Fed., BoJ and BoE set to meet

The Central Banks of the United States, Japan and the U.K. meet this week to determine the path for short term interest rates. The Fed could use one of the “rate hike cards” it has dealt itself, although it may choose to wait until the next meeting as the effect of the trade tariffs that commenced in July is seen.

The Q2 U.S GDP data was stellar by recent standards for G7 nations, but it was the coming together of several factors including tax cuts and infrastructure investment and, as such, came as no surprise to the market. Traders are already looking forward to Q3 data for clues that such a level of growth can be repeated. Even President Trump was reticent about the future while congratulating himself about the Q2 data on Friday.

The Bank of Japan rarely gets a mention, but their meeting this week will be characterized not by any move in short term rates but for any comment on the long-term effect of QE on the economy. Several Japanese officials have voiced concerns recently (the BoJ has been indulging in a form of QE for twenty years as they battle with low inflation).

The dollar is treading water ahead of the Fed. meeting as summer begins in earnest across the Northern Hemisphere. It closed at 64.69 just six points above the low on a day that had a range of just a meagre 28 pips.

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Sterling remains pressured

The pound closed lower for the third consecutive week as positive factors remain in short supply. It closed at 1.3110 versus the dollar on Friday having reached a high of 1.3214 earlier in the week.

Despite that, traders still attach an 81% probability to a rate hike at this Thursday’s Bank of England Monetary Policy Committee Meeting. The only reasons I can see for a hike are to give a final push to lower inflation and to give the Bank “wiggle room” to cut rates if emergency action is needed should a hard or no deal Brexit become (even) more likely.

A hike would be a fitting tribute to Ian McCafferty who leaves the committee the week after five years’ service. He has been one of the most hawkish members and has stuck by his inflation fighting mantra as the economy has faltered.

The MPC vote will be swung by two voters. Carney, Broadbent and Cunliffe will vote no change. McCafferty, Saunders, and Haldane (probably) will vote hike. That leaves Tenreyro and Vlieghe. Tenreyro has been consistently dovish in both word and deed, while Vlieghe has shaken off a cloak of dovishness recently and could change to hike this month from no change.

Sterling’s reaction will be interesting. There have been very few hawkish mutterings this month from MPC members, but any rally will be both short-lived and sold into as Brexit is set to return to cast its huge shadow in a little over a month’s time.

Euro on a long march to 1.1000

The reasons to buy the euro are melting away in a similar fashion to the drivers of the pound. If it is possible to have a bullish currency decline, then that is what the euro is facing. Interest rate differentials are the single most potent driver of G7 currencies and with traders pricing in just ten basis points of rate hike by the ECB by October next year, while the Fed., by then, could have added 125 basis points of hikes.This makes a case for a lower euro both easy and correct.

A sensible target for the single currency is around 1.1000 versus the dollar. This will, of course please Eurozone exporters and give President Trump palpitations, mainly as he will be powerless as Sr. Draghi prepares for retirement never having felt the need to hike rates.

It won’t be a straight path and it may over or undershoot. FX markets are an exercise in relative value, and there will be positive day for the euro that will coincides with dollar negativity. However, in the long term the euro is on a long march lower.

On Friday, it traded in an extremely narrow range and as holiday fever commenced it had a 1.1661/1.1654 range for the entire day, closing at 1.1659