© Reuters. Forex Weekly Review: The U.S. dollar rose to a two-decade high as the Fed hiked rates by 50bps and announced plans to shrink its balance sheet
The U.S. dollar index rose slightly in the week of May 6, breaking the 104 mark during the session, hitting a new high in nearly two decades; most non-U.S. currencies fell, and the pound fell the most. The pound fell nearly 2% against the dollar, and the Swiss franc fell sharply against the dollar 1.56%; the euro, the yen, the Canadian dollar, and the New Zealand dollar all fell against the US dollar, and the Australian dollar rose slightly against the US dollar.
On Tuesday, the RBA announced to raise interest rates by 25 basis points to 0.35%. In the early hours of Thursday, the Fed announced that it would raise the target range of policy interest rates by 50bp to 0.75% to 1%. to shrink its balance sheet by nearly $9 trillion. With the implementation of the Fed’s interest rate hike cycle, a series of spillover effects began to appear, and many central banks followed to raise interest rates. On Thursday, the Bank of England raised interest rates by 25 basis points to 1%.
The U.S. dollar hit a 20-year high as the Fed hiked rates by 50 basis points and announced it would shrink its balance sheet
This week, the Fed announced a 50 basis point rate hike, the first time since 2000, that it would raise interest rates by 50 basis points, as well as announcing that it would shrink its balance sheet in a “predictable manner” starting on June 1. The U.S. dollar index refreshed its highest level since December 2020 to 104.07 on Friday, and U.S. bond yields jumped after the release of the April jobs report on U.S. stocks. The 10-year and 30-year yields rose to the highest since 2018, and the 10-year Treasury yields rose as much as 10 basis points to 3.134% at one point.
The Fed released the latest interest rate statement, and members unanimously agreed to raise the policy rate target range by 50bp to 0.75% to 1%, reiterating that “continuous interest rate hikes are appropriate”. After “warming up” the reduction of the balance sheet, the Fed officially announced the plan to shrink the balance sheet. According to the plan, the Fed will start the reduction of the balance sheet in June, with an initial target of $47.5 billion per month (including $30 billion in U.S. debt and $17.5 billion in U.S. debt). MBS), is expected to reach the monthly shrinking cap of $95 billion (including $60 billion in Treasuries plus $35 billion in MBS) after one quarter.
Federal Reserve Chairman Jerome Powell said at a news conference that the labor market is extremely tight, inflation is too high, and the Fed is moving quickly to bring inflation back down. U.S. households and businesses are in healthy financial shape, the labor market is strong, and the economy is poised for a soft landing. But he also said achieving a soft landing would be very challenging.
Darin, president of Newsom Analysis, said the Federal Reserve remains the most aggressive central bank in the global economy, and there is fundamentally no reason for the dollar to peak now. The employment situation is stable and the economy is supported, so there is no reason for the Fed to stop raising interest rates.This will continue to support the dollar
But Streible, chief market strategist at Blue Line Futures, pointed out that we have reached the peak of Fed hawkishness. Other central banks will have to tighten policy even more. The dollar’s rally looks overdone as other central banks such as the Bank of Japan and the European Central Bank can no longer ignore inflation.
UOB forecasts, given that the May FOMC meeting made it clear that it will continue to raise interest rates to fight inflation, and Powell made it clear that a further 50 basis points of interest rate hikes will be considered in the next few meetings. We now expect a faster 50bps rate hike in June and July. It is still expected to raise rates by 25 basis points at each meeting for the rest of the year. This increase in interest rates means a cumulative increase of 250 basis points in 2022, bringing the interest rate to the range of 2.50-2.75% by the end of 2022 (previously, it was predicted to increase by 200 basis points to 2.00-2.25%). The forecast for two 25bps rate hikes in 2023 is maintained, with a final rate of 3.00-3.25% by mid-2023 (previously 2.50-2.75%).
EUR/USD edged lower, volatile at five-year lows
The euro was down 0.02% on the week at $1.0543, with the euro’s losses slowing this week, boosted by relatively hawkish comments from European Central Bank officials.
ECB Governing Council member and Bank of France President Villeroy de Gallo said the ECB should raise the deposit rate to positive this year. His comments suggest he supports at least three rate hikes in 2022.
