13 May 2022: MPC to lose its biggest hawk

MPC to lose its biggest hawk

13th May: Highlights

  • Economy shrunk by 0.1% in March as cost-of-living crisis bites
  • Powell confirmed as Fed Chairman for four more years.
  • How early is early?

Saunders to be replaced by Brexit critic

The UK economy shrank by 0.1% in March as consumers slashed their spending as the price of energy rose. Even though the price cap had not yet been raised.

The data is seen as a prelude to a far bigger fall when data for April is released. Chancellor of the Exchequer Rishi Sunak confirmed that he has always said that he is ready to support households.

While not strictly true, this comment will be welcomed in households across the country that are struggling to pay their bills as the level of disposable income continues to fall. Sunak went on to say that he is not attracted to the idea of windfall taxes on energy companies, since it is generally accepted that all taxes eventually find their way back to the individual.

This was true of a similar tax on banking profits a few years ago which resulted in banks starting to charge fees on almost every service they provide, which reduced the net effectiveness of tax.

MPC member and Deputy Governor Dave Ramsden confirmed yesterday that the Bank of England will be forced to continue to hike rates as CPI risk remains to the upside.

One of Ramsden’s most hawkish colleagues, Michael Saunders, comes to the end of his tenure as an MPC member in September, and his replacement is something of a surprise.

Although the Bank emphasizes that its independence allows it to recognize a full cross-section of society when appointing MPC members, the announcement that the new member will be Swati Dhingra.

Dhingra is an academic at the LSE and a major critic of Government Brexit policy. She will add a contrasting view to that of Saunders, and will no doubt be asked to confirm her views on inflation and growth in the coming months.

With headline inflation expected to rise above 10% in the next couple of months, the Bank is facing some tough calls, and it is doubtful that Michael Saunders expected prices to be rising at such a pace in the months before his departure.

The negative surprise in the GDP data added to pressure on the pound. The market is skewed towards the downside, with a sell on rallies bias definitely in play.

Expectations of a test of the 1.20 level versus the dollar have risen above 50/50. Yesterday it fell to a low of 1.2165 and closed at 1.2199, although part of its weakness is in reaction to the continued strength of the dollar.

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The market still fears a recession

While it cannot be described as a raging debate, there is no doubt that questions are being asked about whether the FOMC policy of continued rate hikes in conjunction with a reduction in the size of the FED’s balance sheet is going to lead the country into recession.

It is a truism that has existed for many years that Fed Chairmen always lose popularity when they are forced to begin to raise interest rates.

No matter the core reason, hikes are unpopular despite usually being linked to significant expansion of the economy that leads to fears of overheating.

The current picture of the U.S. economy is different and will be the subject of academic debate in the coming years.

At the core of any theory will be the decision to ignore rising inflation that was expected to fall as the country began to emerge from the pandemic, and the Fed decided that stabilizing growth was more important than tackling inflation.

The fact that several factors including the conflict in Ukraine and the price of energy have combined to create something of a perfect storm is being forgiven as something that was almost impossible to predict and add into models.

Despite a fall in his approval rating, current Fed Chairman Jerome Powell was finally confirmed for his second term by the Senate yesterday.

Despite a very real possibility that Congress could throw the nomination back to the President, in a bipartisan vote, there were only nineteen dissenters.

The vote is seen as an endorsement of Powell’s handling of the Covid-19 crisis and the deep recession of 2020. While it is rare for Congress to be seen to interfere in FED policy, the vote is also seen as approval of the hikes in benchmark lending rates.

Prices at the factory gate appear to be moderating, as producer prices fell year-on-year from 11.5% in March to 11% in April. While the FOMC will not be impressed by one month’s data, every trend has to start somewhere.

Weekly jobless claims continue to hover around the 200k mark. In the current period, new claims rose from 195k to 204K

The dollar is still gaining on the back of both divergence in monetary policy and continued risk aversion.

Yesterday, the dollar index rose to a high of 104.92, closing at 104.75. A test of 105 appears likely later today, although once that has been achieved, the market may not want to push on too much further for now.

As the market waits, Lagarde sees hike as early

ECB President Christine Lagarde, in true politician style, continues to play with semantics as she takes baby steps towards agreeing that there will be a hike in Eurozone interest rates as soon as July.

When asked again yesterday for her view, she would only be drawn into confirming that there would be an early hike.

Given the clamour that has been growing for what feels like months, it is hard to imagine anyone on the ECB rate setting board agreeing that a hike could be considered early.

The Governor of the bank of Ireland, Gabriel Makhlouf, spoke yesterday of his expectation that Eurozone interest rates will be back in positive territory by early next year. With rates having been at -50% since 2019, this is hardly considered a radical view.

If the ECB decides to hike in twenty-five basis-point increments, the market will hardly agree that that is a radical turnaround.

Makhlouf agreed with reporters who asked if he believed that the time to act on inflation had arrived.

He also confirmed that the current level of inflation is concerning, and it is the overriding belief of the ECB that it should be returned to the target of around 2% as soon as possible.

It seems a long time ago now that the market was moved by the change in the wording of the target from 2% to an average of 2%.

There are growing concerns about the pace of the rise in inflation in Spain. Last month, it touched 10%, which was mostly attributed to the rise in wholesale energy prices. However, this is in contrast to Portugal, where inflation is currently at 5.4% despite the fact that the two Iberian nations share the same electricity grid.

This is being put down to a statistical quirk in how inflation is fed into the inflation basket in both nations.

The euro continues to slide towards parity with the dollar. Yesterday’s fall was, similarly to Sterling, attributed to the renewed strength of the dollar.

The single currency fell to a low of 1.054 and closed at 1.0380.

Have a great day!
About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”