UPCOMING EVENTS:
Monday: US ISM Manufacturing PMI.
Tuesday: RBA Policy Announcement.
Wednesday: US ISM Services PMI.
Thursday: BoE Policy Announcement.
Friday: US Labour Market Report.
We finished the last week with big rallies in risk assets as the market interpreted the Fed Chair Powell’s words as a pivot in their hiking cycle. In fact, once Powell said “we are now at levels broadly in line with our estimates of neutral interest rates, and after front-loading our hiking cycle until now we will be much more data dependent going forward”, risk assets jumped and continued to rally. The current narrative is that with slowing economic growth, inflation will come down as well and the Fed will have to cut rates sooner than expected. In fact, the market prices in the top in Fed Funds at 3.50% by year-end and cuts coming in 2023. And we can certainly expect worse economic data going forward as we already got very bad reports from leading indicators up to now.
The only problem here is that in this cycle inflation has to come down from a much higher rate and the Fed made it clear that they are committed to bring it down to their 2% target. This commitment was also highlighted by Fed voter George that in light of slowing growth voted anyway unanimously for a 75 bps hike (she was the only dissenter the last meeting). So, this tightening in an already slowing economic growth environment should actually weigh on risk assets as the worst is yet to come. Moreover, the Fed dropped forward-guidance, and this should add to volatility as uncertainty increases and it’s generally bad for risk. Fed Governor Waller also once stated that he wants to see Core PCE Y/Y falling to 2.5-3.0% before considering slowing rate hikes or a pause. That looks like a long way to go. To sum up, the USD should still keep trending upwards.
The difference in this cycle is also highlighted by the chart below where you can see the tightening and easing response from central banks as the leading component “New Orders” in the PMI reports went from expansion to contraction. Generally, you can see them easing as PMIs indicate a slowing growth/recession and thus falling inflation, but this time they are still tightening quite aggressively into a recession as inflation was let to soar to historic highs and their only focus is to bring it down.
On Monday we get the latest US ISM Manufacturing PMI report which is expected to show a contraction to 52.2 compared to the prior 53. Tighter monetary conditions, falling demand and business investment are certainly big headwinds for the Manufacturing sector. The leading component New Orders fell already below 50, so the index is expected to follow soon.
On Tuesday the RBA is expected to hike by 50 bps bringing the rate to 1.85%. In a synchronised global growth slowdown the AUD generally loses against the USD, so we can expect this trend to continue. Technically, the AUD/USD price is pulling back to the top of the wedge pattern which is generally the target on the wedge breakout. Currently, the price action is contained in a rising channel and we may see a spike up on the RBA announcement and a subsequent fade. Alternatively, the price can break down even sooner on the US PMIs.
AUD/USD 4-hour timeframe chart
On Wednesday we will see the latest US ISM Services PMI expected to show a contraction to 53.9 from the prior 55.3 reading. Generally, the Manufacturing sector is the one leading the fall as it’s more cyclical than the Services counterpart. Surprisingly, the US S&P Global PMIs showed a faster contraction in the Services sector though. The general trend in growth indicators is downward anyway.
On Thursday analysts expect the BoE to hike by 25 bps bringing the rate to 1.50%, although the consensus between 25 bps and 50 bps is pretty split. The market expects a 50 bps hike and I would go with the market view. Latest inflation report surprised to the upside so there’s that to weigh in the choice. As for the AUD though, the major FX pairs are driven mostly by the USD strength or weakness, so there’s that to always consider. To sum up, cable should maintain the general downtrend going forward. Technically, the price is respecting the upward trendline on the 4-hour timeframe and a more conservative approach would be to wait for the price to breakdown before looking for trades.
GBP/USD 4-hour timeframe chart
On Friday we will finish the week with the US Labour Market Report. The job gains are expected to moderate and come at 255K with the unemployment rate to remain steady at 3.6%. Average hourly earnings are expected to increase by 0.3% M/M and 5.0% Y/Y. Economists has been citing the strong labour market as a reason of why the US is not in a recession.
This article was written by Giuseppe Dellamotta.
