CAPITALDIGEST MARKET REVIEW, 26/6/2023

DOLLAR FIRMS AMID SUPPORTIVE U.S. DATA; SWEDISH CROWN, AUSSIE SLIDE The U.S. dollar edged higher against the euro on Tuesday after data showed U.S. housing starts surged and as traders awaited Federal Reserve Chair Jerome Powell’s congressional testimony later this week for clues to the outlook for monetary policy. The Australian dollar fell after minutes from its latest central bank meeting showed keeping interest rates unchanged had been under consideration, while Sweden’s crown slipped to a record low against the euro. U.S. single-family homebuilding jumped in May to its highest in more than a year and permits issued for future construction also climbed, suggesting the housing market may be turning a corner after getting clobbered by Fed interest rate hikes. The housing market has taken the biggest hit from the Fed’s fastest monetary policy tightening campaign since the 1980s, but recent data have suggested the worst may have passed. “It was a big increase in the numbers today, and I think the takeaway is that the market may be paying a bit more heed to the FOMC’s warning this month that interest rates will likely need to be hiked further,” said Stuart Cole, chief macro economist at Equiti Capital. The U.S. dollar edged higher against the euro on Tuesday after data showed U.S. housing starts surged and as traders awaited Federal Reserve Chair Jerome Powell’s congressional testimony later this week for clues to the outlook for monetary policy. The Australian dollar fell after minutes from its latest central bank meeting showed keeping interest rates unchanged had been under consideration, while Sweden’s crown slipped to a record low against the euro. U.S. single-family homebuilding jumped in May to its highest in more than a year and permits issued for future construction also climbed, suggesting the housing market may be turning a corner after getting clobbered by Fed interest rate hikes. The housing market has taken the biggest hit from the Fed’s fastest monetary policy tightening campaign since the 1980s, but recent data have suggested the worst may have passed. “It was a big increase in the numbers today, and I think the takeaway is that the market may be paying a bit more heed to the FOMC’s warning this month that interest rates will likely need to be hiked further,” said Stuart Cole, chief macro economist at Equiti Capital. STERLING STRUGGLES AHEAD OF INFLATION DATA AND BOE MEETING The pound traded lower against the dollar and the euro on Tuesday, as money market traders awaited pivotal inflation data due on Wednesday, ahead of the Bank of England’s monetary policy meeting this week. At 9000 GMT, the pound was $1.277, down 0.14% against the dollar, while the euro rose 0.2% to 85.59 pence. On Wednesday, official data for inflation in May will be published. Last month, Britain reported consumer prices eased to 8.7% in annual terms in April, down from 10.1% in March, with food and non-alcoholic drink price inflation in double digits at 19.1% in April from 19.2% the month before. The latest industry data from market researcher Kantar on Tuesday showed grocery inflation in Britain eased slightly for the third month in a row in June, but was still well into double digits. The outcome of the latest inflation figures could be a huge factor for the BoE’s Monetary Policy Committee on Thursday.The market sees a 73% chance that the BoE will hike interest rates by 25 basis-points (bps) and a 27% chance of 50 bps to 5%, up from the previous day. Two-year government bond yields remained above 5% on Tuesday, after slightly moving above Monday’s 5.085% peak for the first time since the 2008 financial crisis. Adding to the expectation, 64 economists in a Reuters poll last week said they saw the BoE adding another 25 bps to the interest rate, with a majority forecasting the bank rate to peak at 5.00% by the end of August. “Hedge funds and asset managers are positioned for the pound to outperform the dollar, but we think these positions could be vulnerable, as too much positivity may be priced into the pound,” Macrohive analyst Bilal Hafeez said in a note. Across the Channel, euro zone policymakers grappled with how the European Central Bank should continue to tackle inflation. Last week, ECB President Christine Lagarde said it was likely the bank would raise interest rates again in July. While some are dovish, the ECB’s hawkish policymakers have said inflation could prove to be higher than expected.Board member Isabel Schnabel said the ECB needed to “err on the side of doing too much rather than too little,” just days after the central bank raised rates to highest level in 22 years.Nonetheless, UK 10-year gilt yields traded at a premium of 197 bps over German 10-year Bunds, just shy of October’s 31-year highs – indicating how much more yield investors are demanding to hold British debt rather than euro zone benchmark bonds. DOLLAR DIPS AS POWELL TESTIMONY DISAPPOINTS HAWKS The U.S. dollar fell against a basket of currencies on Wednesday after Federal Reserve Chair Jerome Powell’s comments on the central bank’s ongoing fight to lower inflation failed to live up to the more hawkish market expectations. Powell told lawmakers the fight against inflation still “has a long way to go” and that despite a recent pause in interest rate hikes officials agreed borrowing costs would likely need to move higher. While noting that inflation remains very far from the Fed’s target, Powell said it may make sense to still raise rates, at a more moderate pace. “Looks as if Powell failed to out-hawk markets that were braced for a more explicit ratification of the median projection in the latest dot plot summary of economic projections,” said Karl Schamotta, chief market strategist at business payments