Breathing room, but not much
Following Jay Powell’s recent private testimony to lawmakers, the market’s belief in the Fed’s conviction to stay the course on tackling inflation is rising. The testimony to lawmakers saw the Chairman confirm that dot-plot released during the latest Federal Reserve decision represented a fair summary of the view at the central bank. This dot plot had shown a further hike to come from the Fed early this year before a pause in hiking and an eventual decline in rates towards the end of this year, gathering pace in 2024. Despite not sounding overly hawkish, it is worth noting that over the past few weeks markets had been pricing more dovish monetary policy action within futures rates.
As of last week, Fed funds futures implied a less than 25% probability for a hike at the Reserve’s next meeting in May. As of today, that probability has almost doubled. Critically, what has accompanied that change is a revision of the size of rate cuts expected for later this year. As a result of the stresses and failures that we have been seeing in the US financial sector, the market had been pricing between three and four full 25 basis-point cuts to interest rates towards the end of this year. This marks a huge turn around both from current policy and what had been implied by forecasts and market pricing in the more benign days of February 2023. Again, as of this morning, the expectations for the degree of monetary loosening by the end of 2023 have fallen by almost half with less than two full rate cuts expected versus the implied May peak by year end.
The implication is that the depreciation in the US Dollar that we have been seeing increasingly dominate the FX market since mid-March may no longer be a foregone straight-line depreciation. It may be more uncertain, although still likely overall, for EURUSD to challenge the February highs of 1.10. What continues to make 1.10 a possibility is that the US Dollar’s role as a safehaven currency is under question given that the unfolding banking turmoil has been US-centric. On the note of safe haven currencies, it is worth noting that the Swiss Franc, a widely regarded defensive currency, is also a little too close to the home of a banking upset in the form of Credit Suisse. Whilst the risk of the Credit Suisse failure has been stemmed by the intervention of Swiss authorities and UBS, it does leave speculation rife over which currencies may be the beneficiary of a deterioration in risk sentiment.
Discussion and Analysis by Charles Porter
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