Euro finally snaps back as Federal Reserve plan to gradually raise rates
23/Mar/2015 • Currency Updates•
The Euro’s losing streak against major world currencies finally came to an end last week as the common currency staged the sharpest rally against the Dollar in many months. The Euro started the week on a solid note buoyed by positive second-tier data releases from the Eurozone, but the fireworks really started after the Fed suggested to the market that, while a June hike remains a clear possibility, the hikes will be more gradual than the markets had been expecting.
Risk assets everywhere reacted very positively, and we saw a flight from the Dollar that was no doubt exacerbated by the extraordinary Dollar-bullish consensus and positioning that had accumulated over the past weeks. The common currency rallied a massive 3% while Sterling reverted to its customary role, trading somewhere between the Dollar and the Euro, appreciating by 1.5% against the Dollar and dropping by a similar amount against the Euro.
While the release of the Budget was a non-event in terms of its market impact, there was material information in the minutes of the March MPC meeting published last week. Sterling recent strong appreciation, both against the Euro and in trade-weighted terms, received far more attention than it had at past meetings. Further, Committee members fretted that its impact both on actual inflation and inflationary expectations may make it harder than expected to bring UK inflation back towards its target in the medium term. This distinctly dovish turn, plus the unanimity in the vote for no change, leads us to revise our expectation for the timing of the first Bank of England interest rate hike and push it back into the first quarter of 2016.
Last week was light in terms of key macroeconomic data releases from the Eurozone. What little there was, mostly car registrations and construction output, was consistent with modestly accelerating growth and the possibility of a 2% YoY seasonally adjusted annual rate print in first-quarter GDP growth. Finally, the take up for the third TLTRO was a higher than expected 98 billion Euros. This is yet another data point that suggests a continuation of the upside surprises from the Eurozone economy, and therefore supportive of a short-term stabilisation of the Euro.
The March meeting of the Federal Reserve Open Markets Committee (FOMC) ended with decidedly mixed messages for the markets. On the hawkish side, the word “patient”, referring to the Fed’s approach to tightening policy, was dropped and the door was definitely opened to a potential June interest rate hike, which had been our expectation all along. However, there were other, more cautious signals. The critical “dots” graph, where every FOMC member publishes his or her expectation of where rates will be at the end of each of the next three years, was materially revised down, suggesting a more moderate pace of hikes than markets had been expected. Expectations for growth were also revised modestly down.
As always, the evolution of the US labour market will be key for Fed policy. We do not expect any slackening in the pace of job creation or modest real wage growth – hence our call for a June hike. However, it is now clear that the Fed will be cautious in its first hikes, and hiking every other meeting by 0.25% seems like a reasonable compromise. At any rate, markets focused on this perceived dovishness and sent risk assets, and just about every major world currency, sharply higher against the US Dollar.