Sterling shines whilst Dollar struggles, as markets react to FOMC and Greece headlines
22/Jun/2015 • Currency Updates•
In a week where investors were focused primarily on Federal Reserve policy and prospects for an agreement that would end the Greek standoff, Sterling stole the spotlight and was the best performing major currency. It rose 2% against the Dollar and over 1% against the Euro, on the back of sharply accelerating wages and the resulting repricing by markets of the timetable for Bank of England hikes.
The Euro befitted from perceived dovishness in the FOMC statement on Wednesday, but failed to get much traction, hobbled by the uncertainty over the prospects for an agreement between the “institutions” and the Greek Government. It ended the week mostly unchanged in trade-weighted terms, though it managed a modest rally against the US Dollar. The latter lost ground against all G10 currencies save the New Zealand Dollar, which endured yet another difficult week, as weak growth numbers there vindicated the RBNZ’s cut on 10th June.
Our long-stated view that Bank of England hikes are coming in the first quarter of 2016 received strong support from macroeconomic news out of the UK last week.
Average weekly earnings grew 2.7% in annualised terms in the three months ending in April. By contrast, headline inflation (also published last week) was barely positive, and core inflation printed just under 1% over the year. As the Bank of England minutes reminded us again last week, wage growth is perhaps the most closely watched indicator for MPC members. Last week’s data (not available at the time the minutes were written) should go a long way to reassure the MPC, and incipient signs of bubbliness in the real estate market, will certainly help steady their hand.
As interest rate markets brought their expectations for BoE policy in line with our view, it was not surprising to see Sterling rally strongly against every other G10 currency.
The mostly-second tier data out last week in the Eurozone was completely overshadowed by the gripping headlines about the state of the negotiations between the “institutions” and the left-wing Greek Government. Last week, the sides failed to reach an agreement, though all indications are that the gap between the two is not large, at least in terms of pure budgetary targets for the Greek Government.
There are (again) positive noises coming from both sides. However, time is running out. Greek bank depositors’ confidence is waning fast, and last week saw around EUR5 billion leave the banking system. We think that failure to reach an agreement today would precipitate the establishment of capital controls in Greece, although we are still confident that an agreement will be reached and such measures will not be necessary.
All eyes were on the Federal Reserve June meeting last week.
Rates were left unchanged, as expected almost unanimously by markets and strategists. Messages from the statement and meeting materials did not change much from the March meeting. The FOMC lowered somewhat its expectation for growth and the labour market this year, while leaving its projections for the medium and long term largely unchanged.
Inflation expectations were virtually unchanged. The key “dots” chart showed a slight downward revision to expected year-end Fed Fund rate for 2016 and 2017. However, and critically, the expectation for the end of this year was unchanged at 0.625%, which implies two rate hikes this year. We now think that these will take place at the September and December meetings respectively.
However, at the press conference, Chairman Yellen sounded cautious about the improvement in the labour market and did not commit to a move in September. This perceived dovishness sent the Dollar lower by roughly 1% in trade weighted terms, as markets appear to be pricing in a good chance of just one hike this year. We think that modest acceleration in wage growth and core inflation (the three month core rate is now running at a 2.5% annualised rate) will give the Fed sufficient cover to deliver the two interest rate hikes we expect in 2015.