Dollar up on Middle East risks and Fed hawkishness
The dollar pushed higher on Wednesday as the Federal Reserve delivered a hawkish surprise at what was likely Chair Powell’s final policy meeting. The FOMC held the federal funds rate at 3.50–3.75% as widely anticipated, but an unexpected four dissents, the most since 1992, caught markets off guard.
USD
The dollar pushed higher on Wednesday as the Federal Reserve delivered a hawkish surprise at what was likely Chair Powell’s final policy meeting. The FOMC held the federal funds rate at 3.50–3.75% as widely anticipated, but an unexpected four dissents, the most since 1992, caught markets off guard. Three of those were hawkish, urging the Committee to remove its easing bias, while Governor Miran dissented in favour of a cut. We are inclined to read this as a deliberate assertion of institutional independence ahead of the transition to incoming Chair Kevin Warsh, who is seen as likely to take a more dovish approach. Safe-haven flows added further support overnight, with oil hitting wartime highs on reports that the US is weighing military options against Iran while Strait of Hormuz traffic remains disrupted. Today’s US data slate is heavy: advance Q1 GDP is expected at 2.3% annualised versus 0.5% prior, core PCE for March at 3.2% YoY versus 3.0%, and the Q1 Employment Cost Index at 0.8% versus 0.7%. Combined with the Fed’s newly reinforced hawkish posture and developments in the Middle East, we expect this mix to keep the greenback well bid into the end of the week.
EUR
The euro drifted lower on Wednesday, pressured by a resurgent dollar and cautious risk appetite ahead of this week’s central bank cluster, while preliminary Spanish and German CPI data for April arrived roughly in line with expectations, offering no directional push. Today brings the ECB’s April policy decision alongside a busy data calendar, topped by preliminary eurozone CPI for April, which is expected at 3.0% YoY, up sharply from 2.6%, while the advance Q1 GDP estimate is seen steady at 0.2% QoQ. That said, we expect the ECB to be the key event of the day. With the Governing Council set to hold the deposit rate at 2.00%, all eyes will be on President Lagarde and any push back against the more than three rate hikes priced by year-end. In our view, April PMIs have already slumped into outright contraction, and with core inflation still subdued, we see little justification for an immediate tightening response. A patient, “no rush” message, if delivered, should keep the euro’s upside capped.
GBP
Sterling traded choppily on Wednesday, ultimately ending the day modestly lower as risk sentiment remained fragile. The pound lost ground during the London session amid elevated energy prices and broad safe-haven demand tied to the ongoing Middle East conflict, while a stronger dollar pushed GBPUSD back below 1.35. Attention today is on the Bank of England’s midday rate decision and the accompanying Monetary Policy Report. We expect Bank Rate to be held at 3.75%. Markets continue to price more than 75bps of tightening by year-end, which we have consistently argued is excessive. With private-sector wage growth tracking just shy of 3.0% YoY and the unemployment rate at 4.9%, the fundamentals do not support a hiking cycle. We expect Governor Bailey to underscore that the current inflation spike is a temporary consequence of the energy supply shock, with our best estimate seeing headline CPI peaking at around 4.0% YoY in Q3. If the MPR’s medium-term projections show inflation falling below target, as we anticipate, sterling could face renewed headwinds as rate expectations adjust lower.
CAD
The Canadian dollar weakened on Wednesday despite firm oil prices, as central bank developments dominated. The Bank of Canada held its overnight rate at 2.25%, matching both our own expectations and economist consensus. Policymakers acknowledged the war-driven surge in energy costs but signalled they will “look through” the inflationary impact of the Middle East conflict, tempering this with a caution against letting “higher energy prices become persistent inflation”. Crucially, the BoC stopped short of endorsing the hiking path markets had priced going into the meeting. We view the Governing Council’s guidance as notably more cautious than market positioning implies: underlying measures of inflation continue to cool, with the core median at 2.3% YoY and the core trim at 2.2%, while CPI ex-food and energy sits at just 1.9%. Still, the loonie is benefitting from the BoC’s modestly more hawkish shift in tone for now, with USDCAD stabilising below 1.37 overnight. Today, attention turns to Canada’s February monthly GDP reading, where a modest uptick to 0.2% MoM is expected. With the Fed and BoC now behind us, we see the loonie’s near-term trajectory as chiefly a function of global risk sentiment and oil prices, and expect USDCAD to remain range-bound with a slight upside bias absent a breakthrough in Middle East peace talks.