Central bank meetings and US jobs data send dollar soaring
08/Jul/2013 • Currency Updates•
Communications from the world’s major central banks continue to drive financial markets. Last week it was the Bank of England and the ECB that decided to shake things up by delivering for the first time ever “forward guidance”, i.e., a more or less explicit reference to how long they expect interest rate to stay at their current near-zero levels. This forward guidance was decidedly dovish in both cases. The contrast with the relatively hawkish tone adopted recently by the Fed could not be more stark, and underpins our long-standing bullishness on the US dollar vs. all other major currencies. A strong payroll report out of the US on Friday only added fuel to the fire, and the dollar ended the week up over 1.5% against the Euro and over 2% against cable.
Over the course of next week we will be revising our main FX forecasts. The sudden and opposite shifts in central bank communications on either side of the Atlantic support our long-term dollar-bullish view. Most of our short-term targets for the dollar have already been reached, and therefore we will be revising upwards our medium-term dollar forecast.
The first MPC meeting with Mr. Carney as chairman did not disappoint. First, a statement was released in spite of there being no change in either rates or the size of the Gilt purchase target, a clear break with tradition. Second, the statement not only provided “forward guidance” to market, but it did so by telling markets explicitly that their recent move up in expected rates was “not warranted”. Clearly, Mr. Carney is not only dovish, but is also succeeding in bringing about a shift in views within the committee towards further monetary stimulus.
The news from the MPC completely overshadowed some very positive business sentiment data. The service sector PMI sentiment survey accelerated in June to 56.9 – clearly above trend, and the highest for nearly four years. However, traders focused on the MPC’s dovishness and sent Sterling down 0.5% against the Euro and by over 2% against the US dollar.
Although the ECB was not quite aggressive in its statement as the Bank of England, its decision to provide “forward guidance” for the first time was a far more significant institutional volte-face. By indicating that [the ECB] expects the key ECB interest rates to remain at present or lower levels for an extended period of time”, not only did Draghi throw out the window the old mantra of “we never pre-commit”, but he also indicated that lower (and negative) rates were more likely than consensus had expected.
As in the UK, the shift in ECB policy overshadowed macroeconomic news. These were mildly positive, though far less so than across the channel. The June composite PMI business sentiment indicator rose one point, but at 48.7 is still consistent with mild contraction in Eurozone GDP. We expect stabilization in European GDP this quarter, though that will not be enough to pull Europe out of its perma-cession. At any rate, the divergence in economic performance across the Atlantic is now matched by an equally stark divergence in central bank policies and outlook, and we expect the trend towards a lower Euro vs. the greenback to continue.
Any hopes investors in the US may have had for a quiet 4th of July holiday weekend were dashed, first by the BoE and the ECB, and then on Friday by a very solid payroll report. The latter provided yet more solid, though unspectacular, proof that the US economic expansion is proceeding apace, and therefore the Federal reserve will almost certainly start tapering off its third round of quantitative easing in September. Job gains are now averaging over 200,000 per month for the last six months, which is solidly above the growth of the labour force and therefore sufficient to bring about the steady reduction in unemployment that the Fed wants to see. Our forecast of 2.5-3% growth for the US economy looks on track, as does our long-standing bullishness on the greenback.