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The GBP/JPY cross struggles to capitalize on a two-day-old recovery from the vicinity of a one-month low retested earlier this week and meets with a fresh supply during the Asian session on Wednesday.
The GBP/JPY cross struggles to capitalize on a two-day-old recovery from the vicinity of a one-month low retested earlier this week and meets with a fresh supply during the Asian session on Wednesday. Spot prices drop back closer to the 186.00 mark in the last hour amid the emergence of fresh buying around the Japanese Yen (JPY), though the downside seems limited ahead of the release of the UK consumer inflation figures.
The headline UK Consumer Price Index (CPI) is expected to rise 0.3% in August following a 0.2% fall in the previous month and the yearly rate is seen holding steady at 2.2%. Meanwhile, the core CPI – excluding the volatile components of food, energy, alcohol and tobacco – is anticipated to climb to the 3.5% YoY rate from 3.3 in July. Against the backdrop of a slowdown in the UK wage growth and a flat GDP print for the second straight month in July, a softer CPI print will lift bets for more interest rate cuts by the Bank of England (BoE) and undermine the British Pound (GBP).
Conversely, the market reaction to a stronger report is more likely to be short-lived amid the hawkish Bank of Japan (BoJ)-led JPY strength. The recent comments by a slew of BoJ officials suggested that the Japanese central bank will hike interest rates again by the end of this year. This, along with the market nervousness ahead of this week's key central bank event risks, is seen benefiting the JPY's safe-haven status and exerting downward pressure on the GBP/JPY cross. This, in turn, favors bearish traders and supports prospects for a further intraday depreciating move.
Meanwhile, the market focus remains on the BoE decision on Thursday, which will be followed by the latest BoJ policy update on Friday. This will play a key role in influencing the GBP/JPY cross and help in determining the next leg of a directional move. Hence, it will be prudent to wait for a sustained break and acceptance below the 184.50 horizontal support before positioning for the resumption of the prior downtrend witnessed over the past two weeks or so.
Headline CPI inflation edged lower in August to 2.0% year-on-year (y/y), versus 2.5% y/y in July, and just below consensus expectations of 2.1% y/y.
Goods prices have fallen into deflation at -0.7% y/y, with gasoline prices down 5.1% y/y. Additionally, Statcan noted greater discounting on clothing and footwear during the back-to-school shopping period.
Services prices were up 4.3% y/y, only down one tenth from July, as Canadians continue to pay up for shelter costs. Rent prices are growing 8.9% y/y, while mortgage interest costs are growing 18.8% y/y.
The Bank of Canada’s preferred “core” inflation measures decelerated to 2.4% y/y in August, down from 2.5% y/y in July. On a three-month annualized basis, the average moved from 2.8% in July to 2.4% in August.
Bullseye! Headline inflation is back at the Bank of Canada’s 2.0% target. At the same time, core measures keep grinding lower. These figures would be even lower if it weren’t for the outsized impact of high housing costs. Inflation excluding shelter is growing at a paltry 0.5% y/y! This exemplifies how still high interest rates have weighed on the Canadian economy and slowed the pace of growth.
Inflation continues to validate the need for the Bank of Canada to continue cutting its policy rate. We calculate that the current policy rate is still nearly 200 basis points above where it should be based on the current state of the economy. And that is after 75 bps in cuts over the last few months. No wonder odds of larger 50 basis point cuts are growing in futures markets. Over the next few weeks, we will be getting a number of BoC members speaking on the economy. This will provide the central bank plenty of opportunity to move market pricing towards its intended path.
After more than two years of currency pain, Asia’s central banks are in for some relief as the Federal Reserve (Fed) is set to cut interest rates by a quarter-point Wednesday. The path for the region’s own monetary policy, though, will be bumpy from here.
Lower rates in the US frees up space for officials in Jakarta to Seoul and Mumbai to move lower too. The prospect for the Fed kicking off a regional cutting cycle has attracted investors, who’ve poured money into emerging Asian debt and equities, helping strengthen currencies in the region.
The question now for Asia’s central bankers is how much they need to cut in the coming months, or whether they even need to cut at all. Places such as India and the Philippines face inflationary risks, while South Korea may prioritise financial stability.
“It would be an error to think the region’s policymakers are chomping at the bit for their chance to commence monetary policy easing,” said Brian Tan, Barclays plc senior regional economist. “It’s not obvious that the economy is just crying out for policy easing and that policymakers need to shift as soon as possible.”
