US dollar fell as Fed’s rate-hike cycle sees an ending

Reuters: The dollar fell on Thursday after the Federal Reserve delivered what some expected to be its last rate hike, while market focus shifted across the Atlantic to the European Central Bank’s rate decision later in the day.

U.S. DOLLAR FELL

The Fed on Wednesday raised interest rates by a quarter of a percentage point, as expected, marking the central bank’s 11th rate increase in its last 12 meetings. While Fed Chair Jerome Powell left the door open to another hike in September, traders were unconvinced, sending the U.S. dollar sliding in Asia trade on Thursday. That pushed the risk-sensitive Australian and New Zealand dollars higher, as the prospect that the global monetary tightening cycle could soon be ending boosted sentiment.

The New Zealand dollar was last 0.8% higher at $0.6259, having earlier surged more than 1% to a one-week high of $0.6274. The Aussie similarly jumped nearly 1% to a one-week top of $0.68195. “Of course, the Fed did not close the door to further rate hikes, but it seems like in the Asian session, people took a firm conviction that this could be the last hike for the Fed,” said Bank of Singapore currency strategist Moh Siong Sim. The dollar index fell 0.3% to 100.81, while sterling touched a one-week high of $1.29735 earlier in the session.

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The British pound was last 0.19% higher at $1.2964. “The U.S. is closer to the end of the hiking cycle than its peers. A dovish pivot from the Fed will likely exert a downward pressure on the U.S. dollar in the medium term,” said Emin Hajiyev, senior economist at Insight Investment. The ECB comes under the spotlight next, with investors expecting the central bank to similarly raise rates by 25 bps at the conclusion of its monetary policy meeting later on Thursday, with focus on its forward guidance. Ahead of the decision, the euro gained 0.18% to $1.11035. “The ECB looks all but certain to hike the deposit rate by 25 bps. This should not surprise market as it has been largely telegraphed,” said Nadia Gharbi, senior economist at Pictet Wealth Management. “The real debate is whether the ECB will hike again in September and beyond.”

Elsewhere, the Japanese yen remained under pressure, though was last roughly 0.3% higher against the U.S. dollar at 139.84. The Bank of Japan announces its monetary policy decision on Friday, and is seen maintaining its ultra-loose policy stance. “Changes to the policy rate and an end to quantitative easing still are far off based on the communication of the BOJ,” said Gregor Hirt, global chief investment officer for multi asset at Allianz Global Investors. “We would thus expect the accommodative policy to continue for the time being.”

Against the weaker dollar, the yuan edged higher in both the onshore and offshore markets, with the offshore yuan rising nearly 0.5% to a peak of 7.1170 per dollar, its strongest level since mid-June. China’s industrial profits extended this year’s double-digit pace of declines into a sixth month, data on Thursday showed, bolstering the case for further policy support to aid the economy.

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SOUTH AFRICAN RAND

Reuters: The South African rand slumped on Wednesday, as analysts said the outcome of a U.S. Federal Reserve policy meeting later in the day could leave it open to losses after strong gains this month. At 1330 GMT, the rand traded at 17.7000 against the dollar, more than 0.8% weaker than its previous close, after earlier being down almost 1% against the greenback. “There is quite a lot of caution in the market because of the Fed rate decision tonight,” said Greg Davies, head of wealth at asset manager Cratos Capital. Rand Merchant Bank said in a morning briefing that after recent gains “the rand is stretched too far”. Referring to the Fed’s interest rate announcement later on Wednesday, it said “event risk is huge tonight” and that a sharp fall in the rand should not be ruled out.

Markets are betting on a 25-basis-point hike from the Fed on Wednesday, but they are split on the odds of another later in the year. If the Fed’s language is hawkish it could boost the dollar and leave emerging market currencies like the rand exposed. The rand has gained more than 6% against the greenback so far in July, helped by dollar weakness in the first half of the month, a commitment from Chinese policymakers to support their economy, and foreign buying of South African government bonds. Kevin Lings, an economist at asset manager Stanlib, linked the foreign bond-buying to a decline in South African inflation and a decision by the Reserve Bank last week to leave its main interest rate on hold. “This reflects the power of a credible central bank,” he wrote on Tuesday on X, the social media platform formerly known as Twitter.

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On the Johannesburg Stock Exchange, the blue-chip Top-40 index was about 0.4% weaker than its previous close. South Africa’s benchmark 2030 government bond was slightly stronger, with the yield down 2 basis points to 10.265%.

BRITISH POUND

Reuters: The pound edged up against the dollar on Wednesday, ahead of a monetary policy decision from the U.S. Federal Reserve and dropped against the euro, which staged its biggest daily fall against the pound in five months the previous day. Sterling was up 0.1% against the dollar at $1.2913 and down 0.1% against the euro , which traded at 85.81 pence. The euro tumbled by 0.7% against the pound on Tuesday, marking its largest one-day decline since February, after data showed economic growth is slowing across Europe as tighter credit conditions kick in.

