Post date: 24/06/2019 10:01
The June meeting of the Federal Reserve was just as dovish as the market had been expecting. The Fed made clear that cuts are coming, the only question being how many and how fast. The current environment could hardly be more dollar bearish. The political consensus in the US is for lower rates, higher deficits, and a weaker dollar. Further, there is no sense that we are about to enter a global recession. This combination of factors should be negative for the dollar and positive in particular for emerging market currencies. The week’s performance tables reflect this. The dollar lost ground against every major currency worldwide, and the losses were particularly severe against emerging market currencies.
Two key events this week should focus the attention of currency traders. On Tuesday, Fed Chair Powell will give a speech. Then Friday we get the flash inflation data for June in the Eurozone. Given the increase importance all major central banks are giving to the lack of inflation pressures to justified dovish stances, every major inflation report worldwide needs to be closely watched.
The Bank of England suggested at its June meeting last week that it is growing increasingly anxious about the possibility of a no-deal exit from the European Union. While its central scenario remains that a deal is reached, in which case a very gradual removal of monetary stimulus would be appropriate, it made it clear that it would cut rates significantly in the event of no deal. Sterling initially reacted poorly, but toward the end of the week it was caught up in the general rally against the dollar. Next week should be a quiet one in terms of economic news so the main driver for Sterling will be any pronouncements on Brexit from the front runner for the Tory leadership, Boris Johnson.
ECB President Draghi’s very dovish tone at the Sintra conference on monetary policy on Monday temporarily brought down the Euro. However, the FOMC meeting on Wednesday brought the common currency roaring back against the dollar, as markets price in multiple cuts from the Fed and a significant narrowing in interest rate differentials. The PMI indices of business activity improved modestly, confirming our view that a recession in the Eurozone is not in the cards, and there is still considerable room for job creation and increased domestic consumption in most major economies there.
The Federal Reserve left little doubt that a cut is coming at the July meeting. The communications were perceived by the market as dovish, and there is now a full easing cycle of four 0.25% cuts priced in the interest rate markets. We do think these expectations are overdone, and a serious gap is developing again between the “dot plot” and those market prices. However, there is little doubt that the policy and political mix in the US is now as bearish for the dollar as one can imagine. The consensus is towards lower rates, higher deficits and a weaker dollar at any cost. We think this validates strongly our forecasts for stronger European currencies and, in particular, further rallies in emerging market currencies throughout 2019.