The wake-up call may arrive as soon as this week, with central banks in China, Taiwan and Japan all expected to hold rates, though there’s some chance of a cut in Indonesia. They’re followed by the Reserve Bank of Australia Sept 24, which is also expected to keep rates steady.
Then, in a 10-day spree mid-October, a swath of peers from India to the Philippines issue their own diverging decisions. Markets and economists are at odds on what that will look like.
Swap markets are pricing in a benchmark reduction of 50 basis points for the Reserve Bank of New Zealand on Oct 9, with some chance of easing also expected for the Reserve Bank of India on the same day.
While New Zealand is likely to cut through the rest of 2024 as the economy teeters on the edge of a third recession in two years, analysts see a different picture playing out for the rest of the region.
Inflationary pressures in India and the Philippines are likely to keep policymakers there more cautious, with analysts forecasting only one 25 basis point cut in the fourth quarter, surveys show. Bangko Sentral ng Pilipinas Governor Eli Remolona signaled a quarter-point cut in October or December.
Economists also see only one cut in the final three months of the year from the central bank in South Korea, where officials are keeping tabs on financial imbalances associated with home prices and household loans.
Economists expect the central bank to cut its key rate as soon as it sees signs that the property market is cooling, particularly in Seoul. In Taiwan, as well, real estate market trouble is likely to make officials wary of cutting rates.
The Bank of Thailand will perhaps be the longest holdout, with expectations that the conservative institution will resist government calls to cut until next year at the earliest.
“Now, central banks are able to focus more on the domestic idiosyncrasies when they are contemplating their monetary policy action,” said Khoon Gho, head of Asia research at Australia and New Zealand Banking Group. “For the last two years or so, when the Fed was hiking aggressively, central banks here were really responding to that pressure on their currencies.”
Two factors may change the picture: A US recession that would strengthen the greenback in a flight to safety or a November presidential election outcome that heralds protectionist policies, hurting trade-reliant countries in the region.
The former isn’t the base case for economists, and the latter isn’t likely to halt the flow of funds into Asia assets just yet.
If Fed Chair Jerome Powell and his colleagues reduce interest rates and signal more cuts are in the offing, that “will keep the party going and we’ll see more money coming to Asia”, said Taimur Baig, chief economist at DBS Group Holdings. “Investors have voted with their feet” for a shallow easing cycle in Asia, he said.
Bridgewater Associates founder Ray Dalio said the overall picture of the economy probably warrants a smaller interest-rate cut by the US Federal Reserve (Fed) this week.
“The Fed has to keep interest rates high enough to satisfy the creditors that they are going to get a real return without having them so high that the debtors have a problem,” Dalio said in an interview on Bloomberg Television in Singapore on Wednesday.
“Whether it’s 25 or 50 basis points, 25 basis points would be the right thing to do if you look at the whole picture,” Dalio said on the sidelines of the Milken Institute Asia Summit 2024. “If you look at the mortgage situation, which is worse and that affects more people, then it’s probably 50 basis points.”
The Fed is widely expected to lower interest rates later Wednesday after holding borrowing costs at a two-decade high for more than a year. Investors and forecasters are split over whether it will cut by a quarter percentage point or a bigger, half-point move.
But Dalio said that ultimately what the Fed does this week “doesn’t make a difference” over the longer term. Policymakers will need to keep real interest rates low to enable the servicing of mounting debts, he said.
Oil prices steadied on Wednesday, after rising in the previous two sessions, as investors await the US Federal Reserve's (Fed) anticipated interest rate cut, with the potential for more violence in the Middle East supporting the market.
Both contracts gained by about US$1 a barrel on Tuesday on lingering supply disruptions in the US, the world's biggest oil producer, after Hurricane Francine and as traders bet that demand may increase following what would be the Fed's first interest rate cuts in four years.
Prices were also supported by the potential for more violence in the Middle East that may cause possible output disruptions in the key producing region after Israel allegedly attacked militant group Hezbollah with explosive-laden pagers in Lebanon.
"Markets have calmed down as concerns over hurricane damage and escalating tensions in the Middle East have been factored in," said Mitsuru Muraishi, an analyst at Fujitomi Securities.
"Now, investors are focusing on the Fed's rate cuts which could revitalise US fuel demand and weaken the dollar," he said, predicting that oil prices are likely to maintain a bullish tone after Brent hit its lowest since 2021 last week.
