By Michael O’Neill
Poets among you will recognize Alfred Lord Tennyson’s words; “The wild hawk stood with the down on his beak. And stared with his foot on the prey.” The same words could be said about Bank of Canada Governor Stephen Poloz and the Federal Open Market Committee. (FOMC), this week.
Both central banks took a walk on the wild side, or more accurately the hawkish side. Governor Poloz got his talons out first. On May 1, He was speaking in Yellowknife, North West Territories about Canada’s “Economy and Household” debt. Mr Poloz said that Canadian household debt was just over $2 trillion dollars at the end of 2017 which translates into 170% of disposable income. (It was 100%, 20 years ago) It isn’t a problem yet but in a rising interest rate environment, it could become a huge issue. However, the BoC believes it is manageable, hinting that the debt issue would not be a barrier to raising rates.
Mr Poloz added that higher interest rates reflect a growing economy. He said the “neutral rate” (defined as the interest rate which wouldn’t stimulate or cool the economy) was estimated to be between 2.5% and 3.5%. The current rate is just 1.25%. He closed, saying “higher interest rates will be warranted over time.”
That was a hawkish comment. It wasn’t new but it was still hawkish. USDCAD was sold on the news but the decline was shallow. Prices were unable to break below the 1.2800 area and by the next morning, traders were looking ahead to the FOMC meeting on Wednesday afternoon.
The May 2 FOMC meeting was supposed to be benign. Traders were convinced that the Fed would leave interest rates unchanged. They did. Traders were also expecting the FOMC statement to be a non-event, almost a copy of the one released in March. It wasn’t.
The FOMC tweaked the wording just enough so that traders thought the scales were tipped to hawkish. Not aggressively so, but somewhat hawkish, not neutral.
In March, the Committee referred to inflation continuing “to run below 2 percent”. On Wednesday, the sentence was altered to say inflation had “moved close to 2%”. Nitpicking? Perhaps. Some say “tuh-MAH-toh” and some “tuh-MAY-toh.” Traders said “MINE” and bought US dollars.
Financial markets assign a 95% probability for a June rate increase, making the range for federal funds 1.75%-2.0%. The FOMC didn’t change those odds very much which suggests there may be more to the US dollar demand than just interest rates.
There is. Last week, The European Central Bank (ECB) held a monetary policy meeting and according to ECB President Mario Draghi “didn’t discuss monetary policy, per se.” They did not raise interest rates or give any guidance as to when they would be ending their quantitative easing program. EURUSD extended its earlier drop and has retraced almost all its 2018 gains.
The Bank of England also had a moment in the spotlight. The BoE was widely expected to raise interest rates at its May 10 meeting. Then, two weeks ago, Governor Mark Carney changed his mind. He cited soft data and pointed out that there were “other meetings. “A soft Q1 GDP report followed. Traders decided a May hike was not going to happen and sold Sterling. GBPUSD has given back all its 2018 gains.
Another reason for US dollar buying is that very stretched, speculative short dollar trades have been or are being closed and have flipped technical trading studies to bearish.
The “bullish US dollar” trade is showing signs of stress. The post-FOMC rally stalled in Asia and Europe. Some are questioning whether the magnitude of the sell-off from peak levels is overdone.
The European Commission released a reasonably optimistic outlook for the Eurozone. They noted that 2017 GDP growth was at the fastest pace in 10 years. They explained the slightly slower pace of growth in 2018 was due to temporary factors and expected above-trend growth to resume. They said core inflation is showing signs of a gradual but moderate recovery. They hedged their outlook by pointing out downside risks to their forecasts from geopolitical tensions and Trade tensions.
The ECB is still expected to begin monetary policy normalization by September. If so, they will be ready to begin raising interest rates sometime afterwards which would be happening at the same time the US tightening program is getting ready to pause.
Weather issues may have been behind the spate of weak UK data which took a rate increase off the table for the May 11 Bank of England policy meeting. If so, better than expected economic reports could make the June meeting interesting.
Renewed EURUSD and GBPUSD demand would support other G10 currencies, including the Canadian dollar. USDCAD has been locked in a 1.2800-1.2920 range for a few weeks. The Canadian dollar benefits from Poloz’s mildly hawkish Yellowknife speech, better than expected February GDP data and an improved tone to the Nafta negotiations were offset by broad US dollar strength. If US dollar sellers emerge, the hawks will be feeding on US dollar bulls.
