How Much Longer

As we approach the end game of the rate hiking cycle, Mister Market is asking himself how much longer will it take.  Some central banks, like the Bank of Canada and the Reserve Bank of Australia, have resumed hiking rates after a conditional pause while others, like the Federal Reserve, have just hit the pause button and warned that it may not be done hiking quite yet.  Mr. Market isn’t convinced that more hikes will be delivered because economic momentum has slowed down at the end of Q2.  Basically, Mr. Market doesn’t believe that central bankers will risk a downturn in the economy.  Having said that, some central banks, like the Bank of England, forecasted a recession which should tell you that they think that an economic slowdown is what helps stamp out inflation.  I guess we are going to find out which side is correct over the next couple of quarters.

Below is the list of central bank policy meeting dates for the third quarter.  As you can see the RBA meets this Tuesday.  After hitting the pause button in April, the RBA resumed the tightening cycle with two hikes of 25 bps in both May and June.  It will be Governor Philip Lowe’s final meeting ashead of the central bank.  Will he go out with bang and hike by 25 bps or just fade away with a pause?  The cash rate futures market has a 72% chance of a pause followed by 100% hike of 25 bps by September.

The central bank most likely to hike in July is the ECB.  It is a forgone conclusion that they will hike by 25 bps to 3.75%, the musing about their meeting is more about what their next move will be, especially against a backdrop of a slowing growth momentum while inflation remains elevated and upcoming fiscal constraints.  Yes, the Eurozone will reintroduce the Stability and Growth Pact fiscal rules, which were suspended during Covid for the start of 2024.  The danger for the euro is that ECB President Christine Lagarde will come across as less hawkish if the ECB hints at a pause, which is counterproductive because a weaker euro only makes inflation worse.

The policy meetings for the Fed and Bank of Canada are much less straight forward.  Remember, the BOC surprised the markets at their last meeting by hiking rates after being on pause since the beginning of the year.  Meanwhile, the Fed elected to pause their rate hiking cycle at their last meeting.

As you can see from the USD performance for the month of June, it was down against all the majors accept Japan.  The USD was down because of the Fed pause.  Where it gets interesting for the Fed is that it Dot Plot in June.  Most of the policymakers had penciled in two more 25 bps rate hikes this year, while only 2 policymakers thought the Fed was done.  As it stands now, the market has about an 84.3% chance of hike, which would bring the top of the target band to 5.50%.

The BOC’s next move is harder to assess.  The overnight swaps markets have a 52% chance of a hike this month and 100% chance of a hike by the end of Q3.  For starters, the Canadian wildfires are likely to weigh on May and June GDP.  The other important consideration is the employment market.  The BOC raised rates two days before the May jobs report.  It showed that Canada lost full-time positions in May.  The April report was also negative making it the first back-to-back loss of full-time jobs in two years.  The unemployment rate also rose to 5.2%, the first increase since last August.  Would the BOC have hiked rates if they new that?  The next jobs report is Friday July 7 which is before the BOC's next meeting.  

The Japanese yen was the worst performing currency last month - hmm, I wonder why?  Could it be that it is the only central bank that is still accommodative?  Of course, that’s the reason.  The Bank of Japan just can’t seem to get off their dovish stance, but pressure is mounting.  After years of deflation, Japan finally has inflation.  As you can see from the chart below there has been two previous times that inflation managed to get above 0% but they were not sustainable.  This could be what is holding back policymakers at the BOJ.  However, with a new Governor at the helm there is whispering that change is afoot.  The BOJ will update its macroeconomic forecasts at its July 28^th meeting, which should set the groundwork for adjustment to its policy stance.

by  Tony Valente Senior FX Dealer, Global Treasury Solutions

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