As we head into this week’s FOMC, the chief economic adviser at Allianz SE, Mohamed El-Erian, has suggested that the meeting will most likely set the scene for a June rate hike. Not everyone agrees though, with quite a few economic strategists suggesting that the data since the last FOMC meeting has shown evidence of weaker domestic growth and softer inflation. So why hike so quickly? On balance, I tend to side with the former view, not the latter. This is because I suspect that normalisation is still a key priority for Fed Chair Yellen and being able to achieve this with the lowest possible terminal rate level means that you hike more proactively. The bottom line is that disappointing though the data has been it hasn’t been terrible. Global risk sentiment has recovered strongly since the beginning of the year; Chinese data has stabilised and in some cases shown signs of improvement; and throughout it all the US labour market continues to grow at a solid pace. It wouldn’t take much for inflation pick up, and central banks hate having to chase inflation. The only problem is that there’s one thing central banks hate more than being behind the curve, having to admit they were wrong and reverse their policy trend. That’s the risk on the other side that some FOMC members fear… the doves will say that to hike too soon could result in having to make cuts if the global economy turns out to be much weaker than feared. Everyone remembers the ECB’s embarrassing retreat at the onset of the global financial crisis, and no one wants that.
So what does this all mean for currencies, and specifically the dollar? From the recent price action it’s clear that the market doesn’t think the Fed will hike this week, in fact it looks like long dollar positioning is being unwound in front of the announcement. There are other factors involved though, in the case of cable (GBP/USD) the market got very short sterling and looks to be in retreat now, and as I mentioned recently, USD/JPY has bounced in the face of the dual threats of a dovish FOMC and the BoJ meeting to follow. Looking at GBP/USD I’m not sure we go much higher than where we are. Perhaps we get up to 1.48, but the case for a weaker pound sterling remains with Brexit risk looming. From a technical standpoint we could be doing an ‘A-B-C’ higher, equality in the move takes GBP/USD up to 1.4680. It is clear from the weekly chart below that GBP/USD remains in a bear trend and we are currently experiencing a counter-trend move. We would need to see GBP/USD climb much higher than this to call that into question…
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