Almost half the meeting participants expect at least one rate increase in 2026, and the market agrees with them. The result was a spike in front-end rates, a relief rally among long term bonds, and a renewed surge of the dollar against just about every major currency worldwide. Even the mighty stock market wavered for a while after the FOMC meeting, though it had largely recovered its losses by the end of the week. Pacific Rim currencies outperformed in relative terms, buoyed by the much lower energy prices following the announcement of the Iran peace deal.
Now that the main central bank meetings are out of the way, attention this week shifts back to the economic scene. The main focus will be the PMIs of business activity, which are the best early indicators of the impact the peace agreement will have on business confidence - the reports for all major economic areas will be published on Tuesday. The US PCE inflation report for June will also be key given the Federal Reserve's apparent new focus on the inflation side of its mandate. We will also be closely monitoring the fallout in UK assets to the resignation of prime minister Keir Starmer.
GBP
Andy Burnham has taken a big step closer to being named Britain’s next prime minister. His commanding victory in the Markerfield by-election on Friday and the subsequent resignation of Keir Starmer this morning has effectively cleared his path to Number 10. Nominations for the post will open on 9th July, although we are expecting an uncontested coronation, rather than a protracted leadership contest. The pound has taken the news in stride, although Burnham’s preference for fiscal expansion, higher taxes and greater gilt issuance is a concern. The critical question is who becomes Chancellor. Continuity with Reeves would be the market’s preferred outcome, but any indication that a new Chancellor intends to loosen or abandon the existing fiscal rules could trigger fresh selling in UK assets.
It will be interesting to see what impact, if any, the leadership change has on the Bank of England. The MPC held rates in a 7-2 vote last week, while keeping the door open to a hike later in the year, if warranted. Yet with May inflation coming in milder than expected, and the labour market remaining weak, we think that the BoE will stay in its wait and see mode at least through the summer, and possibly throughout the remainder of the year.
EUR
Eurozone yields have reacted to last week’s hawkish Federal Reserve announcement with further sell-offs in the longer part of the curve, but this has failed to benefit the euro, which continues to lose ground against the dollar. Macroeconomic news out of the Euro Area, lagged as always, has nevertheless taken a modest turn for the better lately. This, together with the rebound in core inflation, offers some cover to the ECB hawks that want to deliver a second hike in September.
This week's business activity PMIs, out of the bloc on Tuesday, are unusually important, as they will be the first indicators of note released after the positive news about the US-Iran peace deal last week. The end to the conflict in the Middle East should be bullish for the euro, though the common currency is now trading around its lowest level since mid-March. We see this as partly a consequence of the lasting economic damage of the war, and perhaps a reluctance of investors to overcommit until officials put pen to paper on a more permanent peace agreement.
USD
The clear turn for the better in US labour market data, and the inflation spike brought about by the war in Iran, have ended any Trumpian hopes that the Fed would cut rates any time soon. During his first press conference as chair last week, Kevin Warsh made it clear that the Fed’s primary goal is ensuring price stability. The statement was also significantly watered down, removing any semblance of forward guidance - something that Warsh has been very critical of.
It is clear that absent some massive negative surprise the next movement from the Fed will be a hike, though the timing is as uncertain as ever. AI-driven business investment seems to have taken up the baton from a more subdued consumer, but the rebound in the labour market and wealth effects from the continuing equity market rally makes it likely that the latter will rebound soon. Futures are now almost fully pricing in the next hike as soon as September, and the strong hawkish shift in last week’s dot plot suggests that it won’t take much to tip the balance in favour of exactly that.
Deep dives and expert insights:
- G10 currency market report - Get the latest analysis on major currencies.
- FOMC June Meeting Reaction
