Markets continue to price out rate cuts; USD to benefit most?
The markets now price for far fewer interest rate cuts from all the major economies, versus where we were only six or seven weeks ago. The overshoot on US consumer price inflation figures, the running commentary from UK, US and Euroland central bank officials and signs of strength in some of the recent surveys all argue against significant interest rate cuts from a domestic standpoint. However, the global economy looks weak, and recent downgrades to the short-term outlook for growth in 2024 suggest momentum is being lost.
If the markets continue to price out the possibility of interest rate cuts from the central banks, then what currency is likely to benefit? In the short term we could see a rebound in the pound and euro, particularly the euro, since there was confidence only a few weeks ago that the problems in the economy would override any latent concerns over inflation. However, in the longer term, if the US economy continues to outperform the UK and Euroland, then momentum could shift in the USDs favour. Certainly, within the past week or two the pound and the euro have given back more of the gains made previously, and the trend now looks to be tests of the lows, rather than efforts to break higher, in my view.
With a quiet week for data, the focus is likely to be on what central bankers say for themselves. There will be no signs of any concern from what central bankers from the Federal Reserve, Bank of England and European Central Bank will likely say, but equally no evidence of the need to tighten monetary policy any further either.
It’s worthwhile noting that last week saw the European Commission revise down its forecasts for growth in 2024, and this week the French government followed suit with its domestic forecast. This ongoing backdrop of economic weakness, repeated in other economies, hardly lends itself to increased risk appetite. Any supply side led inflation appears to be facing off against increasing weak economic demand. At some point that situation will become unsustainable and then we could see increased volatility and uncertainty in FX markets as a result. I still feel the USD is best placed to benefit from this.
Central banks on hold this week, but the pressure is building
This week sees the central banks of Indonesia, Turkey and South Korea meet. None of the central banks are expected to move interest rates in either direction, but the pressures are building, in my opinion. For example, in Indonesia and South Korea the next likely moves should be a cut, with the economies suffering from the effects of both regional and global economic weakness. There is no urgency for reductions in interest from either economy, but with the decline in population in South Korea, and in the working age population, could prompt a downshift in GDP (Gross Domestic Product), particularly in terms of consumption expenditure.
For Turkey, the pressures from inflation persist. We haven’t seen another big sell off in the lira yet, but the risks are that the authorities are continuing to lag behind inflation and that interest rates are still too low in real terms. A misstep from the central bank of Turkey could lead to fresh TRY weakness, and the import of even greater inflation pressures, in my view.
