FX Daily: A well-paved Fed taper vs an ill-conceived BOE hike rate

The Fed is better than other central banks in managing expectations.
Philip Wee03 Nov 2021
    Photo credit: Unsplash Photo

    DXY is supported around 94 ahead of the FOMC meeting today. The Fed has paved the ground to start tapering asset purchases and end QE around mid-2022. At his post-FOMC press conference, Fed Chair Jerome Powell is likely to reiterate his comments on 22 October that the conditions have been met for the taper but not rate hikes. Nonetheless, USD bulls will be encouraged if Powell’s conviction on transitory inflation falls. Given the record-high US stock indices and better US data in October, expect the Fed to look past the miss in 3Q GDP growth. Consensus expects today’s ISM Services Index to rise to 62.0 in October from 61.9 in September, and Friday’s nonfarm payrolls to bounce to 450k from 194k. Whether the Fed will bring forward and step-up rate hikes, such guidance should be shaped by the many Fed speeches following this FOMC meeting ahead of the next Summary of Economic Projections in mid-December. Overall, the Fed probably reckons that policy normalization will be necessary to ensure that the pricing power by businesses does not erode the purchasing power of consumers and households ahead. 

    GBP fell a third session towards 1.36 despite the BOE rate hike expected on Thursday. Firstly, the market has discounted the 15bps increase in the bank rate to 0.25% tomorrow and a 25bps hike to 0.50% in December. In September-October, the 2-year gilt yield more-than-tripled from 0.20% to 0.70% and dragged GBP higher to 1.38 from 1.34. Over the past week, the 2-year yield eased to around 1.00% which led speculators to take profit on GBP after it failed to break above 1.38. Interestingly, the Financial Times and Guardian newspapers did not see the case for higher rates, citing stagnant wages and less fiscal support ahead for the UK economy. They would like the BOE to adopt a wait-on-see mode; FT suggested ending the asset purchase programme instead. Overall, the market does not view the BOE rate hike as a healthy decision. Hence, GBP could disappoint just as CAD and AUD did after their policy meetings. Look for GBP to test the year’s important support at 1.36 again.

    AUD plunged 1.3% to 0.7429 despite the RBA ending its yield curve control policy. Although the Reserve Bank of Australia discontinued the yield target for the April 2024 bond, it did not abandon buying bonds at a rate of AUD4bn per week. The decision took the pressure off the 3-year government bond yield which fell to 0.95%, below 1% for the first time in four sessions. The RBA abandoned its guidance to keep rates unchanged through 2024. First, it forecast higher underlying inflation of 2.25% in 2022 and 2.50% in 2023. This fulfills one of its assumptions for a rate hike, i.e. inflation holding sustainably within its 2-3% target. Second, the RBA projected the unemployment rate to fall to 4.25% by end-2022 and to 4.00% by end-2023 which fulfills the other criteria for the jobless rate to hit the high threes or low fours. However, the RBA also emphasized that the above forecasts needed to generate wage growth (last at 1.7% YoY in 2Q) of 3% for rate hikes in 2023. Not surprisingly, the 10-year bond yield extended its fall below 2% to 1.89% from 1.91% on Tuesday. For now, AUD is likely to take its cue from the yield curve. After yesterday’s sharp sell-off, the trading range could narrow to 0.738 and 0.744 today.


    Philip Wee

    Senior FX Strategist - G3 & Asia
    [email protected]

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