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.

U.S. inflation is expected to have fallen to 4.1% in May from 4.9%, and core inflation is estimated to be lower at 5.3% from 5.5% published the previous month earlier. If there are no major surprises in the inflation data, the Federal Reserve (Fed) is expected to leave interest rates unchanged at its meeting this week. Activity in Fed funds futures currently suggests a greater than 73% probability of a rate hike next Wednesday. However, that does not mean the Fed is done raising rates. Whatever pause is in shop this week will come with an aggressive accompanying statement and the threat that the Fed could resume rate hikes at the next meeting.

Investors are rushing into call options in droves because no one wants to miss another rally in the stock markets, but no one is sure the rally will last because the Fed has been raising interest rates at a record pace since last year, leading to the collapse of some regional U.S. banks. Earnings expectations for this year are clearly negative, and the sharply inverted U.S. 2-10 yield curve suggests that a recession is certainly not far off. So it’s good to think about hedging when economic fundamentals don’t necessarily support a continued rally, especially if the rally is driven by technology stocks, which are theoretically 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.