The FOMC raised the federal funds rate by 25bps yesterday, as was widely expected. The most noteworthy change in the accompanying statement referred to the Fed’s balance sheet. The Committee expects to begin its normalization later this year in a slow and predictable manner. Meanwhile, economic forecasts were left largely unchanged, as was the all-important ‘dot plot’, which continues to signal one more rate hike this year.
The dollar plummeted hours ahead of the decision, following disappointing CPI and retail sales data for May. This was probably seen as confirming market expectations that the following hike won’t be coming within this year. EUR/USD surged, broke above the 1.1240 (R1) barrier and hit our next resistance zone of 1.1300 (R2).
Nonetheless, during her press conference, Chair Yellen communicated the opposite message, causing the greenback to recover its earlier losses. She was upbeat overall, and noted that the FOMC views the recent slowdown in inflation as being transitory, driven by one-off effects. EUR/USD tumbled back below the 1.1240 (R1) zone. Even if the pair continues to slide for a bit more, as long as it continues to trade above the uptrend line taken from the low of the 17th of April, we still consider the short-term path to be positive.
The key takeaway we got was that the Fed expects economic data (particularly inflation) to rebound soon and if so, it will proceed with its hiking plans. However, investors remain skeptical of further near-term hikes. Market pricing suggests more than 50% probability that the Fed will not raise rates again this year. Therefore, moving forward, we expect market focus to be on incoming data and specifically, inflation-related figures. Signs of a rebound in underlying inflation or wages could make the market more confident that we will get another rate increase this year and thereby, help the dollar recover further.
However, we would avoid exploiting any future dollar gains against the euro, which we also expect to perform well given the Euro area’s robust recovery and that the ECB has started shifting towards a more upbeat bias. Our favorite proxy for further dollar gains is USD/JPY, having in mind that the Bank of Japan keeps the yields of long-dated JGBs near 0%, while the Fed appears willing to continue its normalizing process.
BoE set to stand pat, may appear slightly cautious
Today, the main event will be the Bank of England policy decision. The forecast is for the MPC to keep policy untouched via a 7-1 vote again, with Forbes expected to be the lone dissenter at her final meeting as an MPC member. Since the latest gathering, CPI data showed that inflation accelerated to +2.9% yoy in May, which is above the Bank’s forecast for the entire year, while GDP growth for Q1 was revised lower against BoE’s expectations for an upward revision.
Thus, policymakers are faced with a conundrum: high inflation, but slowing growth – which we expect to remain lackluster moving forward amid negative real wage growth. On balance, we think the Bank may place more emphasis on supporting economic growth than curbing inflation, as growth and jobs have been its main priority ever since the Brexit vote. As such, we believe the risks are tilted towards a slightly more dovish tone in the meeting minutes, something that could weigh on the pound somewhat.
GBP/USD traded south in the aftermath of the FOMC decision after it hit resistance at 1.2815 (R1). As long as the pair is trading below the key resistance territory of 1.2850 (R2), there is the prospect for further declines. A dip below 1.2720 (S1) could confirm the case and perhaps set the stage for another test near the 1.2635 (S2).
As for the rest of today’s highlights:
In Switzerland, the SNB will announce its rate decision and the forecast is for the Bank to keep its policy unchanged. As usual, we believe that policymakers are likely to repeat the franc is still overvalued and that the Bank will remain active in the FX market as necessary.
As for the economic data, the UK retail sales for May are due out and the forecast is for a decline following a remarkable +2.3% mom surge in April. A decline in retail sales could bring the pound under renewed selling interest, but the currency’s intraday direction is likely to be decided by the BoE signals a few hours later.
From the US, we get industrial production for May as well as the Philly Fed business activity index for June. We also get the NAHB housing market index for June and initial jobless claims for the week ended on the 9th of June.
We have only one speaker on the agenda: BoE Governor Mark Carney will speak during the late US session.
Support: 1.1160 (S1), 1.1110 (S2), 1.1075 (S3)
Resistance: 1.1240 (R1), 1.1300 (R2), 1.1370 (R3)
Support: 1.2720 (S1), 1.2635 (S2), 1.2515 (S3)
Resistance: 1.2815 (R1), 1.2850 (R2), 1.2910 (R3)