ECB done and dusted, what will the Fed have in store next week?

Yesterday’s ECB rate decision, where the bank unveiled its new interest rate guidance that takes into account its new symmetric 2.0% inflation target, seems to have been taken as a net dovish impulse; European bond yields were broadly under pressure in its aftermath, with the steepest drop on the week seen in Italian 10-year yields (this is typically taken as a sign of the ECB doing its job “well”), which are down about 6bps. Meanwhile, major European equity bourses are making decent gains on Friday, with the Stoxx 600 up about 0.9% on the session to just under 460 and now less than 0.5% below recently set record levels at 461.50. Judging by the market reaction, the message markets seem to have taken from the ECB’s new interest rate guidance (which essentially says 1) they want to see inflation back above 2.0% before hiking and 2) they want to forecast inflation robustly above 2.0% for rest of the duration of their forecast horizon) is that monetary accommodation in the Eurozone will be more supportive for longer. Risk appetite elsewhere is also being supported in wake of yesterday’s ECB event; despite posting its largest one day drop since May back on Monday, E-mini S&P 500 futures currently point to the index finishing the week higher and only a smidgin lower than the all-time highs set at the beginning of last week. Futures this morning currently trade in the 4380s, up 0.4% ahead of the open, with Dow and Nasdaq 100 futures also pointing to gains of a similar magnitude. Major Asia Pacific equity bourses were a little more mixed overnight, with focus in that part of the world more on the pandemic as it continues to rage across much of the region.

Recent price action in US government bond markets has in a way mirror price action in equities; 10-year yields dipped as low as 1.12% on Tuesday as equities suffered but have since rallied back to probe the 1.30% mark. Dovish impulses in wake of yesterday’s ECB preventing US 10-year yields from breaking back above 1.30% yesterday, but it seems they are going to have another crack today, with yields currently at 1.29%. But, looking at the price action of the last two months in US 10-year yields from a technical perspective, this week’s recovery from lows has not been anywhere near enough to lift the bond yield out of the current downtrend. Technicians may suspect that rallies in the yield remain subject to being sold. But the technicals may not be the most important factor in the immediate future; next week we have another rate decision from the FOMC. That means US bond markets will likely be very subdued ahead of that. In terms of the meeting itself, most analysts agree it remains far too early for the Fed to signal the start of its QE tapering, as “substantial progress” towards its goals is unlikely to have been deemed to have been met just yet. Meanwhile, there will be no new dot plot or economic forecasts at this meeting. These were the two key sources of the hawkish impulse after the June FOMC meets. Recall that the June FOMC saw more hawkish dots, more bullish economic forecasts and Powell signalled the Fed is “talking about” when to taper its QE programme. Without any more info on any of these topics, the market may struggle to find further hawkish information from this meeting. Indeed, with Chairman Powell likely to triple down on his dovish insistence that the current spike being observed in inflation is “transitory”, the tone of the meeting may have more of a dovish bias. This could be a catalyst to push US bond yields lower again, in fitting with the recent trend.

Turning now to FX markets; the US dollar is looking perky this morning, with the DXY again probing the 93.00 level and looking on course to end the week with modest gains of about 0.2%. The buck has unsurprisingly taken its cue from global dynamics this week, given the lack of important economic events or news stateside. The DXY rallied as high as 93.20 early on in the week on safe haven demand, before falling back under 93.00 as risk appetite (stocks and commodity prices) recovered. The reaction to yesterday’s ECB event was choppy, but the DXY now seems to be gaining ground in fitting with the dovish impulse seen in other asset classes (and described above) which is weighing on EURUSD, the DXY’s most important constituent (remember the DXY is an index constructed from a basket of major USD pairs). EURUSD has been looking heavy since it lost its grip on 1.1800 yesterday after the ECB and currently trades in the 1.1760s, just above recent multi-month lows in the 1.1750s. If next week’s Fed event does further highlight the increasing divergence in Fed and ECB policy (i.e. the idea that the Fed moving towards tightening, even if slowly, while the ECB is not close to even thinking about tightening just yet), then this could push EURUSD to fresh multi-month lows. Stronger than expected preliminary Markit PMI survey data out of the Eurozone this morning is a good sign that the economic recovery their continues, but likely won’t be enough to push EURUSD back to safety above the 1.1800 level again.

GBP is amongst the underperformers in G10 FX this morning alongside safe-haven currencies CHF and JPY. The latter two are being weighing by the market’s broadly risk on tone and the former is being weighed on by weaker than expected UK data out this morning, including softer than expected Markit PMIs for the month of July and Core Retail Sales for the month of June. Economists have put the weaker than expected UK PMIs this month down to rising Covid-19 cases in the country which are 1) creating fear, which reduces economic activity and 2) contributing to the worsening “ping-demic” (where the UK NHS app gives people an alert telling them they were exposed to Covid-19 and must self-isolate), which is causing disruption to the workforce (half a million are currently said to be in self-isolation at the moment as a result of the app). With regards to the softer Core Retail Sales; most economists are unconcerned by this, given there is always an expectation of consumer switching spending from physical retail goods to the experiences and services (not captured in retail sales) that have only been allowed to reopen more recently. But looking at GBPUSD on the week; given the pair fell under 1.3600 at one point, the fact that it looks set to end the week above 1.3700 and down less than 0.2% is too bad.

Elsewhere in the G10, NZD is a modest outperformer this morning, up about 0.2% on the session versus the back as NZDUSD creeps back towards the 0.7000 level. Meanwhile, CAD and AUD are all closer to flat. The Loonie is set for its first weekly gain versus the buck in three weeks, with USDCAD set to end the week under the 1.2600 level having briefly spiked as high as 1.2800 earlier in the week on risk aversion and the crash in crude oil prices. Conversely, the Aussie looks set to end a fourth consecutive week in the red, with local Australia lockdown worries continuing to weigh on the currency. Analysts at Commonwealth Bank of Australia suspect “the balance of risks points to more weakness in AUD in the near term”.

Finishing with a quick look at commodities; crude oil prices are mostly flat, but somewhat incredibly look set to end the week in the green. WTI tanked as low as the $65.00 level earlier in the week on Covid-19 and OPEC+ output hike concerns but has recovered back to just below $72.00 by Friday. Looking at the weekly candle stick; some technicians might see this as a “bullish hammer”, which is of course a bullish for the price action next week, as it indicates that in the week just gone, bearish momentum appeared to fade. Indeed, a range of banks and analysts this week reiterated their call for crude oil prices to continue to advance in the medium-term given expectations that oil markets will remain undersupplied for the rest of the year, despite OPEC+’s recent agreement to start increasing daily output by 400K barrels incrementally each month from August. Gold prices, meanwhile, continue to trade in a subdued fashion and close to the $1800 level as they keep an eye on what is happening in US bond markets and with the US dollar. Next week’s FOMC will of course be crucial for gold, and if the tone of the meeting does have an overarching dovish feel, then this could support gold, perhaps to raise back to test recent highs around $1830.

The Day Ahead

Canadian retail sales data for the month of May is out at 1330BST and is worth watching for the Loonie traders. The main economic event of the afternoon, however, will arguably be the release of the preliminary US Markit PMI survey for the month of July, which will give early insight into how the US economy is performing so far this month. Traders will hope for a strong survey in wake of yesterday’s underwhelming weekly jobless claims report. Finally, oil traders will be watching the weekly US Baker Hughes rig count, out at 1800BST, though this is unlikely to move oil prices.