Euro careens towards parity as markets brace for a summer Fed hike
16/Mar/2015 • Currency Updates•
Last week, the relentless rise of the US Dollar against every other major currency continued with no sign of let up. FX markets continue to focus exclusively on the divergence in monetary policies, as the Federal Reserve is the only G10 central bank expected to hike any time soon. We regard this rise as unambiguously good news for the world economy. It provides a welcome boost to the Eurozone and Japan, whereas the inevitable drag on the US economy can be born relatively well as the US labour market and domestic demand strengthen.
That said, the massive rise in the US Dollar, up over 15% in trade-weighted terms over the past seven months, is almost without historical precedent. The consensus of analyst is switching towards a summer hike by the Federal Reserve. We expect this to happen in June. However, we will be paying very close attention to Fed communications at next week’s FOMC meeting. Any explicit reference to Dollar strength will certainly cause a repricing of these hike expectations. More generally, this as good a time as any to point out that markets never move in a straight line for long, and the Dollar has been doing that since the summer of 2014.
Last week we got the first significant negative surprises out of the UK in some time. Construction posted a worse-than-expected 2.6% mom drop in January. January manufacturing production also came in below expectations, showing a 0.5% mom contraction. We are still looking for a 3% reading in economic growth in the first quarter, but in order to maintain this forecast, we need to see some reversals in these numbers when the February releases are out.
Market focus shifts now to the Budget, to be published next week. In years past, the Budget has generally been a non-event, at least in terms of its market impact, and we expect this year’s edition to be no different. We think there is a good chance that economic outperformance and better-than-expected tax revenues will lead to a very moderate relaxation in departmental cuts, but on a scale unlikely to shift macroeconomic forecasts significantly. Sterling performance in the weeks ahead will continue to be driven by the relative timing of Federal Reserve and Bank of England hikes.
We had more mixed news out of the Eurozone last week. Strong industrial production prints in France and Germany contrasted with the disappointment of continued contraction in Italy. At the aggregate level, however, it is clear that the Eurozone economy is still gaining momentum and is likely to post a modest acceleration in the first quarter after the modest growth we saw in the previous two quarters.
As Greece and the ECB continue to recede from the headlines, markets are focused squarely on the divergence in monetary policies across the Atlantic. As we pointed out above, next week’s Federal Reserve statement is key for the short term evolution of the Euro, more so given the absence of significant economic or monetary news from the Eurozone.
Economic news out of the US continues to surprise on the soft side, with the critical exception of the job market. Last week’s disappointment was retail sales, which shrank for the third consecutive month. Of course, it remains to be seen how much of this negative showing is related to the unusually harsh winter in most of the United States. We are holding on until next month’s release, which should no longer be affected by bad weather, before drawing any medium term conclusions based on this weakness.
The Dollar roundly ignored this weakness and continued its record-setting rally, as analysts and markets bring forward their expectations for rate hikes to this summer. Next week’s FOMC statement takes on added importance. A lack of mention of Dollar strength plus the drop of the word “patient” would signal to markets that a summer hike is on the cards as early as June.