Last week, the news around US bank losses undermining core capital ratios continue to reverberate around the financial markets, and spread to Europe, forcing the hand of central banks further, in terms of providing additional liquidity and capital support on top of what the Federal Reserve announced. What the news didn’t do is prompt any clear direction in the FX markets, with market participants perhaps confused about what they ought to buy in this period of uncertainty, albeit the Japanese yen made some headway against the other major currencies, as markets speculated about a possible reduction in borrowing costs, should the uncertainty in financial markets persist. 

The ECB (European Central Bank) meeting on Thursday decided to hike interest rates by 50 basis-points, taking the refinancing rate to 3.5%. The ECB saw this move as the lesser of two sub-optimal paths: either hike rates and be seen as possibly ignoring the risks of market uncertainty, or don’t hike rates and be seen as ignoring the risks of substantially higher-than-targeted consumer price inflation. The ECB President, Christine Lagarde, was out over the course of weekend attempting to reassure markets that the ECB stood ready to react to any change in conditions should it be required. The major central banks also provided USD swap lines in response to market concerns. 

This week sees the Federal Reserve and BoE (Bank of England) meetings in focus. The Federal Reserve is expected to raise interest rates by 25 basis-points, albeit that decision is in jeopardy because of the volatility in markets. With inflation still well above the targeted level, the Federal Reserve faces the same choice the ECB did last week. I think they’ll make the same determination as the ECB, choosing to hike interest rates, but also will signal that there will be no additional hikes from here. The dot plots (Fed officials views of where interest rates are heading) should reflect this new reality, even if it means returning inflation back to target, somewhat later than previously anticipated. 

As for the Bank of England decision, a hike of 25 basis-points is seen as broadly a 50/50 call by the markets, but what is likely to be clear is that the BoE is expected to suggest that, subject to new information, it is prepared to pause on the rate-hiking cycle. Perhaps there could even be 1 or 2 dissenting votes from the likes of Tenreyro and Dhingra that argue for immediately lowering interest rates. The rate decision will be complicated by the February public finances, consumer prices, and retail sales data releases as well as the GfK (Growth from Knowledge) consumer confidence and CIPS (Chartered Institute of Purchasing and Supply) manufacturing and services PMI (Purchasing Managers’ Index) surveys for March. All of this could put a lid on recent GBP appreciation against the likes of the USD and EUR, in my opinion. 

There are significant questions for central bankers beyond the major economies. The Swiss National Bank and Norges Bank are due to decide on monetary policy in the aftermath of the Federal Reserve decision. Could what the Fed does determine what these central banks decide to do? It shouldn’t, in my opinion, but it is looking increasingly likely that central banks will be more concerned by the market uncertainty than they will the short-term economic fundamentals. That could mean that the Swiss National Bank won’t hike interest rates by as much, if at all, when it decides on Thursday. The Norges Bank is expected to hike interest rates again, by 25 basis-points, but much like the Fed and BoE, I suspect they will hint that the hiking cycle is paused until new and conclusive evidence is produced to decide where interest rates go next. 

For the FX markets, the concerns over monetary policy and market volatility and where these are heading, could cause a negative reaction in emerging market currencies, as investors look to protect capital rather than seek a return on it, in my opinion.