Major central bank rundown
It’s time for your central bank catch-up. The link to the latest statement is at the bottom of each section, so just click there to read the bank’s central statement for yourself. Remember, there is no substitute for actually reading a central bank statement and it will almost certainly be of great benefit to your trading. However, here is a summary analysis of the position of the major central banks.
Reserve Bank of Australia, Governor Phillip Lowe, 0.85%, Meets 05 July
The RBA get tough on inflation
The two main reasons the RBA hiked in May were because the economy has been ‘very resilient, unemployment is low and economic growth is expected to be strong this year. Secondly, is that ‘inflation has picked up more quickly, and to a higher level than was expected and there is evidence that labour costs are increasing more quickly’. In the June meeting, the worries over inflation have picked up even further.
The RBA hike by a surprise 50bps
A 25 bps hike was expected and some investment banks had seen the case for a 40 bps rate hike. However, a 50 bps rate hike took markets by surprise and this was prompted by the RBA worrying about inflation. The RBA like many central banks around the world is struggling to keep on top of surging inflation. A string of central banks has been turning more hawkish recently as inflation pressure looms. The RBA put the cause of inflation down to COVID-related supply chain disruptions, the war in Ukraine, and high energy prices, but also looked at domestic factors. Ironically, the tightest labour market in 50 years with record-low unemployment, down at 3.9%, is making inflationary pressures worse. However, the RBA is confident that households can manage rising interest rates due to pent-up savings.
STIR markets price in a 50 bps rate hike for July
Short-Term Interest Rate (STIR) markets are now pricing in a 100% chance of a 50 bps rate hike. This should keep the AUD supported over the medium term. One key uncertainty for the RBA is how COVID develops in relation to China. Sentiment has recently turned higher as Beijing and Shanghai come out of recent COVID curbs. However, with so much of Australia’s economy being linked to how China is doing, this is a key factor in how aggressive Australia can be in hiking rates. See here for more details on the factors influencing China and its COVID policy.
AUDCAD gains ahead?
It is still reasonable to expect AUDCAD gains from here as the CAD looks close to peak bullishness. Stops can be placed as outlined below.
European Central Bank, President Christine Lagarde, -0.50%, Meets 21 July
The inflation challenge is growing
Going into the ECB meeting there was already a high bar set in terms of expectations. Christine Lagarde had signalled a 25 bps hike in July and in September before the meeting. So, when the ECB announced a 25 bps hike in July, there was no surprise. The ECB also announced an end to the APP programme as of July 1; this was expected.
The surprise at the meeting comes from the euro’s response. Despite inflation expectations rising and the ECB’s statement starting with the line, ‘high inflation is a major challenge for all of us’, the euro sunk out of the meeting. This was all the more surprising as the statement did signal that a potentially larger rate hike may be appropriate in September. This, on balance, was definitely a more hawkish response.
So why is the euro selling?
The best explanations of the euro selling can be down to three factors. Firstly, the STIR market’s pricing is too aggressive. Secondly, the prospect of slowing Eurozone growth is weighing on the euro. And thirdly, there is a risk of fragmentation due to highly indebted countries like Italy and Greece.
The market pricing for the ECB is pricing in 140 bps. That would mean one 75 bps rate hike, and two 50 bps rate hikes in the remaining four meetings. This is a tough ask, so markets may be sceptical that it can actually be delivered. The risk to Eurozone growth is self-evident with the Russian crisis ongoing and energy prices continuing to add strain. The risk of fragmentation is high as demonstrated by the BTP-Bund spread. The BTP-Bund spread is simply the difference between the yield difference of an Italian 10-year bond and a German bond. The spread is important due to the different risk factors. German bonds are relatively safe compared to the more indebted Italian nation bond. So, the spread acts as a risk premium on the Eurozone. In other words, the spread rises higher when euro risk is deemed to be rising too. You can see that when the spread moves higher it often leads to euro weakness.
The inflation projections from the ECB have been revised higher which shows the ECB, like many central banks, is trying to tread the balance between hiking interest rates to control inflation without stinting growth.
- 2022 at 6.8% vs 5.1% previous
- 2023 at 3.5% vs 2.1% previous
- 2024 at 2.1% vs 1.9% previous
The path for the EURUSD is trickier to call here, but if the Fed is past peak hawkishness, then these lower EURUSD levels may be offering good value for buyers.
