To gain a greater global perspective on the economy, CMLI talked with George Vessey, Convera’s Lead FX & Macroeconomic Strategist, based in Peterborough, England.
CMLI: Was the Fed’s decision to leave rates unchanged to be expected?
Vessey: At the beginning of the month, markets placed the probability of the Fed not cutting rates at all this year at basically zero percent. But the upside surprise of every possible inflation print changed that. They highlighted that Q1 overall was an inflationary month. And market positioning shifted accordingly as the probability of the Fed fund rate remaining unchanged throughout 2024 rose to 25%.
CMLI: One of the biggest factors is inflation; when do you expect it will bottom out?
Vessey: The big anticipation going into the Fed meeting was that policy makers would shift to a slight hawkish bias. Fed chair Jerome Powell did acknowledge that the central bank failed to make any progress on the inflation front in Q1 and that it would take a bit of time for inflation to return to target. This most likely cemented the higher for longer narrative and justifies postponing rate cuts until Q3.
CMLI: Did anything take the markets by surprise?
Vessey: What took markets by surprise is that Powell pushed back substantially against the idea of the Fed considering to raise interest rates again. This means that the bar for rate cuts is high but the one for rate hikes is even higher, putting the Fed in a dovish to neutral position for the next six months. Perhaps we’ll look back at that meeting as the peak of Fed hawkishness, because it’s unlikely that the inflation surprises from Q1 can continue to such an extent in the coming quarters.
CMLI: What do you expect over the next 12-24 months?
Vessey: Ultimately, although the Fed left rates unchanged, this was priced in by markets, and despite rates staying steady, shifting interest rate “expectations” does move markets and we have witnessed a spike in FX volatility over the last month due to the ebb and flow of rate expectations over the next 12-24 months.
CMLI: Are other countries’ central banks following the US’ lead?
Vessey: We think diverging policy paths of central banks will increase FX volatility going forward, particularly if the Fed stands pat whilst its peers start cutting rates. Such a scenario could see the US dollar remain stronger for longer. Having visibility and certainty over FX payments is crucial and implementing a currency hedging strategy may be appropriate for some companies wanting to set a ceiling on foreign expenses or a floor on foreign revenue values to protect against adverse currency moves.
CMLI: Help us take a step back: What’s the big picture?
Vessey: From a broader economic perspective, April gave us closure on the first quarter of the year with all data points now being published. Soft data is now disappointing relative to expectations at a faster rate – take, e.g. the recent manufacturing and services ISM surveys, both now under 50. The Chicago PMI and CB consumer confidence index surprised to the downside with the expectations component falling to the second-lowest level since 2013. Hard data too is on the same path with GDP growth coming in at a strong 1.6%, but below expectations whilst the labour market looks to be moderating – with the latest US jobs report disappointing expectations across the board – the unemployment rate rising, hiring growth moderating and average hourly earnings increasing by less than anticipated.
CMLI: What’s the impact on the US dollar?
Vessey: Overall, the US economic surprise index has fallen to its lowest level since the beginning of 2022, and that’s starting to put light pressure on the US dollar. Still, lagging data is far from signalling recession and although the US economy grew by less than expected in the first quarter of 2024, the Nowcast from the Atlanta Fed puts GDP growth for Q2 at 3.9%, well above the last two quarters. This first estimate is prone to many revisions, true, but another quarter of above-trend US growth would come with its negative side-effects for many currencies, whist supporting the buck.
