Jesus Cabra Guisasola, Global Capital Markets Senior Associate
Since the beginning of 2022, we have witnessed some of the most aggressive and synchronized monetary policy tightening in decades on the back of the conflict in Ukraine, which has pushed inflation to historical levels. However, the three major central banks are now signalling the start of a new phase with clear divergences among them, partly reflecting growing disparities in economies that are still struggling in the aftermath of the pandemic and exacerbated by geopolitical conflicts and political uncertainties.
Starting with the Bank of England, the old lady delivered in line with market expectations and decided to hike 75bps. However, the decision was interpreted as more dovish than expected, with the vote split with two members supporting smaller hikes and the Monetary Policy Committee pushing back on market expectations around the path of further hikes.
Moreover, the BoE used its growth forecasts in an effort to cool demand by downgrading its expectations and increasing unemployment projections, with Governor Bailey signalling that the British economy will fall into the longest recession on record.
Some market commentators saw this “pivot” coming, as it was suggested that the central bank, having some foresight of the upcoming budget, was adjusting policy to accommodate the incoming fiscal restraint.
In Europe, the Governing Council decided to double the main rate to 1.5%, the highest level in over a decade. Although a 75bps hike in interest rates would have been taken as an aggressive measure by most investors a year ago, the decision came as more dovish than expected, with Lagarde highlighting the higher probability of recession and the lagged impact of rapid monetary policy tightening in her press conference.
On the other side of the pond, the Fed’s decision last week was the most anticipated among all major banks. Reports from the Wall Street Journal weeks before the meeting underlined plans for the Fed to signal smaller increases in rates from December’s meeting.
Upon the release of the statement, market participants took the WSJ reports as accurate, given it contained some dovish language from the Committee where members were considering the cumulative tightening, and its lag effect on the real economy.
This pivotal moment was short-lived, as Powell swiftly corrected any interpretation that suggested the Fed is pausing its monetary policy tightening, saying that it was “very premature” to think about pausing. Moreover, the Chair contextualized the new statement language by highlighting that during the hiking cycle, three important components need to be considered: the pace, the peak of terminal rate and the length of a restrictive monetary policy.
The recent divergence in the rhetoric of the central banks has helped push the US Dollar higher, adding to already incredible performance of the greenback over the last year. Should the policies continue to diverge, we could see the US Dollar push on further.
That said, the US Dollar has been trying to trade lower for the last few weeks, with yesterday’s CPI numbers showing that market participants are desperate for good news to bet against the greenback. Moreover, recent economic data from the US around labour and housing markets are showing clear signs of deterioration. This, coupled with the results from the mid-term election, which could mean a more restrictive fiscal policy if Republicans retake control of the House, could be enough of an argument for the Fed to ease its tightening cycle and for the US Dollar to reverse.
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