EUR/USD slides back below 1.01 level on Fed rate hike bets

The dollar was broadly stronger against most currencies on Thursday, as investors appeared to have a rare change of heart over this week’s FOMC meeting minutes.

Summary:

• The US dollar rallied against most currencies yesterday, as investors have a change of heart over Wednesday’s FOMC meeting minutes.
• US jobless claims come in much stronger-than-expected (250k) - far from recessionary levels.
• EUR/USD falls back below 1.01 level, with GBP/USD sliding below 1.20 for the first time in around a month.
• This morning’s UK retail sales figures likely to be the main economic data release for FX today.

Trading in the FX market has been rather choppy so far this week amid mixed macroeconomic data and some contrasting messages out of Wednesday’s FOMC meeting minutes, which split opinion as to whether the communications were either hawkish or dovish. The minutes were initially perceived by markets as dovish, as they indicated that interest rate hikes would likely slow at upcoming meetings. Focus during the London trading session on Thursday did, however, turn to the bank’s comments on inflation. In the minutes, the Fed said that ‘declines in the prices of oil and some other commodities could not be relied on as providing a basis for sustained lower inflation, as these prices could quickly rebound’. This would suggest that Fed members are not yet ready to declare victory over US inflation, and that a continued pace of aggressive policy normalisation is likely to be required at upcoming meetings.

While the general consensus is that a return to a 50 basis point rate hike is likely on the way in September, markets continue to price in around a one-in-three chance of a third consecutive 75 basis point move. Labour market data out yesterday certainly supports the latter. US initial jobless claims fell to just 250k in the week to 12th August, far below the 265k expected. There was also a pretty sharp downward revision to the previous number to 252k, from 262k, far from levels that can be viewed as recessionary. It is data such as this that are keeping the faint hopes of another 75bp rate hike alive, providing decent support for the US dollar yesterday. EUR/USD, for instance, fell back below the 1.01 level on Thursday afternoon, with the GBP/USD pair sent crashing through the 1.20 mark.

Figure 1: US Initial Jobless Claims (2021 - 2022)

UK retail sales figures for July will be among the most important data releases for the FX market on Friday. Sterling has largely struggled against most of its peers so far this week, as investors place greater emphasis on the ramifications for growth of Wednesday’s bumper UK inflation print than its implications for Bank of England monetary policy. In this context, this morning’s retail sales print may well be key. Signs that consumer spending is holding up better-than-expected in the face of rampant inflationary pressures may be seen as a clear bullish signal for the pound, whereas a downside surprise would heighten recession concerns and likely weigh on sterling. Economists are pencilling in another modest contraction in the headline number (-0.2% MoM).