84 pence. EURGBP=D3 . Britain’s 2-year government bond yield GB2YT=RR – which is sensitive to changes in interest rate expectations – cut some of an earlier fall and was last down 2 basis points on the day at 3.804%.The 10-year yield GB10YT=RR was last down 3 basis points at 3.774%. The blue-chip FTSE 100 share index .FTSE turned negative and was last down 0.3%. The domestically focussed FTSE 250 .FTMC also declined and was down 0.2%. An index of Britain’s banks .FTNMX301010 extended losses and was last down 1.1%. DOLLAR ON PACE FOR BIGGEST WEEKLY RISE SINCE FEBRUARY he U.S. dollar rose against the euro and sterling on Friday, and was on track for its biggest weekly gain since February, as investors shifted to safe havens after consumer sentiment data fueled concern about the U.S. debt ceiling and monetary policy. A University of Michigan survey on Friday showed May U.S. consumer sentiment slumped to a six-month low on worries that political dispute over raising the federal government’s borrowing cap could trigger a recession. Consumers’ long-term inflation expectations jumped to their highest since 2011. That could influence the Federal Reserve which signaled last week that it could pause its interest-rate hikes. “Rate differentials are continuing to tilt in the dollar’s favor,” said Karl Schamotta, chief market strategist of Corpay in Toronto. “The surprises in the University of Michigan consumer sentiment survey are painting sort of a stagflationary picture for the U.S. economy and one that could justify another rate hike at the June Fed meeting, but certainly will diminish odds of rate cuts in the latter half of the year.” Recent data showing a slowing economy has boosted the case that the Fed will pause hiking rates at its June meeting. Data also showed U.S. consumer price index inflation cooling to 4.9% year-on-year in April. Moreover, weekly jobless claims rose more than expected. But the labor market remains tight, with 1.6 job openings for every unemployed person in March, well above the 1.0-1.2 range consistent with a market not generating too much inflation. Fed Governor Michelle Bowman said the central bank will probably need to raise rates further if inflation stays high. The pound fell 0.5% to $1.2448, while the euro weakened 0.6% to $1.0851, a day after falling to a one-month low. That left the dollar index up 0.6% at 102.69, notching a weekly gain of 1.4% – its biggest weekly rise since February. Joe Manimbo, senior market analyst at Convera, noted that elevated U.S. inflation spurred some skepticism about the Fed’s year-end rate cuts, and that the view that other central banks may be closer to pausing rate hikes as well has weighed on European currencies. “Dollar gains this week have been multidimensional. The buck has served as a safe harbor from worries about a weak Chinese economy and volatility on Wall Street,” Manimbo wrote. STERLING STEADIES AFTER UK ECONOMY POSTS FRAGILE Q1 GROWTH The pound steadied on Friday after data showed the UK economy avoided recession in the first quarter, recovering from its biggest one-day drop since mid-April the previous day. Sterling was last up 0.1% against the dollar at $1.252. It fell nearly 1% on Thursday after the Bank of England raised interest rates and said it would stay the course. But with consumer inflation running at 10.1%, investors had long prepared for a more aggressive stance from the BoE, whose move gave no new incentive to actively buy the pound, but also few to sell it. “The Bank of England’s 25-basis point rate hike did not have any major implications for sterling. The drop in cable yesterday was almost entirely due to the dollar rally and was in line with the move in other dollar crosses,” ING strategist Francesco Pesole said. He said there was a case for more sterling weakness ahead, but this would most likely materialize in the euro/sterling rate, which on Friday was down 0.14% at 87.12 pence, as expectations for where UK and euro zone rates converge. “For now, however, there aren’t many convincing reasons to call for sterling underperformance against its main peers in the near term,” he said. The BoE upgraded its economic growth forecasts and said Britain would avoid a recession. Data on Friday showed growth expanded by 0.1% in the first quarter, but contracted in March, which analysts said showed the fragility of the recovery, Not only does the UK have the highest rate of inflation of any developed economy, it also has the slowest rate of growth among the Group of Seven richest nations. However, Berenberg senior economist Kallum Pickering said in a research note on Friday that Britain’s political situation is “starting to look normal again” after several years of upheaval. “The UK is one of the few major economies that does not have either: a) a populist in power; or b) one waiting in the wings to challenge the next election,” Pickering said. “After being among the most populist-ridden Western economies in recent years, the UK now compares favorably with peers – most notably the U.S.,” he said. DOLLAR SLIPS FROM 5-WEEK HIGH; TURKISH LIRA DROPS The U.S. dollar fell slightly from a five-week high on Monday after a period of strength that has confused analysts.Meanwhile, The Turkish lira sank to a two-month low as weekend elections looked headed for a runoff, while the Thai baht rallied after a more decisive election result. The euro was up 0.27% against the dollar on Monday at $1.088, rebounding after falling 1.54% the previous week. That helped send the dollar index, which measures the greenback against six major peers, down 0.19% to 102.49. That was just below a five-week high of 102.75 touched earlier in the session. Analysts have said many factors could be behind the dollar’s recent strength, including concerns about U.S. inflation, and fears about the debt ceiling standoff and global economic growth driving safe-haven buying. Alvin Tan, head of Asia FX strategy at RBC Capital Markets, said a pick-up in U.S. bond yields over the last two days had supported the currency. U.S. yields rose on Friday and Monday after a University of Michigan survey of consumers’ long-term inflation expectations jumped to the highest since 2011. That put a possible Fed rate hike next month back in play, with traders laying down those odds at 11.5%. Tan said: “U.S. interest rates have risen, as the Michigan inflation expectations was stronger than expected, number one, and number two, (Fed officials) seem to be consistently hawkish by emphasizing that the Fed has no plan to cut interest rates.” The dollar was up 0.18% against Japan’s yen at 136.01, after rising 0.67% last week. Sterling was 0.28% higher at $1.248, rebounding after last week’s 1.45% fall. Traders expect the Fed to cut interest rates sharply by the end of the year as U.S. growth slows. But Tan said big cuts are unlikely, and that the dollar could rise as traders change their minds. Other analysts said investors’ concerns about the debt ceiling standoff was causing them to buy the safe-haven dollar, ahead of a key meeting between President Joe Biden and congressional leaders on Tuesday.