Bank of Canada, Governor Tiff Macklem, 1.50%, Meets 13 July
At the last BoC meeting, the BoC delivered a hawkish surprise. It increased rates by 50 bps as expected, but it also increased the neutral rate higher to 2.5% from 2.25%. Like many central banks around the world, the BoC did this in order to show their growing worries about rising inflation. At the prior central bank meeting, the Bank of Canada delivered a hawkish surprise. Since that meeting, inflation print came in high again and the BoC mentioned in June’s meeting that inflation pressure is continuing to broaden. The problem that the BoC identified is that ‘pervasive’ input prices are feeding through into consumer prices. Around 70% of CPE categories now show inflation above 3% and the risk of entrenched inflation is noted. Interest rates were raised to 1.50%. However, the level of inflation has exceeded the BoC’s projections. The day after the decision, deputy Governor Hawkesby said that, with inflation close to 7%, it is well above their most recent forecast and is likely to move even higher. This leads to the BoC being ‘resolute’ in bringing inflation back down. At the moment the BoC considers that interest rates will need to rise to somewhere between 2-3% in order to bring inflation back down to their 2% target. The bank’s attitude seems to be that inflation impacts all Canadians but higher interest rates impact only a few highly indebted Canadians. This means that the lesser of two evils is higher rates.
Larger-than-50bps rate hikes coming?
Quite possibly. BoC Deputy Governor Beaudry confirmed on June 02 that the BoC may have to use bigger moves than 50bps rate hikes and that he expects the policy rate will need to be raised to 3% or above to control ‘galloping inflation’. At the moment the short-term interest rate markets are now pricing in a 94% chance of a 50bps rate hike for July.
You can compare this statement with the prior one below:
This keeps the bullish pressure on the CAD and we saw CADJPY and CADCHF lift higher on this decision last week. However, it is hard to see this move worth chasing, and waiting for peak CAD bullishness may be a more reasonable move as we head into the summer.
Federal Reserve, Chair: Jerome Powell, 0.875%. Meets 15 June
USD: Peak bullishness, Federal Reserve kept to expectations
Heading into the last Fed meeting we were expecting a ‘buy the rumour, sell the fact response’ and this is what the initial reaction was.
The reason for these expectations was that there was already a very high bar set for a hawkish policy meeting. The Federal Reserve kept to its script in the meeting on May 04, 2022. It hiked by 50 bps, indicated that further 50 bps rate hikes were to come, and now estimates the neutral rate is going to be at around 2.40% by year-end. So, with rates currently at 0.875%, there is another 150 bps worth of rate hikes to come between now and the year-end. This was all as expected.
Slightly more dovish if anything
If anything the announcement of the start in QT was slightly more dovish than expected. It was based on a phased approach with the Fed expected to take 3 months to bring the level up to $60 bln in treasures and $35 bln in Mortgage-Backed Securities. On top of this dovish development Jerome Powell ruled out a 75 bps rate hike, so this all meant the Fed were unable to surprise markets with a more hawkish response. So, the initial move lower in the USD made sense.
However, the USD weakness was not sustained post-FOMC. The strength in the USD is also partly due to the slowing global trade situation. As a global reserve currency, the USD tends to gain when global growth slows. So, the recent concerns over slowdowns in China’s growth have also been a bullish pressure on the USD. This week we have some important inflation data out for the US. The US inflation rate is forecast to fall to 8.1% y/y down from the prior reading of 8.5%. Any signs of ‘peak inflation’ takes the pressure off the Fed to hike rates and can result in some USD selling. This could boost the EURUSD this week as the ECB is increasingly making calls for a July rate hike. On the other hand, if inflation comes back high, then expect more USD strength.
Watch gold for a stagflation move when the Fed meets this week
If growth starts to slow, but the Fed keeps hiking rates then that could be a catalyst for another down leg in stocks. It would also help the USD higher. So, there are still two-way risks here. What the Fed’s actions have told us is that they are very concerned about rising inflation and are prepared to act aggressively to contain it. The path from here for stocks is far from clear, but that, in itself, is a message for caution.
Bank of England, Governor Andrew Bailey, 1.00%, Meets 16 June
BoE takes another dovish hike to 1.00%
In February the BoE has had a dovish hike. They hiked by 25bps with an 8-1 vote split. The dissenter voiced a key concern as BoE’s Cunliffe recognised the inflation risk, but also the cost to households with further rate hikes. On May 05 the BoE had another dovish hike. However, at first glance, the BoE decision had signs of a hawkish tilt. Dissenter Cunliffe was now voting for a hike and 3 other board members were voting for a 50 bps hike! However, the details revealed that the BoE is now expecting the UK economy to slip into negative territory in 2023. This was a dovish development that sent the GBP sliding out of the meeting.
Inflation and growth a problem
The problem that the BoE has, alongside many other central banks, is how to control inflation without slowing growth. Inflation is now at 7% in the UK and is expected to move higher this year. In many ways, the problem of controlling inflation without slowing growth is impossible to solve. It is like saying, ‘help me draw a square circle’. So, at the latest meeting, the BoE are signalling they need to contain inflation as they expect it to now peak at 10% in the UK vs 8% in the prior meeting. The surge higher in commodity and energy prices has been compounded by the Russian/Ukraine conflict. The BoE warned that the latest rise in energy futures prices means that Ofgem’s utility price caps could again be substantially higher when they are reset in October 2022. This is seen as an upside risk for inflation to push even above 10%. At the same time, it is recognising that growth will be turning negative in 2023.
