EUR/USD: Fed Downplays Economic Slowdown
Growth Aces | May 04, 2017 07:43AM ET
EUR/USD: Fed downplays economic slowdown
Macroeconomic overview: This week’s FOMC meeting did not bring any news about the policy outlook, as all policy-relevant paragraphs in the post-meeting statement were left completely unchanged compared to March. While Fed officials acknowledged the weak first-quarter growth, they viewed the slowing “as likely to be transitory”. That leaves the Committee on track for a gradual removal of policy accommodation in the course of this and next year.
Notwithstanding weak first-quarter GDP print and a disappointing March employment report, the Federal Reserve reiterated yesterday “that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds.” This unchanged policy outlook is based on the underlying view that the growth slowdown during the first quarter was “likely to be transitory”. One important aspect of that sanguine outlook, which we share, is that the “fundamentals underpinning the continued growth of consumption remained solid”.
Besides giving this nod to the first-quarter economic data, yesterday’s statement was essentially unchanged compared to March. Amid the lack of visible action, internal discussions likely focused on details about when and how to shrink the large balance sheet. And while the results weren’t in yesterday’s statement, we will learn about the deliberations and the state of the debate in upcoming speeches, as well as in the minutes. Our best guess is that, beginning in late 2017 or early 2018, the Fed will gradually reduce the amount of reinvestments, which would allow for a slow normalization of the balance sheet. The announcement of this step, which may have a greater impact on financial markets than the tapering itself, should come during the summer.
Any balance sheet action will come on top of ongoing rate hikes. Financial markets currently expect only three hikes by the end of 2018. We think that this view is too cautious, and continue to see two more hikes for this year, followed by another three in 2018. Our fed funds rate projection for year-end 2018 is thus 50 bp higher than what is currently priced in by the futures.
Earlier this month, Chair Yellen had emphasized that the Fed’s focus has shifted from giving “the economy all of the oomph that we possibly could” to holding the growth gains, implying a less accommodative policy stance.
Obviously, and in line with our expectations, the Fed did not use yesterday’s statement to tee-up for a hike in June. And our baseline view is indeed that after raising rates in December and March, the Fed will take a break in the second quarter, before hiking twice in the second half of the year. But, if anything, the risk is that the Fed will move earlier than we currently think.
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Investors are awaiting Friday's monthly U.S. non-farm payrolls report, for further hints on the Fed's likely rate hike trajectory through the end of the year. ADP and ISM reports released on Wednesday supported the notion that the U.S. economic expansion remains on track despite a weak first quarter. U.S. companies hired workers at a slower but still-solid pace in April while the services sector grew more than expected.
ECB governor Mario Draghi’s speech is scheduled for today (16:30 GMT). EUR/USD bulls will be looking for any hints on the exit strategy from ECB accommodative policy, but we think Draghi may disappoint EUR-long investors.
U.S. President Donald Trump's effort to roll back Obamacare gained momentum on Wednesday as Republican leaders scheduled a vote in the House of Representatives on Thursday on newly revised legislation. House Majority Leader Kevin McCarthy expressed confidence the bill would pass and several moderate Republican lawmakers who previously objected to the bill said they could now support it.
A vote was expected as early as midday Thursday, with lawmakers planning to leave town later that day for a week-long recess. Even if a narrow majority in the House approves the bill, it still faces a steep climb in the Senate, where only a few defections could kill the effort.
Technical analysis: The EUR/USD recovered today after more-hawkish-than-expected FOMC statement on Wednesday. The pair remains above 7-day exponential moving average, which keeps bullish trend intact, but we see that the EUR/USD rise is slowing down. Technical resistances for the pair are aligned at 1.0950 (Apr 25 and 26 high) and psychological barrier at 1.1000. On the flip side, the spot finds next support at 1.0880 (May 3 low), a break below that level could open the door to 200-dma at 1.0830.
Short-term signal: Short for 1.0770
Long-term outlook: Bullish
GBP/USD: Service sector growth accelerates, but prices pressure remain high
Macroeconomic overview: UK service providers experienced a sustained rebound in business activity during April, supported by the fastest upturn in new work so far in 2017. Job creation also picked up to a four-month high, driven by renewed pressures on operating capacity. A strong pace of input cost inflation persisted in April, which contributed to the steepest rise in prices charged by service sector firms since July 2008. Meanwhile, service providers are confident about their prospects for growth over the year ahead, but the degree of optimism moderated for the third month running to its weakest since November 2016.
UK PMI services rose to 55.8 in April from 55.0 in March. The latest reading revealed the fastest upturn in service sector output since December 2016. The robust and accelerated rise in services activity was linked to resilient business-to-business demand. Consumers took a back seat, uneasy about rising costs for essentials such as food, fuel and energy.
UK PMI surveys point to GDP growing at a rate of 0.6% at the start of the second quarter. The PMI surveys also show average prices charged for goods and services rising at the fastest rate since September 2008. Price hikes were widely attributed to the need to pass increased costs onto customers, in turn partly linked to the weak exchange rate making imports more expensive. The survey data therefore suggest that consumer price inflation has further to rise from its current 2.3% pace in coming months.
The strengthening of growth and the upturn in prices will bolster calls for higher interest rates. But weak growth in the consumer sector remains a concern, and is something which could intensify in coming months as consumer prices rise further.
Technical analysis: Today’s drop was stopped at 14-day exponential moving average. The rejection of a downward move is a threat for the GBP/USD bears, but on the other hand the RSI suggests bullish momentum is fading.
Short-term signal: Short at 1.2897 for 1.2700
Long-term outlook: Bullish
Source: GrowthAces.com - your daily forex trading strategies newsletter
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