CAPITALDIGEST MARKET REVIEW, 19/6/2023

DOLLAR INCHES HIGHER AHEAD OF INFLATION DATA, FED RATE DECISION The dollar inched higher on Monday, trading in a narrow range as investors remained cautious ahead of several key policy decisions due this week, with the Federal Reserve expected to keep rates on hold for the first time since January 2022. Monetary policy meetings at the Fed, the European Central Bank (ECB) and the Bank of Japan (BOJ) will set this week’s tone as markets seek clues from policymakers on the future path of interest rates. U.S. May inflation data is also out on Tuesday as the Fed kicks off its two-day meeting. “Though it’s more likely than not that the Fed will ‘skip’ a hike this month, it seems as if no one wants to be caught on the wrong side of the market should they choose to hike this month, keeping volatility low across most majors,” said Helen Given, FX trader at Monex USA in Washington. She said everyone seemed to be “holding their breath” and waiting for cues from Fed Chair Jerome Powell. “A hike Wednesday would likely be very dollar-positive as it would go against current market expectations,” Given said. Money markets are leaning toward a pause from the Fed, according to Refinitiv’s FedWatch, but a majority expect a hike in the July meeting. Conversely, a clear majority of economists polled by Reuters expect the ECB to hike its key rate by 25 basis points on Thursday and again in July, before pausing for the rest of the year as inflation remains sticky. The U.S. dollar index clocked a loss of nearly 0.5% last week, its worst weekly drop since mid-April, and was last up 0.1% at 103.60. The euro was up slightly at $1.0760, having risen 0.4% last week, its first weekly gain in roughly a month. Elsewhere, the Japanese yen slipped 0.2% to 139.55 per U.S. dollar, before a two-day meeting by the BOJ, which is expected to maintain its ultra-loose monetary policy and forecast a moderate economic recovery, as robust corporate and household spending cushion the blow from slowing overseas demand, sources told Reuters. The BOJ announces its policy decision on Friday. DOLLAR GAINS AFTER FED HIKE HINT; YEN TUMBLES The U.S. dollar strengthened on Thursday after the Federal Reserve left borrowing costs unchanged but signalled further rate hikes to come as attention turned to the European Central Bank policy announcement later in the day. The Fed’s policy decision snapped a string of 10 consecutive rate hikes, but the projections, or dot plot, showed policymakers expect two more increases by the end of 2023. Powell said rate cuts in 2023 would not be appropriate. “Fed delivered a hawkish skip,” said Mohit Kumar, chief financial economist Europe at Jefferies. “The revision to the dot plots was more hawkish than our expectations as we had expected an upgrade to reflect one more possible hike.” The dollar index, which measures the currency against a basket of currencies, rose 0.3% to 103.26, recovering from a four-week low of 102.66 on Wednesday. The market’s attention is now turning to other central bank decisions late this week, with the ECB policy announcement on Thursday before the Bank of Japan on Friday. The euro was last down 0.1% versus the dollar at $1.0819 after touching a four-week high of $1.0865 on Wednesday. Money market traders are expecting the ECB to raise the deposit rate by 25 basis points, with a further quarter-point hike seen in July. “Markets will be looking for communication on the balance of risks and whether there’s a need for further rate hikes, but we think the potential for big market moves is much smaller than it has been for recent ECB decisions,” said Kristoffer Kjær Lomholt, head of FX and corporate research at Danske Bank. “Our preference is for the US economy to do better than the euro zone … and hence the dollar looks like a more attractive currency to buy compared to many other currencies, including the euro,” Lomholt added. The Bank of Japan follows on Friday when it is expected to maintain its ultra-dovish stance and yield curve control settings. “We don’t expect changes to yield curve control at tomorrow’s meeting, but we think we are getting closer to that policy shift,” Danske Bank’s Lomholt said. The yen plunged 1% to 141.50 per dollar, a level not seen since Nov. 23 last year, with analysts on the lookout for further signs of currency intervention. “Dollar-yen is at year highs and markets are increasingly beginning to talk about whether a further rise could trigger the BoJ to verbally and also effectually intervene in the FX market,” Lomholt added. STERLING RISES AS UK SIDE-STEPS RECESSION, BUT RED-HOT INFLATION RATTLES TRADERS Sterling ticked higher versus the dollar on Wednesday after data showed Britain’s economy grew modestly in April, as traders remained unnerved by an earlier release signalling sticky inflation. By 0927 GMT, the pound was 0.2% up against the dollar GBP=D3 and 0.15% higher against the euro at 85.49 pence EURGBP=D3. Wednesday’s Office for National Statistics figures showed retailers and the film industry helped Britain’s economy growby 0.2% month-on-month in April, pointing to slow growth rather than a recession. But contractions were seen in manufacturing and construction. “The figures were pretty good. It’s encouraging news if you compare it to where we were at the end of last year with the energy crisis, when the outlook for the UK economy looked extremely grim,” said Francesco Pesole, FX strategist at ING. But he said the GDP