In our FX review this week, we reflect on the impact of two major central bank meetings, and why the USD could be due some weakness in the short term.
No fireworks from the Fed
The first major event from the week was the US Fed meeting on Wednesday. It was widely anticipated that the central bank would increase interest rates by 0.5%. Some were even looking for 0.75%, with bullish optimism almost at fever point. The Treasury yield curve has been soaring in recent weeks, one of the main catalysts behind the stronger USD. So the real question was if the Fed could match such enthusiasm as the market was expecting.
In short, the meeting failed to deliver any real fireworks, with the dollar selling off in the immediate aftermath. However, the picture hasn’t materially changed with the outlook for several more 50bps hikes coming this year, so by the end of the week the greenback has regained most of the losses.
Given the elevated levels of the USD right now, we struggle to see much further upside in coming weeks. Although individual pairs might have room to run on a technical perspective, fundamentally we can’t see why the dollar warrants even more strength with the current backdrop.
Bank of England disappoints
The second event we focused on was the Bank of England on Thursday. A 25bps hike was seen, but the comments with it were much more moderated. Modest further tightening might be due, but forecasts of a recession come the end of the year wasn’t taken well by GBP traders.
As a result, GBP took a hit on Thursday afternoon, finishing the day down 2% against USD. The pair is high risk to trade right now, although we do think it’s worth a small long position to start accumulating GBP, for a new range of 1.22-1.27 in our view.
We don’t think that the pair will get back to 1.3000 anytime soon, as the rate divergence from the Fed and BoE will likely be felt into H2. With UK inflation expected to slump lower next year, the need for further tightening this year should be limited. This could cap further GBP gains.
Trading options from here
Our bias that the dollar may have peaked in the short term post Fed makes us look at the best options to pair it up against. Given resilient commodity prices, we like being long AUD and CAD against USD. We also have added a long GBPUSD position from last Thursday.
USDJPY still is too wacko for us to want to get involved with, and EURUSD still appears to want to grind lower slowly. Therefore, we’re staying clear of both those pairs until the picture becomes clearer.