Fed Delivers its 2nd Hike in 2018; Signals a 4th by Year End
The dollar ended the day lower against all but one of the other G10 currencies. It underperformed the most against EUR, NOK and SEK, while it managed to gain somewhat against AUD.
Yesterday, the highlight was the FOMC policy decision. As was widely anticipated, the Committee raised the federal funds rate by 25bps, to the 1.75-2% range. Given that the hike was already priced in, the market quickly turned its attention to the accompanying statement, and the updated economic projections, especially the new “dot plot”.
According to the new plot, the Committee now projects to end the year with a total of four rate increases, instead of three as the previous one suggested, since one of the policymakers who previously supported a total of three hikes has now changed his mind and is calling for four. As for the other economic projections, officials revised up their GDP forecast for 2018, as well as their inflation estimates for this year and the next. They also revised down their unemployment projections for up until 2020.
In the statement accompanying the decision, the Committee reiterated that the stance of monetary policy remains accommodative, but removed the part saying that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run”.
As for the dollar, it strengthened at the time of the decision, perhaps on the upgraded dot plot. However, the rally did not last for long. The currency gave back all its decision-related gains within the next hour and traded even lower thereafter. Remember, yesterday we noted that if only one member shifts their vote from three to four hikes, we wouldn’t interpret this as a strong hawkish signal and that any dollar gains are likely to stay limited. We wanted to see more members joining the 4-hike camp before getting confident that any dollar strength will be sustained.
According to the Fed funds futures, the probability for getting a 4th hike has now risen to 53% compared to 41% yesterday, which, although above 50%, still keeps the case a far-from-certain scenario. Thus, we believe market participants will remain focused on economic developments and speeches supporting or not that extra hike. The question now may be whether the next plot, released in September, will reveal more Fed members joining the 4-hike camp. After all, the market already assigns an almost 82% chance for a September hike.
EUR/USD – Technical Outlook
We can see that EUR/USD has been stuck within a range for a few days now, between the 1.1720 and 1.1840 levels. Overall though, looking at the bigger picture, the pair continues to hold above its long-term upwards moving trendline, taken from the lows of the 3rd of January last year. The only concern here is that EUR/USD has been on a down-move from around the 19th of April and the recent bounce that we saw on the 30th of May, could be classed as a correction. For now, we will remain cautious and wait for a break through one of the key highlighted levels.
A break through the 1.1840 mark, could open the doors to some higher levels, such as 1.1890, or even 1.1940. If these key areas of resistance are not able to withhold the rate from rising, then the next stop for EUR/USD could be the psychological 1.2000 barrier, where the pair could stall for a while.
On the other hand, a strong pullback down to the 1.1720 area and eventually its break could be seen as a perfect opportunity for the bears to drive EUR/USD lower, towards the 1.1650 zone or even the 1.1615 mark. A break below the last could force the pair to test the aforementioned long-term upwards moving trendline.
The RSI detects upside momentum, as it is above 50 and is pointing higher. The MACD, already positive, has bottomed near its zero line and crossed above its trigger line. Both oscillators are indicating towards a slightly more positive outlook than negative.
Investors Await a QE-announcement from the ECB
Today, the central bank torch will be passed to the ECB. When they last met, ECB officials decided to keep policy unchanged, while they made no changes to the accompanying statement. Thus, the spotlight fell on President Draghi’s press conference. The president acknowledged the economic moderation since the turn of the year but noted that it may in part reflect a pull-back from the high pace of growth observed at the end of last year, while temporary factors may also be at work.
The latest PMI data suggested that economic slowdown continued in the euro area, but preliminary CPI data pointed to accelerating inflation, with the headline CPI rate rising to+1.9% yoy in May, in line with the ECB’s objective of “below, but close to 2%”. The core rate rose as well, to +1.1% yoy from 0.7%. What’s more, following a report that at this meeting, policymakers are likely to hold a discussion that could end up with an announcement on when they intend to end QE purchases, hawkish remarks from several ECB officials reinforced the idea that the gathering is likely to be a “live” one.
Thus, investors will be sitting on the edge of their seats in anticipation of any signals or hints on what happens to the QE program after September, as well as whether officials continue to view the economic slowdown as temporary.
