Central Bank week ahead – FED, ECB, BOJ meeting previews
14:18, 20 July 2023
Another busy central bank week is upon us with the Federal Reserve, European Central Bank and Bank of Japan taking centre stage.
FEDERAL RESERVE - Wednesday, July 26th
At the June FOMC meeting the Fed decided to pause rate hikes after 10 consecutive rate hikes, leaving the rate unchanged at 5% - 5.25%, the highest level since 2007. The market-implied pricing shows a probability of 96% that the Federal Reserve hikes 25bps again at their meeting on Wednesday. The remaining 4% is currently assigned to the Fed choosing to keep rates on hold again.
It is interesting how these probabilities have changed – or rather how they haven’t changed – in the past 10 days. On July 12th the consumer price index (CPI) for June was released, showing a whole percentage point drop from 4% to 3%, the lowest level since April 2021. This is also the upper band of the Fed’s inflation target, which suggests that price pressures are finally getting under control. Core inflation also dropped, albeit a little more stubbornly, to its lowest level since December 2021. After the release, market expectations about a 25bps hike at the upcoming meeting remained unchanged and eventually rose in the days after.
It's becoming increasingly apparent that markets believe the Fed can achieve a “soft landing” scenario, where inflation is reduced without hindering growth in the process. Given the way risk appetite has been booming recently, with stocks leading the way higher, it seems not even another rate hike can ruin the good mood amongst investors. In all fairness, the economy has shown incredible resilience so far, which is helping the Fed's hawkish stance to combat inflation.
It seems like everyone is on the same page for this upcoming meeting so 25bps is the base case. This would allow equities to continue edging higher whilst the US Dollar struggles to find support to reverse the recent losses. It seems highly unlikely at this point that we see any other scenario. If the Fed decided not to hike again at this meeting, it would likely cause some sort of mild panic in markets which would read between the lines that the economy is not as stable and resilient as thought, potentially causing equities to turn lower and the US dollar to pick up some safe-haven demand.
On the contrary, a 50bps hike, which seems like the least likely possibility right now, could see a mixed reaction from markets. It would take them completely by surprise, but equities would probably see a negative immediate reaction but could then turn higher if it is thought that the higher rate hikes mean the Fed believes the economy is resilient enough to sustain tighter financial conditions. For the US Dollar, a hawkish Fed has been a tailwind in the past year, so a bigger rate hike could offer some bullish momentum, although it would likely not last that long.
The key to this meeting will be trying to obtain any further information about the rate curve and what to expect at future meetings. So far, the Fed sees peak rates around 5.6% which suggests a maximum of one, possibly two, more rate hikes. Powell will probably address the drop in consumer prices at his press conference so traders will likely be on the lookout for any signs that the rate hike priced in for this week may possibly be the last one of this cycle.
US Tech 100 daily chart
Source: tradingviewEUROPEAN CENTRAL BANK – Thursday, July 27th
Markets are expecting the European Central Bank (ECB) to deliver another 25bps at their meeting on Thursday, with an implied probability of 98.5%, with the potential for another similar hike before the end of the year.
In Europe, inflation remains more elevated than in the US, with the June consumer price reading (CPI) for the Eurozone coming in at 5.5%, its lowest level since February last year. The drop from the highs has been significant, with inflation peaking at 10.6% in November last year, but the recent stubbornness in the disinflationary process has meant the ECB has had to keep to a more hawkish path in recent months.
In all fairness, the ECB has been very committed to combating inflation, with Lagarde adopting a strong hawkish stance at her recent press conferences, unlike Governor Bailey from the Bank of England, who is facing an even worse inflationary problem.
There is likely to be little surprise regarding the rate hike at this meeting, given 25bps seems pretty much like a done deal but communication is going to be one of the trickiest parts of this upcoming meeting, as it is a very close call on whether another rate hike will be delivered in September.
The narrowing of interest rate differentials has boosted the euro against the dollar this year, with the recent drop in the dollar propelling EUR/USD to a 17-month high. So far, the pair has found resistance around the 1.20 mark, which is an important psychological level. It’s normal for the bullish momentum to take a break after such a significant move in the past few weeks. The RSI was at the highest level since December 2020 which was signalling that the market was overextended and therefore looking primed for a pullback, but the path of least resistance remains higher for EUR/USD, as long as the pair remains above 1.10 over the coming weeks. If bullish momentum resumes, 1.1370 will be the next key area of resistance to look out for.
EUR/USD daily chart
Source: tradingviewBANK OF JAPAN – Friday, 28th July
The Bank of Japan (BOJ) has been one of the most dovish since the start of the pandemic-stimulus era. Inflation in Japan has been much more stubborn, with consumer prices peaking at 4.3% in February this year.
The BOJ has been keeping monetary policy ultra-loose for the past few years, stimulating the economy, and keeping borrowing costs low. This has damaged the performance of the Japanese Yen as the currency has been used as a funding currency in carry trades, given its low yield.
The central bank has justified its policy approach by arguing that inflationary pressures were due to external factors like rises in oil prices and that they wouldn’t last. But given price pressures have recently rebounded and remained elevated despite falling energy prices, suggesting it is being driven by improving consumer demand, many economists now believe that the bank is going to need to adapt their policy to avoid inflation getting out of hand.
Amendments to their yield curve control (YCC) policy are thought to be the most likely policy tweak to happen, but markets have been anticipating this for the past few months, with little action so far. The question is whether anything will change at the upcoming meeting and how markets will react to this. Will they take it as a sign that Japanese inflation is a bigger concern than originally thought or will they see it as a positive sign that the BOJ is finally catching up to the evolving economic situation in Japan?
USD/JPY has staged a dramatic drop in the past two weeks, shedding almost 5% in just one week as the US dollar faced heavy losses. The pair has been tracking the yield differential between US bonds and Japanese bonds, and with the Fed looking more likely to pause hiking rates, yields on US bonds have dropped, tightening the differential, and favouring the Yen. But these moves have been driven by the dollar side of the trade, something that could change if the BOJ took policy action.
So far USD/JPY has found support along the 100-day SMA (137.130) but the move higher seems like it's already slightly exhausted, suggesting that the bearish move could resume in the coming days, with a break below 137.20 as the next target. On the flip side, if bullish momentum continues, the next hurdle for buyers will be the area between 140.50 and 140.90.
USD/JPY daily chart
Source: tradingviewRelated topics