Yesterday, the FOMC decided to keep rates unchanged and kept the door open for two more hikes by the year end. As for today, the central bank torch will be passed to the BoE. The Bank is widely anticipated to hike today, so attention will quickly turn to the votes and to any hints with regards to its future plans.
The dollar ended the day higher or unchanged against all but one of the other G10 currencies. It gained the most against AUD, while it traded virtually unchanged against GBP, CAD and CHF. The sole winner against the greenback was the yen.
Although the dollar’s reaction to the Fed decision was initially a few pips down, the currency quickly rebounded to erase those losses and to gain more. Yesterday, the FOMC decided to keep interest rates unchanged in the 1.75-2.00 range as was widely anticipated, while it made a small change to the accompanying statement. Officials noted that economic activity has been rising at a “strong rate”, instead of “solid rate” as was included in the previous statement. They repeated that labor market has continued to strengthen, while as far as inflation is concerned, they noted that both headline and core inflation remain near 2%.
In our view, the market reaction was muted because this outcome was largely expected. The Committee stood pat but kept the door wide open for two more hikes by the end of the year. According to the Fed funds futures, the market anticipates a 91% chance for a rate increase at the September gathering, while the probability for another one to come in December is around 65%.
The yen was the sole winner against the greenback yesterday, regaining some of the ground it lost following the BoJ’s decision to keep its monetary policy ultra-loose. Some suggest that the yen strengthened after President Trump decided to increase the rate in the next round of tariffs to Chinese goods. That said, rumors around the tariff-rate increase kicked in during the Asian morning Wednesday, well ahead of the official announcement. Actually, at the time of the official announcement overnight, the yen weakened approximately 20 pips against its US counterpart. Perhaps it was a “sell the fact” response.
We believe that the overall strengthening of the yen yesterday may have been due to investors covering some short positions following the yen’s tumble in the aftermath of the BoJ’s decision on Tuesday. As for our view, we stick to our guns that the monetary policy divergence between the Fed and the BoJ could work in favor of USD/JPY. That said, the risk to that view is further escalation in the global trade arena, or any other headlines that could hurt the broader market sentiment.
After a successful last day of July, which led to a strong move higher, USD/JPY reversed lower yesterday and found support near the 111.40 level. Still, the pair is hanging above its upside support line, taken from the low of the 29th of May. All this makes us think that yesterday’s drop was just a correction, which could lead to another push higher.
Currently, USD/JPY is sitting near its newly-found support at 111.55, which also acted as good resistance on the 23rd of July. The area could act as a potential bouncing ground for the pair to shoot back up towards the 112.15 barrier, which yesterday held the rate from moving higher. If broken this time, we could be aiming for a test of the 112.65 zone, marked by the inside swing low seen on the 19th of July. If this doesn’t stop USD/JPY from rising, then the next potential area of resistance could be the 113.10 obstacle, marked by the highs seen between the 18th and 19th of July.
On the downside, if the aforementioned upside support line gets broken, this where would start targeting the 110.75 level, marked by the lows seen between the 23rd and the 31st of July. If we get a clear break and a close from USD/JPY below that level, this is where more bears could start joining in and driving the pair lower towards the next potential area of support at 110.30, which held the rate firmly from dropping lower between the 3rd and the 9th of July. A break below could open the path to the 109.70 mark, or even the 109.35 zone, which was the low around the 26th of June.
As for today, the central bank torch will be passed to the Bank of England. Actually, it will be a “Super Thursday” for the Bank, as besides the rate decision and the meeting minutes, it also releases its quarterly Inflation Report, which will be presented by Governor Mark Carney at a press conference after the decision.
Since the latest BoE gathering, when the Bank’s Chief Economist Andy Haldane joined the ultra-hawks Ian McCafferty and Michael Saunders in voting in favor of a rate increase, data have been mixed. All three of the June PMIs increased, while the NIESR GDP Model showed that the economy expanded +0.4% in the three months to June, in line with the Bank’s view. All these suggest that the economy may have indeed turned the corner following the slowdown in Q1. However, retail sales and, more importantly, the inflation data for June came on the soft side, with core inflation coming back below the Bank’s 2% target.
That said, the market remained overwhelmed with regards to a rate increase at this meeting. Expectations suggest that officials will decide to raise rates by 25bps via a 7-2 vote. Therefore, a hike by itself is unlikely to trigger much volatility. Investors are likely to quickly turn attention to the votes in order to see whether the decision was a clear or close call, as well as well as to any signals with regards to the Bank’s future plans.
As for pound, we view the risks surrounding its reaction as tilted to the downside. Even if officials hike rates, in the midst of such an uncertain environment around Brexit, we see it unlikely that they sound hawkish. We believe that they will avoid overpromising to the market. Instead they may prefer to keep some room for maneuvering in case things do not evolve as expected. The votes could also play a big role. A hike accompanied by a 6-3 or 5-4 vote would mean that the decision was a close call and that there is less likelihood for officials to consider another rate increase in the next few months.
On the other hand, a hike accompanied by a 9-0 vote and optimistic remarks could cause the pound to strengthen as investors may bring forth their expectations with regards to the next rate increase. Some may even start anticipating the next hike to come before year end. That said, and as we already noted, we give the “hawkish hike” scenario less chance than the “dovish hike” one.
Now, the least likely scenario in our view, is the one where the Bank holds its fingers off the hiking button. This would come as a big surprise and the pound could fall off the cliff.
GBP/USD continues to drift lower within a downwards moving channel, which started around the 10th of May. The pair is also below the levels, where it started off the year, which shows that there is still a lot of weakness in the British Pound against its US counterpart. That said, if GBP/USD manages to break through the upper bound of the channel, then this could be the light in the end of the tunnel for the bulls. But for now, as long as the upper side of the channel remains intact, we will aim for lower levels.
A break below the 1.3075 level, where GBP/USD saw strong support starting from the 24th of July, could send the pair down to test the psychological 1.3000 zone, or even the 1.2955 area, marked by the lowest point seen in July. If the fall continues, we could eventually see a touch of the lower bound of the aforementioned channel, which could act as a good potential bouncing ground for GBP/USD.
Alternatively, if GBP/USD finally breaks the upper bound of the channel, this could be a sign of hope for the bulls, and the pair could travel higher from there. For us to get confident with the upside scenario, we would need to see a close above the 1.3220 level as well. This way, we could start examining the 1.3295 hurdle as the next potential area of resistance, which if broken, could open the path towards the 1.3365 barrier, marked by the peak of the 9th of July. Further acceleration in the rate could set the stage for a test of the 1.3475 area, which held GBP/USD firmly from moving higher on the 9th of July.
In the UK, besides the BoE decision, the construction PMI for July is coming out. Expectations are for a slide to 52.8 from 53.1 in June. In any case, we expect this release to pass unnoticed as investors are likely to have their gaze locked on the BoE decision.
From the US, we get initial jobless claims of the week ended on the 27th of July, as well as factory orders for June. Initial jobless claims are forecast to have risen to 220k from 217k the previous week, which will drive the 4-week moving average up to 220k from 218k. Factory orders are expected to have accelerated to +0.7% mom in June from +0.4% in May.
Tonight, during the Asian morning, Australia’s retail sales for June and Q2 are due to be released. The June monthly rate is expected to have ticked down to +0.3% from +0.4%, but on a quarterly basis, retail sales are anticipated to have accelerated to +0.8% qoq from +0.2%. In China, the Caixin services PMI is coming out and expectations are for the index to tick up to 54.0 from 53.9.
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