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The Central bank ABC – Easy as 123?

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Here’s three scenarios for each of the three central bank decisions

A – Fed

  1. The last hike. A clear message that they are on pause (with obvious caveats that they would be prepared to do more if the situation arose). Victory laps on inflation coming down. Worried about the economy, worried about too tight financial conditions. Low probability – Very bearish USD & yields.
  2. Hike and keeping another firmly on the table. Data dependency for the next hike. Maintaining the higher for longer message. Warnings about a ‘job still to do’ on inflation. Financial conditions tightening but not yet to problem levels. Economy still doing well but monitoring any weakness. Jobs still strong. High probability – USD & yield positive but may not be lasting as the market will still anticipate we’re at the end of the cycle.
  3. Hawking til the end. Hike now, definite hike later. May pause after that but with an eye for further hikes. Economy still strong. Inflation is still a big problem, worried about it returning. Low/medium probability – Very bullish USD & yields.

 

B – ECB

  1. Another last hike. The doves finally draw the line in the sand and it’s time for the hawks to concede some ground. Tighter financial conditions, falling inflation/PPI data, worsening economy (especially Germany). Recession fears. Low probability – Uber bearish EUR.
  2. A hike and September very much in play (data dependency again). Core inflation still sticky (went up last month) but other parts of the economy are notably slowing. Financial conditions are tightening further. Recession still not base case but risk to the outlook is growing. To maintain higher for longer until the job is done on inflation. Talk on increasing QT. High probability  – Moderately bullish EUR strength (again may be time limited). There’s a bit more dovish expectation to undo here than for the Fed.
  3. July and Sep are going to see rates rise. Door not closed for hikes after that. Not concerned with financial conditions. Data is troubling but will not stop them hiking unless it gets much worse. No recession likely. QT increase announced and spun almost like a rate hike replacement to keep tightening policy stance. Medium probability – Bullish EUR.

C – BOJ

  1. No action, no tweaks, no forecast changes, no language changes, no hints – Low probability – Very bearish JPY.
  2. No action but higher inflation forecasts (at least above target for FY2023, small chance above target FY2024). Language change to reflect change in inflation assumption to more hawkish. Hints for a tweak later down the line  High probability  – Bullish JPY
  3. Forecasts up, a YCC tweak, language hawkish but cautious – Low/medium probability –  This would bring a big bout of strength for JPY but also give the BOJ some breathing space. YCC isn’t interest rates so it’s not huge tightening if they move the band. We may see too much of a market overreaction on this outcome.

Obviously there are many different outcomes for these three bank meetings but I hope this give you a broad set of outcomes with which to base your trading plans on.

Faster Slower Higher Lower Longer Shorter

/in /by

The Forex Analytix February 2023 Central bank preview

The Fed

What’s expected?

  • 25bp hike.
  • Re-emphasise the high-for-long policy on rates.
  • Pushing the soft landing narrative.
  • A good start on inflation but more to do.

What are the surprises?

  • 50bp hike, or even unchanged.
  • Any indication rates may not get to the dot levels, i.e a pause is coming sooner than. expected.
  • Worries about wages and second wind upside effects for inflation.
  • Changes to QT (Bigger = Hawkish. Smaller = Less hawkish).

What assets should we watch?

  • US yields – 10yr, 2yr & 1yr.
  • USDJPY
  • S&P

Obviously USD all over but USDJPY can often be a cleaner trade, particularly as we have the ECB the next day. EURUSD might not move too far out of sync on the Fed while it has one eye on the ECB. Same for GBPUSD and the BOE. 

Let yields be thy guide for what USDJPY might do.  If yields move, do they hold? If not, don’t expect USD to stay the course either.

Monitor what stocks (S&P) does over the event. I’m still looking to see if the risk definition has changed. Do they go up if Powell pushes the soft landing narrative and keeps a hawkish slant? Do they keep to the old ways and rise if Powell is less hawkish on policy or less bullish on the economy?

 

The ECB

What’s expected?

  • 50bp hike.
  • Promise of more to come (2 more 50’s).
  • Reiterate they will continue until inflation is under control.
  • Also a good start on inflation but more to do.
  • Resilience in the economy.
  • QT to start in March.

What are the surprises?

  • Lagarde rolling back some on the 50bp promise.
  • Larger division among the ECB members for another two 50 bp hikes (maybe this comes from the usual sources pieces after).
  • Any changes to the upcoming QT program (earlier/later start, bigger than expected).

What assets should we watch?

EUR

I don’t feel that this event is going to bring any big surprises so reaction may be limited. However, there’s a risk here that EUR holds something back after the Fed just to get over the ECB hump, so be careful not to get sucked into a false sense of security until the presser is over. If, for example, USD is screaming higher but EURUSD looks like it’s holding back, it may play catch up when Lagarde is done talking. Then be on watch for the sources drops.

 

The BOE (with MPR)

What’s expected?

  • 50bp hike and confirmation of a drop to 25bp going forward, and a possible pause time.
  • Reaffirm the need to be vigilant on inflation being more persistent.
  • Change in forecasts

What are the surprises?

  • 25bp hike.
  • The votes – Last time 7 voted for hikes (6x50bp, 1x75bp), 2 voted for to keep rates unchanged. Likely we see the same hike/unch numbers but if more shift to the unchanged vote, that will be far less hawkish.
  • Statement/minutes show that rate hikes may not stop as quickly as expected.
  • Some pushback against the market’s year-end pricing of a rate cut.
  • MPR forecasts. Will the BOE be more bullish or bearish on the economy?

What assets should we watch?

EURGBP

Having the BOE and ECB so close together could present some interesting opportunities. For one, the ECB is the bigger bank so by size it favours EUR over GBP on big euro news. Secondly, if the BOE says or does something that kicks this out of sync with what the ECB are expected to do, that’s when it will get my keen interest. We’ve got some good range edges to play here. 

 

Generally, while there is room for some shocks, I don’t see anything that might be game changing. The Fed’s not going to say rates are going to 8%, the ECB are not going to announce rate cuts from next month. In market expectation terms, we’re pushing food around the plate. To that end, I’m going to be looking at trading the range edges over all these CB’s, if seen. But, don’t also forget the NFP on Friday, as that could turn everything from these CB meetings on its head (in USD terms). Get a hawkish Fed followed by a -300k NFP and that plate of food might be smashed on the floor.

Our ‘Wizard of Waves’, Grega has some excellent analysis on USD into the FOMC and Stelios has a great overview of central banks in the early part of this year.