Dollar's post-Fed weakness didn't last
Market volatility picked up big time on Thursday. Testing times for traders in a brutal environment. The ‘relief rally’ seen in the S&P 500 and Nasdaq after the Fed meeting was short-lived. The bullish moves were completely undone the next day before the indices posted further losses. The Nasdaq closed 5% lower…
As for the dollar, many were looking to this meeting for signs of peak Federal Reserve (Fed) hawkishness, and by proxy, peak dollar. Initially the dollar obliged and softened…. AUDUSD closed at the highs, up 2.27% in the Fed After Party. Then, ‘The Hangover’ kicked in the next day…
A complete retracement of the prior day’s move as the dollar went on the offensive again. Analysts expected the Australian dollar to play catch up after the RBA finally hiked rates and signalled more to come. That narrative didn’t last long.
And it’s not just the Aussie either. The pound had a shocker after the Bank of England’s 0.25% rate hike came with a recession warning. Here’s GBPUSD:
The decision came with updated economic projections that really painted a grim picture for the UK economy. The BoE maintained the forecast for economic growth this year at 3.75%, but it was all downhill from there.
The forecast for 2023 is a contraction of 0.25% from the previous estimate of 1.25% growth, and for 2024 they downgraded expectations to 0.25% from a previous 1.0%.
In the subsequent press conference, a downbeat BoE Governor Andrew Bailey said
"It is a very weak projection, a very sharp slowdown,"
"There's a technical definition of a recession it doesn't meet - but put that to one side - it is a very sharp slowdown in activity."
The Governor tried to push back against the “stagflation” depiction, arguing that it was poorly defined, but the forecasts speak for themselves. Higher inflation, lower economic growth and higher unemployment certainly seem to point that way.
The Euro fared better than GBP, sending the EURGBP cross 1.4% higher on the day, even as the euro lost ground vs the dollar and Eurozone confronts the enormity of the challenges ahead. The embargo on Russian oil is threatening EU unity, and the spread between Italian and Germany’s 10 year bonds is at its widest (200bps) since March 2020. This BTP-Bund spread is a key gauge of investor appetite for riskier EZ debt.
All while the ECB is talking up rate hikes. The doves seem to be losing the internal battle, and it looks to be a question of when, rather than if, the European Central Bank joins the ranks of central banks in hiking mode. Some policymakers are talking about the June meeting, although the more centrist members such as Schnabel & De Guindos have hinted at July.
For EURUSD, higher rates could send the euro higher vs the dollar although the economic costs of higher interest rates and higher inflation could still weigh on the single currency in coming months.
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