Photo: Flickr

By Michael O’Neill

“The world’s major central bankers are enrolled in an interest rate aerobics class: ‘pause, hike, and repeat.’

The question of the past month was: Would the Fed ‘skip’ or ‘pause’ when it came to its benchmark rate? The query could also have been: Would they stop briefly, take a break, or even think twice? It was a matter of semantics.

As expected, the Fed delivered a hawkish pause (skip). By itself, the statement was terse, vague, and the epitome of ‘wishy-washy.’ However, the Summary of Economic Projections (SEP) left no doubt about the Committee’s hawkish bias. Policymakers are projecting at least two more rate hikes in 2023.

The Committee clearly sees a need for higher rates, as Powell stated in his press conference: ‘Looking ahead, nearly all Committee participants view it as likely that some further rate increases will be appropriate this year to bring inflation down to 2 percent over time.’ He also emphasized the tight labor market and the persistent inflation pressures that still need to be addressed.

They expect inflation to fall to 3.2% (compared to March’s guess of 3.3%), and further decline to 2.5% in 2024. The GDP forecast for 2023 has risen to 1.0% from 0.4% in March, while the unemployment rate is projected to fall to 4.1% from 4.5%.

So, why pause?


One reason may be to maintain a modicum of credibility. The Fed claims to be data-dependent and is aware of the lag between monetary policy decisions and their impact on economic activity and inflation. Since the May headline inflation data was weaker than expected, and Powell strongly hinted at a pause for the June meeting, the timing was perfect.

The Fed once again leads the pack of hawkish central banks. Now, the focus shifts to the July 26 FOMC meeting, which the Fed Chair described as a ‘live meeting’ (What is the opposite of a live meeting?)

On June 15, the European Central Bank raised its benchmark overnight rate to 3.50%. This move was not surprising, as ECB President Christine Lagarde had already signaled the action. The justification for the hike was that policymakers determined inflation would remain too high for too long.

Next week, the Bank of England will meet. They are expected to raise rates by 25 bps to 4.75% on June 22 and continue hiking until rates hit 5.5% due to their own inflation problem. April CPI surprised on the upside, rising to 8.7% y/y, exceeding the expected 8.2%.

China is the odd one out. They don’t have an inflation problem; instead, they face a Xi Jinping problem. The wannabe emperor’s Covid-Zero policy was a heavy-handed, ego-driven failure that crushed the economy and resulted in about 1.5 million deaths from the virus. The country is now struggling to jumpstart its economy through planned fiscal stimulus packages and interest rate cuts.

The People’s Bank of China (PBOC) has already lowered rates twice this week and is widely expected to cut its key 1 and 5-year Loan Prime Rate (LPR) next week.

But what about the Loonie?

It is fair to say that Canada was a hot topic in Washington, DC, New York, and even Philadelphia, but not for the reasons you might think. The plumes of smoke from wildfires in Quebec and New Brunswick drew attention, while the Bank of Canada and the Canadian dollar remained off the radar.

The market narrative has not changed. Traders and analysts will continue to assess incoming economic data to determine where the Fed’s terminal rate is, the timing as to when it is reached, and how long rates will remain at that level.

The second-half story is the same as the first.

However, the inflation story has improved greatly, which suggests there is only limited need for future interest rate increases. Inflation dropped to 4.4% in April from 5.9% in January, while US CPI fell to 4.0% in May compared to 6.4% in January. If the Fed is close to its terminal rate, so is the BoC.

Equity markets are not reacting as if US interest rates have a lot more room to rise, despite what the dot-plot projections indicate. The S&P 500 is up over 14% YTD because traders do not believe the dot-plot forecast and only expect one more rate hike in 2023.

If risk sentiment remains positive, USDCAD will likely test the long-term uptrend line in the 1.2990 area before the end of the summer.

The Loonie may be a big beneficiary of the central bank aerobics.