A risk to cable
The sequencing of rate cuts will be a huge driver of FX pricing this year. As we saw several years ago as we approached this latest hiking cycle in the face of rising inflation, those central banks swift to raise rates were at best rewarded and at least spared the slings and arrows of traders. Those central banks quickest to drop the inflation is transitory story and get on with the job saw their currencies least affected by the risk-off turn. The likes of the Euro and Yen, whose central banks the ECB and BoJ respectively buried their heads in the sand fared worse. In contrast early movers including the likes of Canada and to some extent the Fed in the US saw their currencies relatively outperform.
The same dynamics will be true regarding rate cuts. The market will punish early movers and those seeking to cut benchmark rates prematurely. For the sake of maintaining economic growth, there will be the temptation to cut in the face of falling inflation. The sequencing that has been implied by market pricing so far has already been a significant driver of spot prices. Let’s take a look at the sequencing in the UK in contrast to the US. In the UK rate cuts had almost been banished from the Bank of England narrative altogether. This has successfully staved off implied rate cuts that are now not expected to commence until the second half of this year.
As discussed in our briefing yesterday, it’s far too soon to write off the Dollar. Rate expectations have been on the move with the market currently pricing only half of the number of interest rate cuts this year than they had expected only a few months ago. What is still interesting is that the first cut is still expected within Q1 of this year. This expectation seems vulnerable based upon the Fed’s narrative and the most recent minutes showing a more hawkish narrative shared by policy makers than perhaps that received by markets from the Chair. In contrast, in the UK, weak retail sales data over the Christmas period and BoE’s own survey of CFOs all show inflationary pressures could be easing faster than expected. An adjustment of rate cut expectations earlier in the UK and later in the US as above could put a strong downward pressure on GBPUSD.
Discussion and Analysis by Charles Porter
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