Traders kept bets the Fed will start an expected series of interest rate cuts with a half-percentage-point move downward on Wednesday, an expectation that may itself put pressure on central bankers to deliver just that.
Hezbollah promised to retaliate against Israel after the pagers detonated across Lebanon on Tuesday, killing at least eight people and wounding nearly 3,000 others, including fighters and Iran's envoy to Beirut. Israel declined to comment on the detonations.
The market also found support from the expectation of US oil purchases for the Strategic Petroleum Reserve (SPR).
The Biden administration will seek up to six million barrels of oil for the SPR, a source familiar with issue said on Tuesday, a purchase that if completed will match its largest yet in the replenishment of the stash after a historic sale in 2022.
US oil inventory data released on Tuesday from the American Petroleum Institute (API) was mixed. Oil stockpiles rose by 1.96 million barrels in the week ended Sept 13, according to market sources citing the API figures, but gasoline and distillate stocks both rose by about 2.3 million barrels.
Analysts polled by Reuters estimated on average that crude inventories fell by about 500,000 barrels last week. The US Energy Information Administration's report is due on Wednesday at 10.30am EDT (1430 GMT).
The United Kingdom (UK) Office for National Statistics (ONS) will release August Consumer Price Index (CPI) figures on Wednesday. Inflation, as measured by the CPI, is one of the main factors on which the Bank of England (BoE) bases its monetary policy decision, meaning the data is considered a major mover of the Pound Sterling (GBP).
The BoE met in August and decided to trim the benchmark interest rate by 25 basis points (bps) to 5%, a decision supported by a slim majority of 5 out of the 9 voting members of the Monetary Policy Committee (MPC). The widely anticipated announcement had a negative impact on the GBP, which entered a selling spiral against the US Dollar, resulting in the GBP/USD pair bottoming at 1.2664 a couple of days after the event.
The UK CPI is expected to have risen at an annual pace of 2.2% in August, matching the July print. The core annual reading is foreseen at 3.5%, higher than the previous 3.3%. Finally, the monthly index is expected to grow by 0.3% after falling by 0.2% in July.
It is worth adding that the BoE will announce its monetary policy on Thursday and that inflation levels could affect policymakers' decision. Ahead of the announcement, financial markets anticipate officials will keep rates on hold before adopting a more aggressive stance from November on. The central bank anticipated that inflation could reach 2.75% in the upcoming months before gradually declining and even falling below the 2% goal in 2025.
Meanwhile, the BoE released a quarterly survey on public inflation expectations last week, which showed that inflation for the next 12 months is expected to fall to 2.7%, the lowest in three years. However, the 5-year perspective ticked higher, to 3.2% from 3.1% in May. The figures support the case for on-hold rates, and so will the expected CPI outcome.
Finally, it is worth noting that the UK entered a technical recession in the last quarter of 2023. Ever since the economy has recovered, but growth is sluggish, and the risk of another setback remains.
In such a scenario, a mild deviation from the expected figures could have a limited impact on Pound Sterling. Higher than-anticipated readings could cool down hopes for aggressive rate cuts, but the path is clear. The BoE will reduce interest rates and there is no room for hikes. Even further, market participants don’t expect the BoE to deliver a cut when it meets later this week, which would likely reduce the potential impact on the currency.
The UK Office for National Statistics will release August CPI data figures on Wednesday at 06:00 GMT. Before analysing potential scenarios, there’s still one more thing to consider: Despite headline inflation hovering around the central bank’s goal, services inflation has remained quite hot and above 5% for most of the year, more than doubling the headline one.
As said, a modest uptick in inflation could be seen as modest rate cuts coming, but it will not surprise investors enough to consider the opposite scenario. On the contrary, a lower-than-anticipated outcome with easing services inflation should fuel hopes for more aggressive rate cuts and put the Pound Sterling under strong selling pressure.
Valeria Bednarik, FXStreet's Chief Analyst, notes: “The GBP/USD pair is heading into the event trading above the 1.3200 mark, and not far from the multi-month high at 1.3265 posted in August. Most of the pair’s strength is the result of the broad US Dollar’s weakness, as the Federal Reserve (Fed) is expected to deliver its first rate cut on Wednesday. The Fed’s event is likely to overshadow UK CPI release, as market players would wait until after the US central bank announcement to take positions.”
