He said it. Federal Reserve (Fed) President Jerome Powell said that the Fed may delay its first rate cut due to the lack of progress in cooling inflation following a rapid decline observed by the end of last year. The three straight months of rising inflation in the US convinced the Fed Chair - as many other Fed members - that cutting the interest rates in summer may be a bad idea.
On a side note, I saw a Bloomberg article suggesting that the rate hikes in the US boosted the economy instead of pushing it into recession as many economic actors have their borrowing costs locked at low levels but benefit from rising interest on their savings etc. But the Fed’s balance sheet -which is trending lower but remains significantly higher compared to the pre-pandemic levels, and the massive fiscal spending from the US - with the national debt rising at a sustainable speed toward the $35 trillion mark, explain why the US economy is performing so well despite higher rates.
Anyway, the June rate cut expectation fell to around 15%, the July cut expectation retreated to around 41%, the US 2-year yield jumped past the 5% level, where it sees some resistance, as BoFA’s MOVE index, which is a gauge of volatility in US treasuries, is on a rise. I believe that we will see the 2-year yield fluctuate between 4.75/5.25% range as the Fed will bring the ‘higher for longer’ rhetoric back on the table.
For the FX…
It means that the US dollar has room for more gains, provided the Fed’s major peers don’t share the same inflationary worries than the Fed does. They are, on the contrary, sticking to their rate cut plans into this summer. The Bank of England (BoE) Governor Bailey said yesterday that the UK might be able to lower its rates before the Fed as the inflation dynamics in their economies diverge. The sell-off in Cable accelerated, as the pair tested the 1.24 level on the back of loosening jobs numbers but the wages growth remained stubbornly high. Inflation numbers released this morning in the UK showed further easing in both headline and core inflation, though both figures came in slightly higher than expected by analysts. Cable made a very small positive attempt just after the data but the dovish BoE expectations remain intact and UK’s falling inflation toward target strengthens the case for a rate cut sooner rather than later for the BoE. As such, the outlook for Cable remains negative.
Across the Channel, the ECB Chief Christine Lagarde can’t be clearer when she says that the ECB is closing in on a rate cut as long as shocks don’t derail the slowing in inflation. The EUR/USD is testing the 1.06 level to the downside ahead of this morning’s inflation data, which is expected to reveal a certain rise on a monthly basis due to rising oil prices and the dollar appreciation but is expected to continue to fall on a yearly basis. The major risk to the EUR/USD and Cable’s bearish trend is indeed a shock – the most obvious being a further jump in oil prices due to rising tensions in the Middle East as Iran is getting involved in the conflict. Also, the dollar appreciation will likely complicate the inflation battle for the rest of the world as the prices of pretty much everything will increase due to a broadly stronger US dollar.
In Japan, the USD/JPY is preparing to test the 155 level as traders are left wondering when the Japanese authorities will intervene.
Oil Risks Remain Tilted to the Upside
The barrel of US crude remains offered on geopolitical news, or the lack thereof, after Iran attacked Israel this weekend. Israel said at the start of the week that there will be a response, even though the US and allies are putting a lot of effort to prevent a further escalation of tensions with Iran. This being said, Yellen said that there will be more sanctions against Iran for daring to hit Israel. I am not a political expert but the situation in Gaza is already frustrating the supporters of Biden, and I believe that rising tensions in the Middle East on top if it – which would result in higher energy prices - will be offering the presidency on a silver plate to Donald Trump. Therefore, the Biden administration has all the interest in the world to cool tensions, but Israel has been ignoring US’ warnings/recommendations since the beginning of the Gaza conflict. At this point, risks remain tilted to the upside for oil prices. Any escalation with Iran has the potential to send US crude past the $90pb.
Golden Hedge
The IMF is optimistic that the world economy will do just fine this year as they upped their growth forecast by 0.1 percentage point to 3.2% this year, but warned that this outlook remain cautious due to persistent inflation and geopolitical risks. And indeed, the latter – persistent inflation and rising geopolitical tensions - keep gold appetite intact near record levels despite rising US yields. Gold is perceived as a good hedge against rising geopolitical tensions and against a potential meltdown in risk appetite due to a more hawkish Fed. Any disappointment in corporate earnings could accelerate the risk selloff and strengthen the gold’s bullish trend.