A Busy Week for Central Banks

Sentiment is cautiously bullish into the next US CPI figure, due tomorrow, and the next FOMC decision due Wednesday.

Inflation in the US is expected to have eased from 4.9% to 4.1% in May, and core inflation is seen slower at 5.3%, versus 5.5% printed a month earlier. If there is no major surprise on the inflation data front, the Federal Reserve (Fed) should keep the interest rates unchanged at this week’s policy meeting. Activity in Fed funds futures currently gives more than 73% chance for a no rate hike for this Wednesday. But that doesn’t mean that the Fed is done hiking. Whatever pause we might see this week will come with a hawkish accompanying statement, and a threat that the Fed could resume its rate hikes next meeting.

Investors are flocking into call options because no one wants to miss a further rally in stock markets, but no one is sure that the rally will continue given the fact that the Fed has hiked rates at a record speed since last year, leading to the failure of a couple of US regional banks on the way. The earnings expectations for this year are comfortably negative, and the strongly inverted US 2-10-yield curve hints that recession is certainly not far. So yes, it’s good to think of protection, when economic fundamentals don’t necessarily support a further rally, especially when the rally is shouldered by tech stocks, who are, in theory, sensitive to changes in interest rates.

Across the Atlantic Ocean, the European Central Bank (ECB) is expected to hike its interest rates by 25bp when it meets on Thursday, while the Bank of Japan (BoJ) is expected to keep its policy rate at the negative territory despite the rising inflation.

The USDJPY remains bid into the 140 level, with the possibility of a further retreat toward the 200-DMA, which stands near the 137 mark. But that possibility is very much dependent on where the USD will be headed after the inflation report and the Fed decision. The dollar index slipped below past month’s bullish trend and is preparing to return to its 100-DMA. A surprise inflation uptick, and/or a hawkish Fed pause are the major upside risks to the dollar’s downside correction this week. If that’s the case, we could see the USJDPY jump back above 140 easily, though the upside potential will likely remain limited above this level. The EURUSD on the other hand has a better chance to temper a potential rise in USD demand, as the ECB will likely sound and act hawkish despite the waning inflation and slowing demand.

In commodities, crude oil slips below the $70pb at the start of the week. Goldman dropped its forecast for Brent crude by almost $10 to $86pb for December pointing at recession fears a supply increases from nations facing sanctions like Russia, Iran and Venezuela. But the US driving season and the Mid-East boiling hot months will likely bolster demand, while the US will still have to fill in its oil reserves at levels below $70pb, which will likely throw a floor under US crude selloff near $65pb.