Technically speaking, Bednarik adds: “GBP/USD is bullish according to technical readings in the daily chart. A break through the aforementioned August high could lead to a quick test of the 1.3300 mark, while once beyond the latter, the rally can continue towards 1.3360. A daily close above the 1.3300 threshold would support the case for a steady advance in the days to come. On the other hand, the pair would need to slip below the 1.3140 region to put the bullish case at risk. In that case, the next level to watch and the potential bearish target comes at 1.3000.”
Uncertainty over the size of an initial interest rate cut expected Wednesday from the Federal Reserve has sparked a related debate over the possibility of an accelerated halt to the central bank’s balance sheet drawdown.
Prospects for an opening cut of half a percentage point have been gaining ground over a smaller quarter-point reduction in rate futures markets, and if policymakers do go for the larger option and signal worry about the economic outlook, the runway for more quantitative tightening, or QT, could get much shorter.
QT is largely seen as a liquidity management tool and distinct from Fed interest rate policy focused on quelling inflation without inflicting too much pain on the labor market. But more aggressive interest rate cuts from the Fed might be seen at odds with tighter liquidity, depending on the reasons behind the rate cuts.
An imminent shuttering of QT would represent a major shift in the outlook for the central bank balance sheet. A survey of major banks from the New York Fed in July found firms predicting QT’s end in April of next year, as Fed officials have signaled they saw ample room to continue it.
“If they ease rates by 50 basis points, I think the decision about the balance sheet becomes more complex,” said Patricia Zobel, former manager of the New York Fed’s group that implements monetary policy and now head of macroeconomic research and market strategy at Guggenheim Investments.
“We do have some chance” of an earlier QT end if a larger cut is accompanied by concerns about the economy, Zobel said. For now, the former Fed official is anticipating a quarter-point cut and QT continuing on its current trajectory.
The Fed currently targets the fed funds rate in a 5.25% to 5.50% range.
Matthew Luzzetti, economist at Deutsche Bank, said a big rate cut joined with hints of more aggressive easing in the updated policymaker projections due on Wednesday as well would mean “there would be a conflict between reducing rates and continuing to run down the balance sheet, and they might not want that kind of mixed signal about their policy tools in that environment.”
Bank of America analysts, meanwhile, agreed a half-point cut aimed at propping up the economy would bring a halt to QT relatively soon.
The heightened rate-cut uncertainty comes down to gauging whether the Fed will be lowering borrowing costs simply to normalize them given abating inflation, and some reckon a big reduction or two could still fit along that path. But the more salient risk to the QT outlook is if interest rate policy adjusts because of rising worries about the job market hitting stall speed.
The clouded outlook for the balance sheet comes after the QT process just crossed the two-year mark. The Fed more than doubled the size of its holdings by the summer of 2022 via purchases of Treasury bonds and mortgage-backed securities, topping out at holdings of $9 trillion. The buying was aimed at smoothing unsettled markets and providing a lift for the economy beyond near-zero percent interest rates as the COVID-19 pandemic raged.
The QT process kicked off as the Fed shifted to rate increases to quell inflation and officials decided excessive accommodation was no longer appropriate. The drawdown has clipped about $1.8 trillion from Fed holdings so far, and in May the Fed slowed what had been a targeted monthly drawdown of $95 billion to its current limit of $60 billion.
The Fed seeks to have enough liquidity in the financial system to allow for normal short-term rate volatility and firm control over the fed funds rate. So far, discussion around ending QT has largely centered around finding that sweet spot for liquidity.
QT "is not going to be adjusted until the Fed thinks that they've made the transition from abundant reserves to ample reserves," said William Dudley, who led the New York Fed until his retirement in 2018. "They don't know exactly where, when that's going to occur, but they are pretty confident they haven't gotten there yet," he said.
So far, QT has run squarely in the background. It has faded as a market mover because investors have already "built in" QT into longer-term borrowing costs, New York Fed President John Williams said.
Meanwhile, former St. Louis Fed leader James Bullard, now dean of Purdue University's business school, noted that at least for now, QT and interest rate policy are aligned and can remain so even with rate cuts.
"Even if you lower the policy rate somewhat, it will still be above everyone's estimate of neutral, so you'd still be running a restrictive monetary policy with respect to the policy rate, and that complements the quantitative tightening part of the policy," Bullard said.
When the funds rate gets to around neutral, Bullard said that would be time to consider ending QT to better align the two policy tools. Analysts at research firm LH Meyer said any move to a fed funds rate of 3% or lower would be by itself a trigger for ending QT.
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