Dollar Fed Up

US FEDERAL RESERVE POLICY UPDATE This week’s biggest moves in global financial markets revolved around the US Federal Reserve policy update. As expected, interest rates and the pace of asset purchases were left unchanged, but Fed Chairman Powell indicated that policymakers may soon start talking about scaling back its asset purchase programme. Powell once again argued that price pressures were likely to be temporary, although he did acknowledge some upside risks. Consistent with that view, the ‘dot plot’ still shows a very shallow path for interest rates, with the majority of policymakers expecting no increase in 2021 or 2022, although a substantial minority do see a rate rise in 2022. However, there has been a change to 2023, with the consensus now for two hikes of 0.25%, where previously there was a small majority in favour of no change. The outcome was a hawkish surprise. US 10-year Treasury yields gapped higher following the Fed policy announcement, rising back up towards 1.60%, a level last surpassed in the early part of this month, although they subsequently fell back. The US dollar firmed across the board, contributing to the fall in GBP/USD below 1.40 for the first time in over a month. Also potentially weighing on sterling were data showing daily UK Covid cases rising above 10,000, while the government confirmed that ‘removing all legal limits on social contact’ in England is to be delayed to 19 July to allow more time for vaccinations and to assess the data on the Delta variant. However, despite that, sterling is little changed on the week versus the euro. The fall in UK May retail sales was in line with our forecast, but surprised the markets adding to prevailing market sentiment. The stronger-than-expected increase in CPI inflation to 2.1% in May provided limited support for the pound, while the labour market data showed rising employment, reflecting the previous easing of restrictions. HALDANE’S FINAL DISSENT The Bank of England (BoE) policy update (Thu) and UK June flash PMIs (Wed) will be the main focus for UK markets next week. There will also be updates for GfK consumer confidence (Fri) and CBI industrial and retail surveys (Tue/Fri). We forecast a fifth consecutive albeit small rise in the services PMI, to 63.2 from 62.9 (chart 1), while manufacturing PMI is expected to edge lower to 65.0 (still very strong) from 65.6. Consumer confidence is predicted to reach a new post-pandemic high of -7 from -9. The BoE is set to leave policy settings unchanged, including total asset purchases at £895bn and Bank Rate at 0.1%. It will be the last MPC meeting for its most hawkish member, chief economist Andy Haldane, who is expected to dissent in favour of less bond purchases. Understandably, there has been a lot of focus on the latest inflation upside surprise (Chart 2), which suggest that the BoE’s near-term forecasts were too low. April GDP also pointed to a strong start to the quarter and potentially faster Q2 growth than predicted. Nevertheless, the UK inflation rise mainly reflected likely temporary factors, including energy, supply chain costs and services prices linked to the reopening of the economy. In our view, while the MPC will acknowledge potentially stronger near-term growth and inflation, the tone of the minutes may not be as ‘hawkish’ as some commentators anticipate, not least because of the delay to the 21 June lockdown easing and uncertainties surrounding the Delta variant.

EUROZONE SERVICES ACTIVITY PICKING UP

The June flash PMIs also loom large for the Eurozone. Here, we expect see more concrete improvements in services activity, which have lagged behind the US and the UK, supported by the acceleration in vaccine rollout and the lifting of some containment measures. We forecast Eurozone services PMI to increase to 59.0 from 55.2, which would represent expansion (above 50) for a third month. Manufacturing activity is expected to remain strong, although we see a slight fall to 62.8 from 63.1. The outturns would reaffirm a return to positive growth in Q2 and acceleration in Q3. The German IFO business survey (Thu) is also expected to show a further rise in the headline business climate index. There will also be focus on European Central Bank (ECB) President Lagarde’s appearance in the European Parliament (Mon). She is likely to repeat her comments from the ECB’s latest meeting, which upgraded the risks to the economic outlook to “broadly balanced”. Despite that, the ECB maintained asset purchases “at a significantly higher pace” than in the early part of this year. Policymakers have mentioned that the US recovery is more advanced and will continue to monitor tapering developments across the pond. Markets will also keep a wary eye on the performance of the far right in the first round of French regional elections this Sunday, as a potential gauge of next year’s Presidential election.

POWELL TESTIMONY IN FOCUS The US focus is likely to remain on the outlook for monetary policy, with investors continuing to digest the Fed’s latest update. There is a slew of Fed speakers next week, but the highlight may be Chair Powell’s testimony to Congress (Tue) on “Lessons Learned: The Federal Reserve’s Response To The Coronavirus Pandemic”, which will include addressing the outlook for the asset purchase programme. There are also a number of data releases, with perhaps the most interesting being personal consumption and PCE inflation for May (Fri). We expect core PCE inflation to rise to 3.5% from 3.1%, while consumption probably increased despite weaker retail sales, helped by spending on services. Other data releases include the flash PMIs (Wed), new home sales (Wed), the goods trade balance (Thu), durable goods orders (Thu) and the third estimate of Q1 GDP (Thu).

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