The scenario that is likely to benefit EUR the most, but also the most unlikely in our opinion, is the one where the Bank maintains its optimistic view on the economy and announces that it would end its asset purchases in September. In such a case, the euro could skyrocket, as something like that could also mean that interest rates are likely to start rising much faster than investors are currently anticipating.
A more plausible case in our view, is one where the Bank announces a reduction in asset purchases beyond September but does not commit to a clear end-date. It could provide some hints that the program is likely to come to a halt in December, but officials may prefer to avoid pre-committing on that. We believe that they may want to see evidence of a rebound in economic momentum, confirming their view that the latest slowdown was temporary. In such a case, the euro could still gain, but not much. The common currency has been already drifting higher on expectations of an announcement today.
Now, in the absence of any announcement of what happens after September, or at least some hints, market participants could get disappointed and the euro could give back its latest ECB-related gains.
BoJ Decides on Policy as Well, but no Fireworks are Expected
During the Asian morning Friday, another major Bank decides on monetary policy: The Bank of Japan. However, no major changes are expected from this Bank. At their latest policy meeting, the BoJ removed from its quarterly Outlook Report the timeline for reaching its inflation target, which we interpreted as a signal inflation will take longer to hit target, thereby keeping policymakers sidelined for more.
The latest CPI data showed that inflation continued to slow in both headline and core terms, which, combined with the economic contraction in the first three months of 2018, supports our longstanding view that BoJ policymakers have a long way to go before they start thinking about a stimulus exit. Even the Bank’s own core CPI continued to slow in April, to +0.5% yoy.
At the press conference, Governor Kuroda may even get questions as to whether additional easing is required. Recently, the Governor acknowledged the softness in inflation, but he blamed that weakness on temporary factors. Thus, we expect him to stick to his guns and reiterate that the current policy stance is appropriate.
EUR/JPY – Technical Outlook
EUR/JPY continues to slowly drift higher, holding onto its short-term steep upside support line. On a bigger picture, the pair has placed itself back above the mid-term upwards moving trendline, drawn from the 18th of August last year. Everything points to a continuation towards higher levels, but one should remain cautious as the upside could be limited, due to the downwards moving trendline, taken from the peak of the 2nd of February.
As long as both the aforementioned upwards moving trendline and the upside resistance lines remain intact, we will stick to the idea of EUR/JPY continuing its uprise for the short run. The 130.30 level is currently acting as a strong resistance area, but a strong push through that level could open the path towards the next key area of resistance at 130.90, which currently coincides with the aforementioned downwards moving trendline.
On the downside, before we could start examining whether the short-term outlook has turned negative, we would need to see a break of, not only the short-term steep uprising support line, but also the previously mentioned upwards moving trendline. Only then we could fully turn our heads to the bears and aim for lower levels. A break below the 129.55 area could open the way to the 129.25 mark. If that level fails to withhold the rate from dropping further, then the pair could end up moving towards the 128.65 level, or event 128.20 zone.
As for the Rest of Today’s Events
During the European morning, we get inflation data from Sweden. Expectations are for both the CPI and CPIF rates to have risen to +1.9% yoy and +2.1% yoy from 1.7% and 1.9% respectively. At its latest meeting, the Riksbank pushed back the timing of when it expects to start hiking rates, noting that the repo rate will begin to be raised towards the end of the year. Back then, the CPI and CPIF rates were 1.9% and 2.0% respectively. So, a rebound back near those levels is unlikely to alter officials’ view. The next gathering of the world’s oldest central bank is scheduled for the 3rd of July.
From the UK, we get retail sales for May. Both headline and core sales are anticipated to have slowed notably, but still, the yoy rates are forecast to have edged up. Specifically, the headline yoy rate is anticipated to have risen to +2.4% yoy from +1.4%, while the core one is expected to have increased to +2.5% yoy from +1.5%. The case for rising yoy rates is supported by the BRC retail sales monitor for the month, the yearly rate of which rebounded strongly.
We get May retail sales data from the US also. Both headline and core sales are anticipated to have accelerated to +0.4% mom and +0.5% mom, from +0.2% and +0.3% respectively. The Conference Board consumer confidence index for the month rose, but the UoM sentiment index slid somewhat. So, given that these indices are not painting a clear picture with regards to consumer morale during the month, we find it hard to say to which direction the retail sales’ risks are tilted.
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