Bundesbank President Nagel also said the window for the central bank to raise interest rates in response to record inflation is slowly closing, signalling his support for an early rate hike.
Trading in the eurodollar options market has surged since the Federal Reserve raised interest rates on Wednesday, as investors abandoned bets for a larger rate hike at a future Fed meeting.
Generali’s base case is for EUR/USD to rise above 1.10 by the end of 2022, citing a “significantly overvalued dollar”.
Stephanie Kennedy, economic research analyst at Julius Baer Research, said the euro could appreciate against the dollar over the next 12 months, given that the European Central Bank will already start raising interest rates. “While the dollar should remain strong for the next few months, the focus should turn to the ECB’s rate hikes by the end of the year,” Kennedy said, adding that, coupled with lower commodity prices, should keep the euro up over the next 12 months. Kennedy expects the ECB to raise interest rates for the first time in December, raising the deposit rate to 0.75% by the end of 2023 from the current -0.50%.
The Bank of England raised interest rates by 25 basis points as scheduled, and the pound hit a new low in nearly two years against the dollar
This week, the pound fell 1.91% to 1.2336 against the dollar. It hit 1.2275 in the intraday session on Friday, the lowest since June 30, 2020. Analysts said that the Bank of England has insufficient confidence in controlling inflation in the short term, and is worried about the future economic outlook. The increase, the subsequent cooling in inflation and the economic fallout will make the BoE cautious.
On Thursday, the Bank of England raised interest rates by another 25 basis points to 1%. The Bank of England also said it would consider starting to aggressively sell bonds purchased under the QE policy, a milestone since it started QE 10 years ago.
However, the Bank of England said the UK faces the risk of a double whammy of recession and inflation exceeding 10% this year. Bank of England Governor Bailey also expressed a pessimistic view on the prospects for economic recovery, saying that rising prices are starting to limit economic growth and may tip the economy into recession.
Standard Chartered expects the Bank of England to stop raising interest rates by 25 basis points each in June and August to 1.5%, compared with previous expectations for a rate hike only in August. We still think the market is pricing in too aggressive this year (four to five more 25bps rate hikes by the end of the year); therefore, while further monetary policy tightening in Q4 cannot be ruled out, we think the BoE will raise rates at Rate hikes are paused at 1.50% to assess new data. The rate is expected to peak at 2.00% next year, so two additional rate hikes are expected in 2023 (up from three previously), most likely in the second and third quarters, but the timing of these additional hikes Very uncertain at this stage.
Canadian dollar hits half-year low against U.S. dollar
USD/CAD rose 0.39% this week to 1.2904, after hitting 1.2913 during Monday’s session, the highest since Dec. 22 last year; however, economists at Scotiabank said gains in USD/CAD would be limited above the 1.29 level. We think the CAD has some fairly clear fundamental strengths, such as the Bank of Canada’s tighter monetary policy and resilient growth, but these continue to be overshadowed by external factors (equity volatility), which may give the USD better support for the time being . We do think gains in the US and Canada will remain capped above 1.29, the range top that has held for the past 10 months or so.
Aussie edged up on RBA rate hike by 25bps
This week, the Australian dollar rose 0.16% to 0.7070 against the US dollar. On Tuesday, the Reserve Bank of Australia even announced a 25 basis point interest rate hike, raising the benchmark interest rate from a record low of 0.1% to 0.35%, exceeding market expectations of 0.25%. It was the first rate hike by the Reserve Bank of Australia since 2010 and the first time in nearly 15 years that it has raised rates during an Australian election. And the RBA also hinted that it will raise interest rates further, pushing the Australian dollar and bond yields higher.
The RBA also sharply revised up its inflation forecast, signaling how high interest rates may have to rise to bring the cost of living crisis under control. In its quarterly statement on monetary policy, the RBA warned that core inflation could hit 4.6% by December, a full two percentage points higher than the forecast given in February. That would be well above the RBA’s 2-3 per cent target range, and inflation is not expected to return to the top of the range until mid-2024, suggesting a protracted tightening cycle is on the horizon. RBA President Lowe wrote that this will require further rate hikes in the period ahead. Markets are pricing in another rate hike to at least 0.60% in June, followed by monthly hikes to 2.75% by Christmas.