reading remained overshadowed by Tuesday’s wage data, which “it definitely points to red-hot flaring alarms of inflation not cooling down at all.” That showed annual UK wage growth at 7.2%, excluding bonuses, in the three months to April – the biggest increase on record excluding data during the COVID-19 pandemic and prompting traders to ramp up bets on how many rate hikes the BoE has left in its tightening cycle. They see a 79%chance of a 25-basis-point rate rise at next week’s meeting, and a 21% chance of a 50 bps rise IRPR, with bets that the BoE’s Bank Rate – currently at 4.5% -could go as high as 5.7% by the end of 2023. The BoE has already raised the rate 12times since late 2021 from 0.1%to try to calm inflation. BoE Governor Andrew Bailey said the wage data showed the labour market was “very tight” and said inflation had been slower to fall than the central bank had hoped. UK short-dated gilt yields inched up to a 15-year high after markets opened on Wednesday, with the mortgage market already showing signs of strain in recent weeks. The next important read for UK inflation will be the consumer price index on June 21, a day before the BoE convenes. The latest developments mark a divergence from the trajectory expected from the Federal Reserve, widely expected to leave interest rates unchanged later on Wednesday for the first time since March 2022. EURO ADVANCES, SURGES TO 15-YEAR PEAK VS YEN, AFTER ECB LIFTS RATES The euro hit a 15-year peak against the yen and a five-week high against the dollar on Thursday after the European Central Bank raised interest rates for the eighth straight time and signaled further tightening to bring euro zone inflation to its medium-term target of 2%. The ECB lifted rates by 25 basis points (bps), as expected, to 3.5%, the highest in 22 years. Its staff have also increased their forecasts for inflation excluding energy and food, especially for this year and next, owing to past upward surprises. The inflation projection for this year was raised to 5.1% from 4.6%. “Our baseline expectation is a final 25-bp hike in July to a terminal rate of 3.75%. The risks remain clearly to the upside,” wrote Deutsche Bank in a research note led by chief economist Mark Wall. “There were hawkish elements in the latest ECB press conference, in particular the upwardly revised 2025 inflation forecasts. There were a few dovish elements too. President (Christine) Lagarde clearly signaled a hike in July but deliberately avoided guiding expectations for September.” In afternoon trading, the euro was last up 1.1% at $1.0948 after earlier touching a five-week high of $1.0952 against the dollar. Versus the yen, the euro rose 1.2% to 153.52, hitting 153.68 yen, the highest since September 2008, following the ECB decision. The ECB move came a day after the U.S. Federal Reserve left interest rates unchanged but signaled further rate hikes to come this year The Fed’s policy decision snapped a string of 10 consecutive rate hikes, but the projections, or dot plot, showed policymakers expect two more increases by the end of 2023. Chair Jerome Powell said rate cuts in 2023 would not be appropriate. The Bank of Japan follows on Friday, when it is expected to maintain its ultra-dovish stance and yield-curve control settings. The dollar index, which measures the currency against a basket of other major currencies, was last down 0.8 at 102.11. Earlier in the session, the index dropped to 102.08, a five-week low. POUND TREADS WATER AGAINST DOLLAR, DIPS VERSUS EURO AS ECB HIKES RATES Sterling struggled to make headway against the dollar and eased against the euro on Thursday after the European Central Bank raised interest rates to their highest level in more than two decades. At 1300 GMT, sterling was stuck at $1.2661 GBP=D3, but had surrendered earlier gains against the euro, which was up 0.22% at 85.74 pence EURGBP=D3. The ECB said it expected inflation to hover above its 2% target rate through to 2025 and hinted at more interest rate hikes, even as the euro zone economy lags. The ECB said it had revised up its projections for inflation, excluding energy and food, for the next two years due to the implications of a “robust” labour market. “Economic growth is likely to remain weak in the short run but strengthen during the course of the year as inflation comes down,” ECB President Christine Lagarde said at a news conference after the policy meeting. On Wednesday, the Federal Reserve left interest rates unchanged after 10 successive hikes, but signalled a more hawkish tilt later this year. However, Michael Hewson, chief market strategist at CMC Markets, said he saw the guidance from the Fed more as a mechanism to stop markets pricing in further U.S. rate cuts and remained fairly bullish on the pound against the dollar. “We’ll probably see $1.30 over the course of the next few weeks and months,” Hewson said. “I don’t think many people buy the Fed’s guidance that they’re going to do another two rate hikes.”Expectations for further UK rate hikes meanwhile have shot up this week after Tuesday’s jobs data. The Bank of England plans to hold a review into how it forecasts the economy, after lawmakers criticised its failure to foresee the scale and duration of inflation. Two-year gilt yields GB2YT=RR were 5.5 basis points higher on the day at 4.88%, having touched their highest since 2008 on Tuesday. Markets are pricing in a 25-bp BoE rate hike next week, and slightly less than a 20% chance of a 50-bp move IRPR.