USD struggles as Fed tightens

USD struggles as Fed tightens

• While the USD has stabilized a little against a basket of major currencies it does not appear able to recover significantly even as the Federal Reserve continues to project higher interest rates and a stronger economy in the year ahead. Although US interest rates were raised last week to between 1.0-1.25%  (the second hike this year and the third since December 2016), what was expected to be a ‘dovish tightening’ turned into one which was more ‘hawkish’ as the Fed stuck to its forecast for another hike this year and for more rises to come in 2018 and 2019...

Markets doubt Fed projections

• This reaction shows that the markets’ believes that the Fed’s projections for both the US economy and for the fed funds rate are too optimistic. The elevated levels of US equities also speak of forecasts for rate hikes that are not really believed either. While the markets were able to absorb weak growth data in Q1 as a seasonal phenomenon, they are becoming less tolerant of it carrying over into Q2, with inflation falling back and retail sales weaker than expected...   

GBP firms on BOE hawkishness

• Not helping the USD is that other central banks are becoming more hawkish including the Bank of England (BOE). The 5:3 vote by the BOE’s Monetary Policy Committee to keep interest rates on hold was a surprise, with three dissenters voting to raise interest rates. A surprise rise in UK inflation in May, where the headline rate rose to 2.9% and the core rate to 2.6%, was probably behind the shift in mood but this is also occurring against a backdrop of more sluggish economic growth which would make an actual hike in interest rates difficult... 

EUR well placed approaching summer

• The EUR on the other hand looks better placed, with data remaining relatively upbeat and the political news broadly favourable. President Macron looks likely to complete a strong victory in the final round of parliamentary elections today, and an agreement was reached by the Eurogroup last week to avert a Greek crisis for another year, with bailout funds coming just in time for Greece to be able to make debt payments next month... 

JPY loses ground with no signs of QE exit

• USDJPY staged a good recovery at the end of last week climbing above 111.00 to make a fresh two-week high at 111.42. EURJPY GBPJPY and other yen crosses also climbed as the yen underperformed. This came as the Bank of Japan (BOJ) remained on hold, with its dovish message contrasting with those of the Fed and the BOE... 

CAD rallies as BOC turns hawkish

• By contrast the CAD was the strongest performer over the week, rising by almost 2% versus the USD, benefiting from hawkish comments from the Bank of Canada.  Senior Deputy Governor Carolyn Watkins implied that the next move in Canadian interest rates was likely to be higher, highlighting that the economy’s recovery is broadening across regions and sectors and that the BOC is assessing the need for maintaining the current stimulus, with interest rates currently standing at 0.5%... 

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