Consumer confidence falls
Higher taxation, rising living costs, and soaring energy bills have all meant a squeeze on real household disposable incomes. Unsurprisingly the BoE stated that consumer confidence has fallen. The BoE expects this to now drag on growth, so this is why the MPs recognised this and the medium-term growth outlook has been revised down lower. 2023 growth was revised down (and negative) from 1.25% and is now -0.25%. This is what sunk the GBP post the BoE. This means the BoE may now need to pause the hiking cycle around the summertime and potentially cut rates in 2023. Investors will be expecting another dovish hike from the BoE this week on Thursday.
You can read the full BoE policy report here
Swiss National Bank, Chair: Thomas Jordan, -0.75%, Meets June16
This is interesting as the SNB is showing signs of growing impatience with the strong CHF. The SNB interest rates remain the world’s lowest at -0.75%. This is due to the highly valued franc (CHF) which has seen significant gains over the last few years due to safe-haven demand.
The SNB want a lower CHF
The SNB repeated their willingness to intervene in the FX market in order to counter upward pressure on the Swiss franc. The SNB hates a strong CHF and their patience is now fractionally thinner. As an export-driven economy ( a strong CHF makes their exports more expensive to other countries) they hate a strong CHF and are doing their best to make it as unattractive as possible. The market generally ignores this and keeps buying CHF on risk aversion which has been here in one form or another since around 2008/2009. Also, note that their trade surplus is high, boosting the CHF. The moves from the ECB mean that the SNB are more likely to move on hiking interest rates, so that should strengthen the CHF into the meeting on Thursday.
Bank of Japan, Governor Haruhiko Kuroda, -0.10%, Meets 17 June
The Bank of Japan still remains a very bearish bank and there is no sign of it exiting from its easy monetary policy. Once again the latest meeting saw no surprises and everything was as expected. Interest rates remain at -0.10%. The Yield Curve Control (YCC) was maintained to target 10-year JGB yields at around 0.0%. The vote on YCC was made by 8-1 votes. The only dissenter was, once again, Mr. Katoaka. The BoJ expect current rates to stay at present, or at lower levels.
Will JPY weakness worry the BoJ?
Going into this week’s meeting the obvious concern will be the JPY weakness. JPY weakness has been extreme recently as the US10Y yields keep pushing higher on US inflation fears.
There have been growing concerns about the weakness of the JPY from Japan’s officials, but the key aspect of this is whether there will be action from the BoJ. For years Japan has struggled to see any inflation, so with inflation rising around the world, it was interesting to see that the BoJ now do expect consumer inflation to rise. However, not by much, and the latest inflation metrics for this year were lower than expected. Core CPI was down to 0.0% vs 0.6% expected and GDP growth was down as well to 3.4% vs 3.8% previous. However, the 2022 forecast for inflation is 0.9% and 1.0% for 2023. This is reflecting that Japan’s wholesale inflation hit a 13-year high (which will put a squeeze on industry profits), as the BoJ expects costlier input prices to be passed on to consumers.
The bottom line
The USDJPY pair has been very extended. If we see an end to yield curve control at the next BoJ meeting, then a sharp sell-off in the USDJPY could be expected; this is a key chart to watch over June, especially through the BoJ and Fed’s meeting this week.
Reserve Bank of New Zealand, Governor Adrian Orr, 2.00%, Meets 13 July
At the end of 2021, the RBNZ was the most hawkish central bank of the G8 currencies. On May 25 the RBNZ hiked again by 50bps, but crucially they have raised the terminal rate to nearly 4%. This is the RBNZ saying that they need to do more to tackle inflation quickly. Heading into the meeting STIR markets had priced in a 100% chance of a 50bps hike. That was expected. However, the raising of the Official Cash Rate (OCR) and Governor Orr’s forecast was what got all the attention and lifted the NZD higher.
Time to tackle inflation
The stated aim of the RBNZ is to raise the OCR rate (interest rate) to a level that brings consumer inflation down. Here is a signal of their intention:
- Sep 2022 now at 2.68% vs 1.89% prior
- June 2023 now at 3.88% vs 2.84% prior
- Sep 2023 now at 3.95% vs 3.1% prior
And then the RBNZ see the interest rate dropping in June 2025.
- OCR for June 2025 now at 3.5% vs 2.6% prior.
You can read the full forecast appendix from the RBNZ below.
The RBNZ recognised that those with high debt levels would be pressured by the rising interest rate levels. However, Governor Orr stated that he was confident that households can withstand higher rates. The RBNZ stressed that the risk of doing too little too late is worse than doing too much too soon.
This is a bullish development from the RBNZ and means the NZD has reasons for more strength as the RBNZ hikes rates more aggressively. The main risk to this outlook is if New Zealand’s economy slows and can’t take higher interest rates. If the Fed deliver a dovish surprise this week that could lift the NZDUSD sharply higher.