As the Reserve Bank of New Zealand (RBNZ) takes a decisive move, major central banks are developing their stance on policy normalization. We are seeing clear divides forming and this will impact across major forex markets especially in the coming months.
- Measured against other major central banks, the Federal Reserve is now seen as a middle of the road benchmark on policy tightening
- The RBNZ has jumped to the hawkish end of the scale with the Bank of Canada (BoC) not far behind.
- The European Central Bank (ECB) is very much on the dovish side and next week’s meeting will confirm this.
- This leaves NZD and CAD positioned to outperform, whilst EUR will struggle versus USD.
FOMC is the benchmark on policy tightening
The June FOMC meeting brought forward the possibility that the Fed would be tightening in 2023. Perhaps as the economic recovery and policy stance develops further in the coming months, this expectation could come forward further into 2022 (we are looking at the September dot plots for the next clue there).
Fed chair Powell’s Congressional testimony looked to dampen tightening expectations, suggested that tapering asset purchases remained a “ways off”. However, Fed Funds futures are still projecting +25 basis points of hike during the second half of 2022. This would suggest the market is still positioning for asset purchases to be tapered in the latter stages of this year.
We still look towards the Jackson Hole Economic Symposium (26th to 28th August) to be the moment for serious hints of the taper from Powell.
The position of the Fed leaves a line in the sand around which other central banks can be measured. Those tightening sooner than the Fed (more hawkish)and those tightening after (more dovish).
- We see the RBNZ and Bank of Canada as decisively ahead of the Fed
- We see the ECB, Bank of Japan and Swiss National Bank as being decisively behind the Fed
- The Bank of England is probably about where the Fed is. The Reserve Bank of Australia is behind for now, but this could change as employment and wages pick up.
The RBNZ is now the clear hawkish leader
The message from the RBNZ this week has propelled the central bank to head the list of banks to tighten monetary policy first. Not just tapering, but announcing to end emergency asset purchases from the end of next week is a clear sign. New Zealand inflation has also increased above the 1% to 3% target range for the first time in 19 quarters.
Markets are pricing for at least a +25bps rate hike this year, whilst Westpac (an Australian investment bank) is forecasting three rate hikes this year. Three hikes may be a bit of a stretch, but clearly, this is way ahead of the Fed.
This hawkish bias puts the kiwi (NZD) in a strong position for outperformance across major forex.
The BoC is not far behind
The BoC also updated monetary policy this week and also remains on a hawkish path. Reducing asset purchases once more (from C$3bn per week, down to C$2bn per week), the BoC is seemingly on the path towards perhaps ending QE this year.
Furthermore, forward guidance on the first rate hike is for “some time in H2 2022”. This leaves the BoC still ahead of the Fed but just behind the RBNZ. It does also leave the loonie (CAD) well-positioned for outperformance versus major forex.
The ECB is seriously lagging now
The re-positioning of the Fed left the ECB decisively lagging on monetary policy tightening. Inflation in the US, New Zealand, Canada and the UK is way ahead of the sluggish Eurozone. Even if this proves to be transitory, it shows that even during massive inflation inducing global economic recovery, the Eurozone struggles to generate enough inflation to exit ultra-loose monetary policy positioning.
This has been exacerbated by the announcement that the ECB would be looking to replace its emergency PEPP program with some sort of additional easing measures in March 2022. We can expect a fairly active meeting next week where we are likely to get more detail from Christine Lagarde.
However, this does leave the ECB towards the bottom of the pack (albeit slightly above the perpetual dovish BoJ and SNB).
It means that the euro (EUR) is likely to struggle for performance in the months to come. With central banks increasingly pushing ahead down the path of tightening, the ECB is being left behind.
The RBNZ is out in front for tightening, whilst the BoC follows not far behind. This should help to support NZD and CAD moving forward. The ECB remains a distant laggard on tightening and this dampens the prospects of any sustained positive bias for EUR.