Higher and for longer!
Last week Fed Chair Powell turned more hawkish and delivered another bumper 0.75% interest rates hike for the fourth time in a row. To counter the growing market narrative that the FED was about to pivot, he declared the Fed had “some ways to go” and that the “ultimate level of interest rates will be higher than expected”.
Unemployment
However, the markets are not so convinced, and despite a strong dollar rally post-FOMC meeting, the dollar sold off on Friday as the US unemployment rate ticked up from 3.5 to 3.7% despite a positive non-farm payroll result.
The rise in unemployment is a sign that the FED rates are starting to slow the economy but will it tame inflation? It’s certainly a case of when, not if, the FED will pivot, but Powell has kept the markets guessing for now.
CPI Wednesday
This Wednesday, CPI data, one of the FED’s prefered inflation metrics, will guide the market’s narratives. A high reading will confirm that Powell is correct and that a more aggressive approach is necessary, boosting the dollar. But a lower-than-expected reading will suggest it’s time the FED begins to ease off, likely resulting in a dollar sell-off. The era of the dollar is king may be coming to an end.
BOE Bumper Interest Rate
The Bank of England also raised the interest rate by 0.75% on Thursday, the most significant single rate hike in 30 years and brought the bank rate to 3%.
Whilst the FED took a hawkish stance the night before, Governor Bailey stated that the peak interest rates would be “lower than priced into financial markets” and said the UK would fall into a two-year recession. Markets reacted as expected and sent GBP/USD tumbling nearly 2%.
A Divergence is Coming
GBP did recover ground on Friday after US employment rates ticked up, but the outlook doesn’t look good for the UK, with a divergence forming between a dovish BOE and hawkish FED and ECB. With the upcoming budget announcement next week, markets are perhaps paying more attention to the UK’s fiscal policy, which will look to plug a £40 Billion hole.
Winter in Europe
In Europe, ECB President Lagarde is becoming more hawkish, stating that more restrictive rates are needed to tame inflation and that a “mild recession” won’t be sufficient to curb skyrocketing prices.
With the FED coming closer to its terminal rate and the idea of a pivot approach, the ECB has plenty of room to play catch up. Next year we may see a strong EUR, but the war and depth of Europe’s recession will determine how far it can rally.