US dollar soars on hawkish Federal Reserve
The Federal Reserve administered a serious corrective to general financial market ebullience last week.
The ‘dot plot’ suggested that most members expect hikes to come no later than the end of 2023, from
mid-2024 in the previous projections. Short-term rates in the US shot up higher and the dollar rallied, as
markets priced in a Fed that will not be as tolerant of inflation as they had expected. For now, markets are
reacting exactly as one would expect after a significant hawkish surprise. Real rates are rising, inflation
expectations dropping, risk assets are selling off and the US dollar is unambiguously king. Only the Brazilian
real among major currencies managed to outperform the greenback last week.
The focus this week will be squarely on a veritable storm of speeches and communications from Federal
Reserve officials, nearly a dozen of them spread throughout the week. Markets will try to elucidate the extent
and conditions of the Fed’s hawkish turn. On the macroeconomic front, the Eurozone and UK PMI indices of
business activity will be released, but we think expectations for a very strong number will be validated so the
market impact should be limited. Finally, the Bank of England June meeting is on Thursday.
The UK saw another spate of positive economic news. Unemployment fell sharply in May, while wage growth
sped up. Inflation continued the recent trend worldwide, surprising to the upside. None of this mattered much
as markets were upended by Federal Reserve hawkishness.
The Bank of England meeting this week takes on added interest on the back of this hawkishness. We think it’s
possible that the MPC will follow in the Fed’s footsteps, at least rhetorically, by signalling that it may be in a
position to wind down its asset purchase programme sooner than originally anticipated. We expect sterling to
be well supported as a result, especially against the euro.
A solid monthly gain in May industrial production out of the Eurozone was completely overshadowed by the
Fed meeting. The dollar rally was exacerbated in the case of the euro by the clearing out of the long positions
traders had accumulated going into the Fed meeting.
This week’s flash PMI indices of business activities should remain extremely high, as activity soars on the back
of the lifting of lockdowns, but their market impact should be limited as markets will be focused on comments
and speeches from Fed officials.
A softer turn in second-tier economic indicators out of the US was roundly ignored by markets after the
hawkish surprise delivered by the Fed last week. In addition to the ‘dot plot’ suggestion that the Fed is
bringing forward its calendar for hikes.
Chair Powell’s press conference suggested that the Fed has much less tolerance for above target inflation than
previous communications had led markets to assume. More generally, the Federal Reserve seems to share our
views that the main short- and medium-term constraints to US growth are in the supply side, not the demand
side. We wait for the plethora of Fed speeches this week to clarify this shift in outlook, but some revision to our
forecasts may be forthcoming in the next two weeks.
The Swiss franc sold-off sharply against the dollar last week, alongside every other G10 currency, with the
EUR/CHF pair returning above the 1.09 level. Most of the shift had to do with external news, particularly the
Fed’s hawkishness. That being said, the Swiss National Bank also met last week, shifting its inflation forecast
slightly higher from its March projections. Additionally, it now sees stronger growth in 2021 (3.5% compared to
2.5-3%). The bank also reiterated that it’s ready to intervene in the FX market and continued to call the franc
We don’t think that SNB communications will have a great deal of influence on the franc in the near future,
given that its ultra-dovish stance is unlikely to change anytime soon. We believe that the external situation will
prove much more important, particularly shifts in US yields and risk sentiment.
Last week’s sell off in everything but the US dollar hit the Australian dollar particularly hard, given its status as
one of the higher risk currencies in the G10. The AUD/USD cross tanked by around 3% for the week, crashing
back to the 0.75 level and almost in an instant erasing all of its year-to-date advances.
As was the case just about everywhere else, news outside of the Fed meeting was largely overlooked by
investors. Last week’s Australian labour report was actually a very encouraging one, with the country adding
115k net jobs in May, well above the 30k consensus and its largest month of job creation since October. The
jobless rate also dropped sharpy to 5.1%, returning it back to pre-pandemic levels. It will be interesting to see
whether this is reflected in a more upbeat assessment from the RBA in the coming weeks. So far, the RBA has
been one of the more dovish in the G10 and an insistence on keeping rates low for longer could significantly
cap upside for AUD over our forecast horizon.
The sell-off in the Canadian dollar last week returned the currency back towards levels that we think better
reflect its fundamental value. CAD has been the best performing currency in the G10 year-to-date, although we
think that the move in the currency had perhaps gone a little bit too far, particularly given the worsening
situation in the Canadian labour market. Regardless, CAD remains one of only two G10 currencies to still be
trading higher for the year versus the resurgent greenback, alongside sterling.
Inflation data out last week was very much in line with the picture globally, exceeding expectations and
growing significantly on a year previous. The headline measure rose again to 3.5% YoY, up another 0.5% in May
versus the 0.4% consensus. So far, the Bank of Canada has shrugged off the jump in prices, saying that it will
likely prove temporary. This patience may well be tested the longer the current trend continues, and we will be
paying increasingly close attention to upcoming inflation prints as a consequence.
Of all the currencies in the emerging market spectrum, the yuan held up better than almost all of its peers last
week, cementing our view that its behaviour is increasingly resembling that of a major currency. The move
higher in the USD/CNY cross was indeed contained to less than 1%, albeit the yuan is now back trading around
its weakest position since early-May.
Macroeconomic data out of China last week far from helped CNY, and largely came in less than economists’
had anticipated. Retail sales expanded handsomely on the year, although growth of 12.4% was much less than
consensus. Industrial production growth also came in at just 0.5% month-on-month, its lowest level since the
sharp downturn in activity in February 2020 at the start of the pandemic. These are slightly concerning signs
that the rebound in the Chinese economy may be slowing, which could present somewhat of a risk to our
highly bullish forecast for the yuan.