company Corpay. The Fed had left interest rates unchanged at its June meeting but signalled in new projections that borrowing costs may still need to rise as much as half of a percentage point by the end of this year. “By sticking to the balanced, data-dependent language deployed in last week’s press conference, he left investors betting that the ongoing deceleration in growth and inflation will translate into one – not two – rate hikes by year end,” Schamotta said. The dollar index , which measures the currency against six rivals, fell 0.43% to 102.07 following Powell’s testimony to the House Financial Affairs Committee. The hearing, the first of two Capitol Hill appearances this week, is part of his twice-yearly reports to federal lawmakers. “Consumer Price Index and Non-Farm Payrolls in July are going to be huge events, though it does feel that unless there’s some kind of disastrous jobs print they’re going to hike in July come what may,” TraderX market strategist Michael Brown said. Investors broadly expect rate hikes to resume at the Fed’s July meeting, though financial market indicators reflect doubts that the Fed will deliver more increases beyond that. STERLING TICKS UP AS INVESTORS POISED FOR BOE INTEREST RATE HIKE The pound was up slightly against the dollar but held steady versus the euro on Thursday as investors bet on further interest rate hikes by the Bank of England to tackle stubbornly high inflation which is plaguing the British economy. At 0910 GMT, sterling was up 0.13% versus the dollar at $1.2785, and 0.01% softer against the euro at 86.04 pence. As all eyes turn to the BoE policy decision at 1100 GMT, investors are anticipating that the central bank will need to raise borrowing costs much further than initially anticipated to tame inflation. “Consensus is that it will be a hawkish 25 basis-point rate hike, with clear signals that the Bank of England will continue to tighten policy ahead,” said Francesco Pesole, foreign exchange strategist at ING. Markets now see the chance of a 25 basis point rise at 52% and a 50 bps hike at 48%. Pesole said there were 150 bps of monetary policy tightening by the BoE being priced in, so the room for sterling to benefit from hawkish rhetoric on Thursday was limited, while the room for it to soften from a dovish surprise was considerable. “Sterling is still in somewhat vulnerable position, despite the faWednesday’s data, which showed the rate of inflation remained unchanged from the previous month at 8.7%, saw the pound retreat against the dollar and euro as money managers expected the task faced by the BoE to be more substantial than initially envisioned. The BoE’s conundrum is how to tame inflation without taking the British economy down alongside it. Finance minister Jeremy Hunt said the government would “stick to its guns” and “won’t be pushed off course” on fighting inflation, highlighting the political support the central bank has to pursue a tighter monetary policy despite the consequences to the real economy.ct that we think that the Bank of England will try not to push back against rate expectations for the time being,” Pesole said. One issue that has drawn attention from the wider public and politicians is the growing mortgage costs faced by households, with Hunt due to meet representatives of banks on Friday to ensure home loan lenders live up to their commitments to help borrowers. STERLING CLOBBERED AS JUMBO RATE HIKE RAISES RISK OF RECESSION The pound fell on Friday, heading for its largest weekly loss in over a month on rising expectations the UK economy could slip into recession after the Bank of England delivered an outsized rate hike in response to persistent inflation. The BoE on Thursday raised interest rates to their highest level since 2008, with a half-point hike that markets had anticipated, but that caught a number of investors off guard. Money markets show UK rates could peak as high as 6% by the end of this year and stay there for another six months, given how entrenched inflation is becoming in the broader economy. Meanwhile, a key market-based gauge of confidence in the economy fell to its weakest since early 2000, reflecting how investors are upping their bets on the UK succumbing to recession. Sterling fell by as much as 0.5% on the day against the dollar to a low of $1.2685. It later recovered to trade down 0.4% at $1.2702, but was set for a weekly loss of nearly 1%, its largest since mid-May. “What has been interesting has been the pound’s reaction. Normally, a G10 major central bank going for a jumbo rate hike, you’d expect a jump in sterling. But that fact that it’s come off is just a reflection of those fears,” City Index markets strategist Fiona Cincotta said. “Fears of a recession are going to ramp up from now on and that is going to limit sterling’s potential, especially when you’ve got Fed Chair (Jerome) Powell sounding hawkish as well, so there isn’t going to be any respite coming from a weaker dollar.” The pound fared more strongly against other currencies, rising 0.6% against the euro to 85.47 pence after data showed a surprise deterioration in euro zone business activity that could dampen expectations for the European Central Bank to keep raising rates. Sterling was down 0.4% against the yen at 181.6 yen, having hit its highest since late 2015 against the Japanese currency this week. Data earlier on Friday showed British retail sales unexpectedly rose in May, boosted by an extra bank holiday to mark the coronation of King Charles, but also suggesting most consumers were – for now – coping with high inflation’s squeeze on their spending power. The resilience of Britain’s labour market has been another factor that has given the BoE very little room to relax its drive to bring inflation back towards its 2% target.