However, a day ahead of a rate decision by the European Central Bank, few investors were overly willing to commit to pushing the euro much lower, given the expectation for the ECB to raise interest rates again and possibly signal more are in the pipeline. “This is entirely a euro-driven move and does not represent some bullish re-appraisal of sterling’s prospects,” ING strategist Chris Turner said. “Given that we are mildly negative on the euro going into tomorrow’s ECB meeting and that UK rates might be dragged higher by U.S. rates later today, we would say euro/sterling could have a little more downside to the 85.20 area over the next couple of sessions,” Turner said.

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The major driver for the currency market on Wednesday was the run-up to the Fed’s decision on monetary policy later on. Money markets show traders fully expect U.S. rates to rise by another 25 basis points from their current 5.00-5.25% range and to peak around 5.45% by November. Expectations for what the Bank of England signals when it meets on Aug. 3 have shifted this month. Traders expect UK rates to rise to as much as 5.84% by next March, from 5.0% right now, but this is well below a peak of around 6.4% by May just two weeks ago.

Evidence that UK inflation is finally starting to slow after having lingered in double digits for months, as well as a softening in business activity and a cooling in the job market has taken some of the pressure off the BoE to keep raising interest rates. As such, some of sterling’s appeal for foreign investors has faded as UK bond yields have fallen, reflecting those lower rate expectations. Two-year gilt yields , the most sensitive to shifts in expectations for monetary policy, have fallen by 30 bps this month to below 5%, leaving their premium above equivalent U.S. yields at just 9 bps, from closer to 40 bps at the start of this month. Against that backdrop, sterling has fallen nearly 2% in under two weeks.

GLOBAL MARKETS

Reuters: Asian shares jumped to five month highs on Thursday amid optimism the U.S. tightening cycle was over and the economy was heading for a soft landing, boosting the outlook for global growth and risk appetite generally. Investors are now waiting for European Central Bank later in the day, which is also seen approaching the end of its tightening campaign, and the Bank of Japan on Friday, which is expected to maintain the ultra loose monetary policy. The upbeat mood is set to extend to Europe, with EUROSTOXX 50 futures up 0.4% and FTSE futures rising 0.3%.

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Nasdaq futures advanced 0.6%, helped by a 6.8% jump in Meta Platforms in after-hours trading. Facebook’s parent company reported a strong rise in advertising revenue, topping Wall Street targets. In Asia, MSCI’s broadest index of Asia-Pacific shares outside Japan rose 1% to the highest in five months. Japan’s Nikkei also advanced 0.7% to a three-week top. Hong Kong’s Hang Seng index rallied 1.4%, driven by a 4.9% surge in Chinese property stocks, as they extend a rebound from Monday when a top Politburo meeting fuelled hopes that more support to a battered sector is on the way.

Overnight, the U.S. Federal Reserve delivered a quarter-point rate hike as widely expected. Chair Jerome Powell in his press conference said the Fed no longer expects a recession. “Even though the Fed has left the door open for an additional rate hike before the end of the year, we believe that we’ve now reached peak cycle – the Fed tightening cycle is done,” said David Chao, a global market strategist at Invesco. “We expect an increasing global risk appetite as markets continue to positively re-price recession risks, and ultimately look forward to and discount an economic recovery that could begin to unfold late this year.”

No details were given on a potential stimulus, but state media reported China would implement its macro adjustments “in a precise and forceful manner”. “There is discussion among investors as to whether China could implement an old-school stimulus in the property sector and look to support developers, which is positive for steel consumption and producers,” said Karen Jorritsma, head of equities in Australia at RBC Capital Markets. “Or whether it will be a consumer led stimulus to boost consumption and that is not as positive for the big resources names. But overall in markets confidence has improved, people are starting to look through the noise and that is a positive,” she said.

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Futures only imply a slim chance – about 20% – that the central bank could surprise with a quarter-point increase in September. They also moved to price in sizeable rate cuts of 125 basis points by the end of next year. On Wall Street, stocks ended little changed after the Fed hike, with the tech-heavy Nasdaq closing lower, dragged down by mostly technology stocks. The European Central Bank is widely expected to raise interest rates by a quarter-point on Thursday, but markets sense the end is also in sight, with at most one more hike expected after this week. However, the slow retreat in inflation could pile pressure on policymakers to keep rates higher and for longer.

Another major risk event this week is the Bank of Japan meeting on Friday amid jitters of more tweaks to its ultra loose monetary policy. The majority view is policymakers would hold steady, according to a Reuters poll. The yen climbed to as high as 139.35 per dollar but last hovered near the 140 level. Overnight dollar/yen implied volatility jumped to 36.3%, the highest since March. The U.S. dollar continued to be pressured in Asia, off 0.3% against a basket of major currencies. Both the risk-sensitive Australian dollar and New Zealand dollar were up 0.8%.

Treasury yields were mostly steady on Thursday. The yield on 10-year Treasury notes held at 3.8610%, after a drop of 6 basis points overnight, while the rate-sensitive two-year was little changed at 4.8329%, having also eased 7 bps. Elsewhere, oil prices were higher. Brent crude futures were up 0.9% at $83.69 per barrel and U.S. West Texas Intermediate crude futures rose 1% to $79.59. Gold prices edged up 0.2% to $1,976.18 per ounce.

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Published by the Mercury Team on 27 July 2023

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