A hawkish Fed, but soon...an even more hawkish Fed?

The foreign exchange market has returned to stability in recent days with the dollar still being more sought after compared to the euro. After a start to the year that saw investors pay less attention to safe havens such as the dollar, the Swiss franc and, to a lesser extent, the Japanese yen, these are back in the spotlight. For the dollar, it is of course being supported by the prospect of higher-than-expected rates holding for longer than expected. According to New York Fed Chairman John Williams, monetary policy could remain at restrictive levels for a few years to reduce inflation. The median projection of 5.1% by the end of 2023 implies two more rate hikes this year. According to Mr Williams, this seems a reasonable view of what needs to be done to reduce inflation. Yes, the European Central Bank will continue to tighten its monetary policy, but if the Fed does so too the spread between the two currencies will remain in favour of the dollar. We note that US consumer confidence, which is the main driver of the economy, as measured by the University of Michigan, reached a two-year high, with the index rising from 64.9 to 66.4 points in February. The situation is diametrically opposed in the eurozone, where the low level of consumer confidence points to a continued decline in household spending, against a backdrop of persistently high inflation. High inflation is having a direct impact on retail trade, and future monetary tightening will only worsen it.

In Switzerland, the January consumer price index showed an increase in inflation to +3.3% year-on-year, compared with expectations of +2.8% and a figure of +3.1% the previous month. Over one month, the price index increased by 0.6 vs. 0.4 expected. This should support the SNB’s desire to raise rates at the monetary policy meeting on 23 March to combat price increases. The market now expects the key interest rate to rise by 0.50% to 1.50%. The prospect of higher rates coupled with escalating tensions between the US and China as well as fears of another major Russian offensive in Ukraine all point to a strengthening of the franc. The franc is also benefiting from the SNB’s desire to keep it strong and use it as an additional tool in its fight against inflation. The CHF 2.48 billion decrease in demand deposits with the institution, announced on Monday, also suggests that the bank has intervened in recent days to prop up the Swiss currency, which approached its highest level against the single currency in 2023 at the beginning of the week. This was despite the fact that the euro rose back above parity in January.

Bank of England Governor Andrew Bailey expects inflation to fall rapidly this year and suggested that the series of interest rate hikes could soon end. However, he points out that the labour market is very tight and that wages are on a strong upward trend, as shown by the data published yesterday. The increase in average income exceeded estimates and reached a record level since the beginning of the statistics in 2001. At the same time, the United Kingdom recorded zero growth (0%) in the fourth quarter of 2022, which helped avoid the recession, after a decline of 0.3% previously. But although economic data are slightly better, such as industrial production or manufacturing, economic activity is suffering from the measures taken by the Bank of England to combat inflation.

As expected, the Swedish Central Bank raised its key interest rate from 0.50% to 3%, its highest level since late 2008. The Bank’s press release indicates that further rate hikes are coming to the fore to counter inflation that peaks at 12.3 per cent. The decision, although anticipated, benefited the krona, which reached its highest level of the year against the single currency at SEK 11.0610 for a euro on Friday.

The ounce of gold has continued to fall against the dollar. It has now lost nearly $120 from its peak on 2 February at 1,959.73 dollars per ounce. The return of the greenback, following new expectations of interest rates in the United States, has had a significant impact on prices. A strong dollar and high interest rates for a prolonged period of time are particularly negative factors for gold.

President Joe Biden appointed Lael Brainard as the White House’s main economic advisor. The Fed’s Vice Chair has been known as the most dovish on the Board of Governors. This decision therefore creates a vacancy at the US central bank and speculation is beginning on the nature of its successor or successor. Will it be Hawk or Dove? This will have an influence on the Fed’s policy in the future.