With five major central banks giving monetary policy decisions in the first half of June, this is a period that could shape the outlook of forex markets for the weeks to come. There is a key theme that is emerging, with hawkish surprises coming from both the Reserve Bank of Australia and the Bank of Canada. These moves are leaving traders to question what might be in store for next week’s decisions, with the Federal Reserve and the European Central Bank in focus.
- Surprise hikes from the RBA and the BoC
- How does this leave the Fed and the ECB?
- Falling forex volatility may turn around next week
- EUR crosses remain under pressure
Stubborn inflation is driving central bank hawkish surprises
There have been two central bank rate hikes this week. Neither was expected (although deemed possible). The driving factor behind the hawkish moves has been inflation.
In hiking by 25 basis points to 4.10%, here’s what the Reserve Bank of Australia (RBA) said on Tuesday:
“Inflation in Australia has passed its peak, but at 7 per cent is still too high and it will be some time yet before it is back in the target range.”
Upside risks to inflation have increased, with wage growth picking up. The RBA is alert to the risks posed by expectations of ongoing high inflation. Subsequently “some further tightening of monetary policy may be required”.
All this after the RBA had paused its rate tightening just a couple of meetings ago. I will certainly be watching wage data and also inflation expectations in the weeks ahead.
The vibe from the Bank of Canada (BoC) was fairly similar too. The BoC has been on pause since January but shocked markets in hiking rates by 25bps to 4.75%. It would seem that economic activity is holding up well as “excess demand looks to be more persistent than anticipated”. However, once more it is the pick-up in inflation that is the primary concern.
“Inflation could get stuck materially above the 2% target”
Having come off a pause of five months, it is difficult to see the BoC only hiking once. Although there was no explicit forward guidance, markets will likely position for at least one more hike to come. A 25bps hike in July is now priced in interest rate futures. But will also push potential rate cuts further out too.
Inflation is also key for the Fed, ECB likely to hike too
This theme of sticky inflation seems to be prevalent across major economies. It will certainly be on the minds of traders for the meetings to come.
If the RBA and the BoC have surprised with hawkish moves, does this also mean the Federal Reserve will hike next week? Taking the dovish rhetoric (talking about a “skip” in June) in the run-up to the FOMC blackout and the rather tepid ISM data recently, I am not anticipating a hike. Even in the wake of the BoC hike, markets are suggesting this too, with just a 30% probability of a hike.
However, US CPI will be an important indicator on Tuesday. If there is further evidence of stubborn inflation then this could lead the Fed to give us a hawkish hold. If so, that would continue the market’s pricing for a July hike (currently almost 70% probability on CME Group FedWatch) but also firm the likelihood that rate cuts are pushed further into next year.
If you were to look purely at the data, you would probably say that of the two, the European Central Bank (ECB) would be the most likely to hold. But this does not seem to be the case.
Thursday’s ECB decision will be intriguing. Inflation is reducing in the Eurozone, whilst growth continues to disappoint. However, the ECB has previously signalled for a hike and ECB President Lagarde was steadfast in her assessment on Monday:
“Underlying inflationary pressures remain high and, although some are showing signs of moderation, there is no clear evidence that underlying inflation has peaked.”
A 25 basis point hike is expected next Thursday.
How forex markets are positioning
Amid all these central banks, we are seeing CAD and AUD pushing strongly higher. Surprise rate hikes and the likelihood of more to come are helping the outperformers amongst major forex. Charting the performance versus the USD over the past month, the CAD is now the best-performing currency. The AUD is also not far behind.
However, given the disappointing Eurozone activity data and falling inflation, the EUR continues to languish. The ECB is ready to hike, and perhaps could again. However, there is a feeling that markets are beginning to look upon further hikes as a policy mistake. That, along with the decisions of the central banks this week is a key reason why we are seeing downside moves in key EUR crosses.
EUR crosses look weak
The downside moves on two crosses in particular have caught my eye. Looking at the technical analysis, EUR/AUD has broken below a key support band at 1.6130/1.6190. This has completed a reversal pattern that now arguably implies around -650 pips of further downside under 1.5500. With the Relative Strength Index momentum increasingly negative in configuration, I see near-term rallies as a chance to sell. The old 1.6130/1.6190 support band is now an overhead supply and is an area of resistance.
The other pair I am looking closely at is EUR/CAD. There is a continued slide towards a crucial six-month support at 1.4233. A big nine-month uptrend has already been broken and with momentum on the RSI now decisively corrective, intraday rallies are consistently being sold into. If the support at 1.4233 is broken it would open for a much deeper correction. With resistance now between 1.4490/1.4510 I would see any bull failure under here as a chance to sell.
