BBGFX Update: May 2023

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5/1/2023

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BBGFX Update: May 2023

Bannockburn Global Forex

April 30, 2023

Economic Calendar

May 1: Labor Day, Europe and China markets closed
May 2: Reserve Bank of Australia meeting, China markets closed
May 3: Federal Reserve meeting, Brazil’s central bank meeting, China and Japanese markets closed
May 4: European Central Bank meeting Norway’s central bank meeting, Australia monetary policy statement, China’s Caixin PMI, Japan markets closed
May 4: UK local elections
May 5: US and Canadian employment, Japan markets closed
May 8: UK Bank holiday
May 9: Mexico CPI, Australia Budget
May 10: US CPI, China CPI and PPI, Poland central bank
May 11: Bank of England meeting, Q1 UK GDP, OPEC monthly oil report
May 14: Turkey Election
May 15: China one-year medium-term lending facility rate
May 16: Eurozone Q1 GDP, UK employment report, Canada CPI
May 16-17: EU Summit
May 18: Mexico central bank meeting, Australia labor market
May 18: Northern Ireland local elections
May 19: Japan CPI,
May 19-21: G7 Summit
May 21: Greece parliament election
May 22: Canada holiday
May 23: Reserve Bank New Zealand meeting, flash PMI
May 24: UK CPI
May 25: Tokyo CPI
May 26: US Personal Consumption and Personal Income, Mexico Q1 GDP
May 29: US holiday, UK holiday
May 30: Australia CPI

May 2023

May will feature likely rate hikes by the Federal Reserve, the European Central Bank, and the Bank of England. The banking stress that erupted in March appears contained, though one regional bank's dramatic loss of deposits saw it rekindle at the end of April. What makes the May rate hikes important is that the derivatives markets are confident (again) this is the last hike for the Fed. The swaps market anticipates two more hikes from the BOE and the ECB. Headline CPI in the UK has been above 10% for seven consecutive months through March. The ECB, which was slower than the others to initiate the tightening cycle, is understood not to be quite finished either.

Before the bank stress emerged, the market had priced in a peak Fed funds rate of nearly 5.75%. Now, the May hike to 5.25% is expected to be the top. Similarly, the swaps market had the ECB's target rate rising to 4.0% by the end of September, and now it sees the peak between 3.50% and 3.75%. The market thought the Bank of England's base rate would top between 4.75% and 5.0% in Q4 22. After pulling back to 4% in late March, the swaps market finished April back near its pre-stress levels.

We suspect the market is under-appreciating the risk of a Fed hike after May. Indeed, the futures market has moved dramatically in the other direction, pricing in a cut in Q3 and for the year-end rate to be about 4.50%. That implies 75 bp in cuts over five FOMC meetings that remain after this month., which seems unreasonably aggressive. It would likely take more than a quarterly contraction to deter the Fed. It would imply some kind of shock. The economy was contracting when the Fed began the tightening cycle.

Click here for further currency analysis

Bannockburn's World Currency Index, a GDP-weighted index of the 12 largest economies, eased slightly (~0.1%) in April after rising 1% in March. It has been alternating between monthly gains and losses this year. It traded quietly in April between roughly 96.40 and 97.05. Year-to-date, it is up almost 0.5%.

Leaving aside the dollar itself, seven of the remaining 11 currencies were +/- more than 1%. Sterling was the strongest, with a little more than a 1.8% gain. It reached its best level since last June at the end of April ($1.2585). After hitting its record low near $1.03 in the turmoil last September, sterling recovered to nearly $1.2450 in the middle of December.
The euro was second, rising 1.6% last month. It approached $1.1100 in the last week of April, its highest level since last April. It first breached the $1.10-level in early February and has been chiefly in a four-cent range in the three months through April. After hitting its record low near $1.03 in the turmoil last September, sterling had recovered to nearly $1.2450 in the middle of December. The Brazilian real was the only other currency in the index that rose by more than 1%.

Outside of the Russian rouble, which fell by 3.1% as sanctions bit and the external balance deteriorated, the yen and the South Korean won were the weakest performers in the index, shedding about 2.5% and 2.7%, respectively. Around half of the yen's losses were recorded on the last trading day in April after the Bank of Japan left policy unchanged. There was no strong sense of urgency, though stronger than expected, Tokyo April CPI was disconcerting. The deterioration of South Korea's external balance and low policy rate (3.5%) weighed on the won. Four currencies in the index (the Canadian dollar, Chinese yuan, Indian rupee, and Mexico peso) were little changed (+/- 0.5%).

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