Central Bank Week: Fed, BOE, and ECB meeting previews - USD, EUR, GBP, S&P 500
14:40, 31 January 2023
Content
It’s that time of the month again when we get the latest employment data in the US, but this time we also have three major risk events in the previous days. The Federal Reserve meeting will be the key event this week, followed by the Bank of England (BOE) and European Central Bank (ECB) meetings on Thursday.
Federal Reserve
Markets are convinced that the Fed will hike just 25bps at this meeting after the latest economic data has evidenced that growth in the US economy has started to slow. Retail sales, consumer prices, industrial production and factory gate prices were all below expectations in December, a good thing for those hoping for a more dovish Fed, but a bad sign for the economy. In fact, we’ve seen on the back of these a shift in the “bad data is good” mentality that traders had whilst the Fed was on its fierce rate hiking path.
If you look at equity markets now you can start to see the uncertainty that this change in mentality is causing. That said, both the S&P 500 and the Nasdaq have managed to break above their 200-day SMAs and their 2022 descending trend lines, which is a key turning point and a clear sign of a breakout. The key test now is going to be whether they can hold above these two levels after the meeting on Wednesday, at which point there is likely to be further upside if so. Watch out also for the RSI divergence. In the past, when a new high in RSI is failed to be matched by a new high in price (as we saw last week) we see a pullback below the previous low (3800 in this case) before moving back higher.
S&P 500 daily chart
S&P 500 daily chart. Photo: capital.com. Source: tradingview A lot is going to depend on the messaging from the meeting. So far, as higher borrowing costs have slowed economic growth, some FOMC members have started to acknowledge the need to stop and assess the impact the 425bps of hiking in 2022 has had on the economy, which suggests a possible pause to rate hikes after the February meeting. Markets are currently positioned for another small rate hike in March but in the past, some officials have suggested that another one in May will likely be needed. This is likely going to be a key focus for traders as they want to know where the terminal rate will be, but more importantly how long will it remain at that level. This is where there is the most disagreement between the Fed and the markets, as the central bank expects rates to be above 5% in December whilst the latter see a few rate cuts before year-end.
If the messaging suggests a possible realignment in the terminal rate and its duration then equity markets will likely get another boost whilst the dollar resumes its downward trend. But I have the feeling Powell is going to stick to his hawkish stance reiterating that despite the welcome easing in inflationary pressures it is not the time to be complacent and risk under-tightening, meaning the recent run in risk sentiment may well be over for the time being.
Bank of England
Market pricing is leaning towards a 50bps hike on Thursday with just 15% expecting a more modest 25bps. Two members, Tenreyro and Mann, voted to leave policy unchanged at the December meeting so the vote split is something that there is a struggle to find a consensus on. Those two members are likely going to remain as dissents at this coming meeting but the question is whether any other member will have made the move, something that seems unlikely but could happen.
Unlike with the Fed, the focus for traders will be on the actual rate hike given the BOE’s history of disappointing markets and remaining on the “safe side”. Governor Bailey has been pretty clear in the past that he fears the risk of over-tightening more than under-tightening, meaning 25bps isn’t completely off the table despite inflation remaining highly elevated, hence the lack of consensus in market positioning.
The base case scenario where we see rates increased by 50bps but the messaging suggesting slowing the pace of rate hikes in March would likely see little impact on UK assets. GBP/USD could continue to hover around 1.2350 as it attempts to build the momentum to push towards 1.25, whilst the FTSE 100 struggles to recover the appetite to push higher, with support around 7,707.
A more dovish approach, which sees 25bps at this meeting and a commitment to see further gradual rate hikes in the coming months would likely see the Pound pullback as the immediate reaction, likely below 1.21 for GBPUSD but the momentum is unlikely to see much of a change in the longer run, as long as the commitment for further hikes seems convincing. A more hawkish approach, whether that is 75bps at this meeting or a shift towards the risks of persistently high inflation in the press conference would likely see the most upside in UK bond yields and could provide the push needed to send GBP/USD above 1.25.
GBP/USD daily chart
GBP/USD daily chart. Photo: capital.com. Source: tradingview European Central Bank
Markets are pricing an 82% chance of a 50bps hike taking the deposit facility rate to 2.5%. The messaging from the December meeting was pretty hawkish, with President Lagarde suggesting that there could be up to 3 more 50bps hikes before the pace is slowed. Markets are currently pricing in a 70% chance of another 50bps at the March meeting, followed by 92% that the rate hike in May will be slowed to 25bps, which seems pretty feasible.
Another key point to figure out is what is going to happen to the balance sheet, with the General Council announcing in December that the APP would be reduced at an average pace of 115bln euros per month starting from March up until the end of Q2, with the continuation to be determined at a later date. It’s unlikely that we see any change in this, but if we do see the unwind increase and the ECB remains firm on its hawkish path then EUR/USD would likely look at moving above its 50% Fibonacci (1.0895) heading towards the 1.10 level where we could likely see some consolidation. So far the pair has found good support around 1.08.
If, on the other hand, we see focus starting to shift towards a slower pace of rate hikes, which seems highly unlikely right now given the comments we’ve had from members recently, then the reversal in EUR/USD could gather pace as sellers look to target December’s high around 1.0735.
EUR/USD daily chart
EUR/USD daily chart. Photo: capital.com. Source: tradingview 
