The USD is mixed to firmer versus its major currency peers as the sell-off in global bonds extends. US 10Y yields have advanced to 2.35% after messaging from Fed Chmn Powell was more hawkish yesterday (when he was expressing his own opinions) than last week (when he was speaking on behalf of the FOMC) and the import was clear. Powell expressed more concern about inflation risks and was more forthright on the potential for 50bps rate moves in the coming months. We had expected Fed messaging to prepare market expectations for a more aggressive move and we think this will be a consistent feature of Fed communications in the coming days and weeks. OIS pricing had reflected the risk of a bit more than 25bps late last week but May FOMC contracts are now reflecting 49bps of implied tightening at the next policy decision; another 50bps is priced by the July FOMC but there is a growing risk of back to back 50bps (i.e., May and June), we believe, which will serve to support the USD generally. The DXY is trading a little off earlier highs and continues to consolidate; we remain bullish on the overall outlook for the USD and look for the DXY to advance above 99.15/20 shortly. So far today, USD gains are concentrated mostly against the low-yielders—EUR, CHF and JPY (which has dropped to a 6-year low). High beta FX is relatively better supported, reflecting a firm bid for risk assets (despite rising rates). There’s more central bank-speak today—a lot of it; Panetta, Lagarde and Lane of the ECB, the BoE’s Cunliffe and the SNB’s Jordan, while Williams, Daly and Mester are up for the Fed while Bloomberg will interview Bullard at 8.30ET.
The GBP was pulled almost a cent lower from its break above 1.32 yesterday (on Powell’s hawkish comments) earlier today. A decline in oil prices and an improvement in risk sentiment in the past few hours has helped the GBP to re-test the 1.32 zone shortly before writing to hold a marginal gain on the day. Since mid-February, markets have sharply re-priced central bank expectations for the BoE and the Fed that have resulted in a quick widening of the USD’s yield advantage over the GBP. From practically no differential five weeks ago, 2-yr gilts yields are now ~80bps lower than that of 2-yr USTs, with the move occurring practically as quickly as the early-2020 pandemic shift in the opposite direction. While the Fed is preparing markets for a 50bps hike, last week’s dovish BoE hike suggested to markets to not only forget about a 50bps move but also prepare for the possibility of a pause in hikes at one of the upcoming meetings. Markets understood the message, but only partly and only briefly. After falling to ~117bps expected by year-end on Friday, OIS pricing is back to expecting a Bank Rate above 2% at the end of this year with ~140bps in hikes projected. This implied policy rate is about 65bps higher than where BoE communications suggest it will be at the December meeting, and we think it will be tough for the GBP to gain ground against the USD while a re-pricing of hike expectations weighs on it. Smaller than expected damage from the war in Ukraine may be GBP positive but even prior to the war the BoE seemed unlikely to meet lofty market expectations. If the stars align, the GBP could aim for a test of 1.34, but gains beyond this level look limited—while a re-test of 1.30 towards 1.28 seems the more likely development.
