Last night’s decision by the Federal Reserve to raise rates for the second time this year, and the seventh time since the financial crisis wasn’t unexpected, it had been well telegraphed for months. The key focus was always on the guidance expectations about whether the Fed would layout the prospects for a further two rate rises this year, and whether they would hold back in keeping their options open for next year.
In any event the FOMC were bullish about the prospects for the US economy, upgrading their forecasts for this year and next on the back of rising inflation, and a tightening labour market, as they adjusted their predictions for the unemployment rate to drop to 3.6% this year. The Fed said it expected to deliver another two rate rises this year, as well as another three in 2019.
Despite the hawkish message US yields only firmed modestly with the 2-year retesting the 2.6% level, while the 10-year yield made another failed attempt to push above 3%. The US dollar swung around a little but remained within its recent range, before trading slightly weaker, while stock markets slipped back, with Asia trading weaker after Chinese industrial production and retail sales for May also came in softer, with retail sales sliding to a multiyear low of 8.5%, a big miss on the 9.4% expected.
More importantly these rate increase expectations could deliver wider ramifications globally in the months ahead if US monetary policy continues to diverge along this expected path. By the end of 2019 the Fed expects to have raised rates 12 times since the end of 2015, yet we remain no clearer as to when to expect the next rate increase from either the European Central Bank, Bank of Japan or the Bank of England. This continued widening of interest rate differentials could act as a significant global headwind in the coming months.
The UK economy has continued to paint a picture of inflation at its lowest levels in 12 months, remaining at 2.4% in May, while the recent increase in wages appears to have stalled out albeit slightly higher at 2.8%. On the bright side this still keeps wages rising at a slightly faster rate than prices, however not at a rate likely to deliver a significant boost to the economy in the longer term.
One bright spot might be today today’s retail sales numbers for May which look set to post another decent number after a strong April rebound which wiped out the sharp decline at the end of Q1. A combination of a Royal Wedding, and two sunny bank holidays are likely to carry over into May with expectations of a gain of 0.5%. This seems a little on the low side given the strength seen in other recent surveys from the CBI and BRC, while we also saw a strong services PMI in May as well. A decent number here could well give the pound a lift and keep expectations of a rate rise in the next few months on the table.
It’s all eyes on Riga, Latvia today as the European Central Bank mulls over its latest rate decision.
For most of the last few months the expectation has been that the ECB would start to set out its exit strategy for its asset purchase program with September widely expected to be the starting date for either a reduction from the current €30bn a month, or a sudden stop.
While the economy was growing strongly at the end of last year this was almost a no brainer, however circumstances have changed somewhat since then.
Firstly, policymakers will have to weigh up a number of conflicting signals with respect to the European economy which is showing signs of slowing sharply. Weak industrial production and PMI data from France and Germany as well as a sharp plunge in German factory orders for April is likely to raise serious questions as to whether the strong growth we saw in 2017 is well and truly gone, at a time when price inflation now appears to be starting to bite, after a sharp rise in the most recent headline CPI reading to 1.9% in May, from 1.2% in April.
Secondly, policymakers will have to establish whether this rebound in the rate of inflation is transitory in order to at least allow them to adopt an approach that doesn’t box them into a corner when they start to discuss how to execute a possible exit policy.
The recent decline in the euro appears to have found a base in recent weeks on speculation that policymakers would look to start a discussion on ending asset purchases, however this was always likely to happen given current time lines, despite recent events in Italy which have seen borrowing costs sharply there in recent weeks.
Once again ECB President Mario Draghi will have to be at his dextrous best at buying the ECB time when it comes to verbalising the likely differing opinions on the timing of an exit strategy that appears to be moving towards the end of the year given current weakness in some of the recent data.
EURUSD – while above the 1.1720 area the recent uptrend remains intact but we need to see break through the 1.1850 area to target a move towards 1.1930. A move back below 1.1720 defers this prospect and opens up a return to 1.1650.
GBPUSD – the pounds recent rebound appears to be losing momentum after last week’s test of the 1.3460 area. We retain support at the 1.3270 area as well as the lows at the end of May at 1.3200. A move below 1.32000 targets a test of the trend line support from the 2017 lows which comes in around the 1.3100 area.
EURGBP – while below the 200-day MA at around the 0.8820/30 area the risk remains for a move lower, however we still appear range bound, with support at 0.8760 as well as the 0.8720 area.
USDJPY – now above the 200-day MA and opening up a retest of the May highs at 111.30. Support comes in at the 109.50 level.