FX Commentary - June 18, 2018
The U.S. dollar index continued its rally to 11 month highs this week on the back of central bank and trade developments which have favored the dollar’s outlook.
The Federal Reserve raised its benchmark rates last week and signaled that two further rate hikes were to follow this year. Offering optimistic comments on the economy, Fed Chair Jerome Powell addressed concerns on the effects of recent trade policies, remarking that “Right now, we don’t see that in the numbers at all. The economy is very strong, the labor market is strong, growth is strong.” Powell extensively alluded to the strength of the labor market, although he did acknowledge that slow wage growth was “a bit of a puzzle” before suggesting that it would normalize as the economy strengthens. In addition to supportive remarks from the Fed, the dollar also benefitted from positive readings on producer price inflation and retail sales last week which offset a flat, albeit expected, increase in consumer prices. This week the dollar sees a lighter schedule of data, with some mixed housing data through Wednesday and June’s purchasing manager’s index due Friday. As a result, the dollar will likely find itself driven on a short term basis by global trade and risk sentiment. Given the dollar’s recent strength and general confidence in the U.S. economy, the dollar has largely played beneficiary to risk-aversion flows as a safe-haven asset.
While the Fed delivered a hawkish hike last week, the European Central Bank followed with a dovish taper. Although the announcement of the end of quantitative easing was well expected, the ECB surprised markets by updating its forward guidance to nine months rather than the six months expected by markets. This latest revelation pushes back the prospects of any rate hike from the ECB until at least next summer. Furthermore, ECB President Mario Draghi acknowledged recent global trade tensions, stating that, “This decision has been taken in the presence of a strong economy with increasing uncertainty” but dismissed risks from Italy’s recent political developments, commenting, “contagion was not significant if any at all.” In all, the ECB’s latest decision and comments from its President left markets feeling the central bank was entering its next phase on a dovish footing sending the euro back to 11 month lows against the dollar. Moreover, the difference in rhetoric between the Fed and the ECB reflects the divergence in economic data between the U.S. and other major economies. At the ECB Forum on Central Banking in Portugal this week, Fed Chair Powell and ECB President Draghi reiterated their stances, with Powell calling the case for additional rate hikes “strong” and Draghi stating the ECB “will remain patient” on its rate hike timing.
Several central banks also meet this week headlined by the Bank of England this Thursday. The BOE is not expected to offer any surprises and should stay on hold, likely communicating that their policy remains data dependent with recent data offering little room for surprise. Unless the vote line in the Monetary Policy Committee should substantially shift, the meeting is unlikely to be a material driver for the pound. Other central banks meeting this week include the Norges Bank, Swiss National Bank, Bank of Mexico, Bank of Taiwan, Philippines Central Bank, and Banco do Brasil. The Philippines Central Bank has already raised interest rates with the Bank of Mexico expected to follow suit. However, the central banks of the developed economies are expected to offer little change in policy or rhetoric. As such, a core theme amongst central banks going forward will likely be reflected this week—central banks of emerging market economies sensitive to rising US rates will be under pressure to adjust their policy rates while central banks of developed economies may choose to remain accommodative while they can.
Sources: Bloomberg, Wall Street Journal, Reuters, Barclays, Bank of America, Econoday, 4cast
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