Up and Down - A Big Week for Policy Rates and Currencies

There is a plethora of central bank policy rate meetings this week across the developed and emerging market economies. Rates could be raised as much as 500bp in Turkey, cut 50bp in Brazil, raised 25bp in four G10 economies, and left unchanged in the US. My baseline assumes that the dollar holds onto its strength through the week.

USD: Dollar looks likely to hold gains.

This week marks a significant period for central bank policy rate meetings, with six of the G10 central banks actively engaged. The focal point for setting the global market tone will be Wednesday's Federal Open Market Committee (FOMC) meeting. In this context, I anticipate a decidedly hawkish stance from the Federal Reserve. Despite maintaining unchanged rates, the Fed, through its statements and dot plots, is likely to hint at the possibility of an additional rate hike later this year, potentially pushing the range to 5.50-5.75%.

While I expect to witness 25 basis point rate hikes from four European central banks throughout the week (as detailed below), I remain sceptical that the US dollar will experience significant depreciation, if any. The expectation of an extended period of stable interest rates in the US is exerting downward pressure on US interest rates and curbing volatility across various markets, all while sustainably elevating the appeal of carry trade strategies. This, combined with Brent crude oil trading near $95 per barrel, is underpinning the demand for currency pairs like USD/JPY. Few are anticipating any substantial shifts in the Bank of Japan's policy this Friday. If Japan does decide to take further action, it is more likely to occur in late October when fresh economic forecasts are unveiled.

Additionally, emerging markets are also witnessing a pivotal week for policy rate meetings. In the EMEA region, particular attention is on whether the Central Bank of Turkey will implement another significant rate hike, potentially by 500 basis points, as part of its ongoing shift towards policy orthodoxy. Meanwhile, Brazil is expected to reduce rates by an additional 50 basis points in accordance with recent guidance. Despite these divergent rate trajectories, the strong interest in carry trade strategies this year may provide support for both the Turkish lira and the Brazilian real.

In other regions of Asia, several rate meetings are on the agenda for the week, with expectations leaning toward no adjustments in China's Loan Prime Rates or policy rates elsewhere in the region.

The US Dollar Index (DXY) remains relatively robust, and there doesn't appear to be a compelling case for a substantial downturn this week, unless there are unexpected developments from the Federal Reserve. Notably, there is a sturdy resistance zone in the range of 105.40/80, which could act as a potential cap for the week. Nevertheless, DXY is expected to continue attracting reasonable demand below the 105.00 threshold.

EUR: Soft week culminates in the flash September PMIs

The EUR/USD currency pair has been trading without much direction following the European Central Bank meeting last Thursday, which pushed it lower. The primary driver for its movements this week will be the Federal Reserve's actions and statements. However, there is potential for further negative news for the eurozone and the euro on Friday when the flash eurozone PMIs for September are released.

EUR/USD currently finds decent support in the 1.0610/30 range. If it were to breach this support, there is a risk of it falling to the 1.04/05 area. Nevertheless, the overall strategic view is that the US economy will eventually align with the sluggish growth in Europe next year, leading to a weakening of the US dollar. Therefore, any dip to the 1.05 area in the coming weeks could be seen as an opportunity to establish hedges in preparation for the seasonal weakness of the dollar in November and December this year.

In other parts of Europe, we anticipate 25 basis point rate hikes in Switzerland, Sweden, and Norway, all scheduled for Thursday. It's important to note the differences between these currencies:

a) In terms of characteristics, the Scandinavian currencies (Swedish krona and Norwegian krone) are considered high beta 'growth' currencies, while the Swiss franc is more defensively oriented.

b) Central bank involvement also varies, with the Swiss National Bank actively guiding the franc stronger through foreign exchange intervention.

Both CHF/SEK and CHF/NOK have experienced significant rallies of 10% and 13%, respectively, year-to-date. These trends are unlikely to reverse until the Federal Reserve concludes its tightening cycle.

GBP: 25bp BoE hike widely expected on Thursday.

Economists are almost unanimously predicting a 25-basis point (25bp) rate hike by the Bank of England on Thursday, which would raise the Bank Rate to 5.50%. However, the market has significantly tempered its expectations for any future tightening measures. Consequently, market participants will be keenly interested in the Bank of England's statement to see if it retains language like the following: 'If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.

The upcoming August UK Consumer Price Index (CPI) data, set to be released tomorrow, will also be closely watched as it could influence the central bank's decision-making.

The Bank of England has likely observed how the euro reacted last week after the European Central Bank (ECB) essentially signalled the end of its tightening cycle. If the Bank of England's statement on Thursday suggests that the UK policy rate is now "sufficiently restrictive," it could negatively impact the value of the pound.

Overall, there is a slightly bearish outlook on sterling in the latter part of this year, based on the belief that the easing cycle by the Bank of England in 2024 will be more substantial than what is currently priced in. However, the timing of this potential sell-off will be contingent on the cues provided in Thursday's Bank of England statement.

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