Central Bank Watch Overview:
- None of the three major central banks are expected to cut interest rates in 2021, despite jawboning otherwise.
- While the ECB threatens an exchange rate study and openly opines on market-based rate expectations, the BOE has distanced itself from negative rates. Nevertheless, the Fed is likely to lead all central banks in terms of easing, exposing the US Dollar.
- Retail trader positioning suggests a mostly bearish outlook for the US Dollar.
Central Banks Sitting on Their Hands
In this edition of Central Bank Watch, we’ll cover the trio of central banks that typically garner most of the attention in financial markets: the Bank of England, European Central Bank, and Federal Reserve. We’re still in a period immediately post-crisis, yielding low interest rates and ample liquidity. But as vaccination rates accelerate and the prospect for economic normalization to begin sooner than otherwise expected just a few weeks ago, this trio of major central banks have taken divergent paths that are proving consequential for FX markets.
For more information on central banks, please visit the DailyFX Central Bank Release Calendar.
Federal Reserve Confirms What We’ve Known
The Federal Reserve has firmly pushed back against nascent taper tantrum fears, with Fed Chair Jerome Powell making clear that the FOMC was in no hurry to shift course. As long as Fed Chair Powell is at the helm, the FOMC will stay the course, with the intent of keeping interest rates low through 2023.
Federal Reserve Interest Rate Expectations (FEBRUARY 11, 2021) (Table 1)
Fed Chair Powell’s speech on Wednesday, February 10 reminded markets of this reality, with the Fed Chair effectively saying that the FOMC will look through near-term inflation rises in favor of delivering a robust labor market recovery. In other words, “lower for longer” when it comes to the main rate. Fed funds futures are pricing in a 96% chance of no change in Fed rates in 2021.
IG Client Sentiment Index: USD/JPY Rate Forecast (FEBRUARY 11, 2021) (Chart 1)
USD/JPY: Retail trader data shows 64.17% of traders are net-long with the ratio of traders long to short at 1.79 to 1. The number of traders net-long is 7.77% higher than yesterday and 24.23% higher from last week, while the number of traders net-short is 0.80% higher than yesterday and 28.59% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/JPY prices may continue to fall.
Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/JPY-bearish contrarian trading bias.
ECB Trying to Contain Euro, Failing
In September 2020, the ECB upgraded its forecasted 2021 EUR/USD exchange rate up from 1.08 to 1.18, and EUR/USD rates were already near 1.2300 prior to the end of 2020. Historically, the ECB has only raised concern over the Euro exchange rate if the currency is +/-5% beyond its year-end target. As noted at the end of 2020, “there is a reasonable basis of expectation that the ECB may begin to saber rattle about more dovish policy adjustments in early-2021 if the Euro continues to climb.”
Certainly, the ECB has stepped up their saber rattling in recent weeks, threatening to conduct an exchange rate study to understand why the Euro was stronger than the US Dollar, as well as floating a report through financial media that Governing Council members believed that market-based measures of interest rate cut expectations were “underpriced.”
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (FEBRUARY 11, 2021) (TABLE 2)
According to Eurozone overnight index swaps, however, rate cut odds have been shrinking. At the end of 2020, there was a 66% chance of a 25-bps rate cut by the end of 2021; now, that measure clocks in at 37%. Now that the Euro is rallying anew (particularly at the US Dollar’s behest), the ECB may attempt more jawboning in the near-term. Otherwise, more immediate action can’t be ruled out at the March meeting, when the next iteration of the Staff Economic Projections will be released.
IG Client Sentiment Index: EUR/USD Rate Forecast (FEBRUARY 11, 2021) (Chart 2)
EUR/USD: Retail trader data shows 40.06% of traders are net-long with the ratio of traders short to long at 1.50 to 1. The number of traders net-long is 1.81% higher than yesterday and 18.15% lower from last week, while the number of traders net-short is 0.36% lower than yesterday and 24.67% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.
Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.
Bank of England Shies Away from Negative Rates
‘Super Thursday’ has come and gone, leaving markets with a fresh batch of BOE forecasts for growth, inflation, and employment (among other items). The recent vaccination developments have been a positive influence on UK growth expectations, and BOE policymakers more or less signaled that they would not move forth with negative interest rates, even while telling banks to take measure to prepare for such an occurrence.
BANK OF ENGLAND INTEREST RATE EXPECTATIONS (FEBRUARY 11, 2021) (Table 3)
It’s worth noting that markets have taken the negative interest rates comment in stride, a sign that the BOE doing its ‘due diligence’ and nothing more. At the end of 2020, there was a 32% chance of a 25-bps rate cut by the BOE. Now, that measure stands at 11%. As long as the post-Brexit UK economy remains on pace to overcome COVID-19 faster than most if not all other major developed economies, the BOE is unlikely to act again on the rates channel.
IG Client Sentiment Index: GBP/USD Rate Forecast (FEBRUARY 11, 2021) (Chart 3)
GBP/USD: Retail trader data shows 32.72% of traders are net-long with the ratio of traders short to long at 2.06 to 1. The number of traders net-long is 2.53% lower than yesterday and 12.36% lower from last week, while the number of traders net-short is 1.16% higher than yesterday and 36.84% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests GBP/USD prices may continue to rise.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger GBP/USD-bullish contrarian trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
