(Bloomberg) — Investors began the week desperately searching for answers to questions about the near-term path of global monetary policy after conflicting signals from major economies roiled markets.
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Major central banks are due to meet in Tokyo and Washington on Wednesday and again in London on Thursday, and traders are struggling to decide whether the Bank of Japan will raise interest rates and when and by how much the Federal Reserve and the Bank of England will cut them.
At stake are the recent gains in the yen and sterling, as well as the decline in short-term US Treasury yields. Several markets ended last week with some nervousness due to the uncertain outlook for monetary policy and economic growth.
“This week will be more interesting,” said Wong Kok Hoong, head of institutional equity sales at Maybank Securities Pte. in Singapore. “And perhaps more tiring.”
Here’s a traders’ guide to this week’s central bank action:
Bank of Japan
Markets are uncertain about what the Bank of Japan will do after years of rarely touching rates.
Governor Kazuo Ueda set a personal record for not making public comments before a policy meeting, and recent economic data showed inflation accelerating but consumer spending disappointing.
The prospect of further monetary tightening sent the yen higher last week. The currency has strengthened about 5% against the dollar since July 11, partly because of alleged intervention by authorities weary of the currency’s weakness.
Options traders saw their bets on a rate hike rise from less than 40% to nearly 90% last week, before settling somewhere in between. Economists are similarly uncertain: Just 30% of them expect a hike, but more than 90% see it as a risk, according to the latest Bloomberg survey.
The yen’s interdependence with a multitude of leveraged investments via carry trades, where the Japanese currency is borrowed and used to buy higher-yielding assets, has shown that big swings can quickly reverberate across global markets. The currency’s recent surge has challenged popular currency strategies on everything from the Australian dollar to the Mexican peso.
Ueda’s inaction would leave yen bulls vulnerable, especially if Fed officials also disappoint expectations for a significant reduction in bond purchases. But currency bears are at risk if the Fed does anything later Wednesday to accelerate hopes of U.S. rate cuts in the coming months.
“I remain in the yen bear camp, although the risks are enormous heading into the important week,” said Charu Chanana, head of foreign exchange strategy at Saxo Capital Markets. “Expecting the BOJ to hike rates and tweak its bond purchases in a single meeting seems far-fetched for a central bank that is accommodative by nature.”
Federal Reserve
Investors will be scrutinizing the Fed’s monetary policy announcement and Chairman Jerome Powell’s remarks on Wednesday for anything that might support expectations of a first interest rate cut in September.
Such a move would be in line with the view of economists and swap traders, who anticipate at least two quarter-point cuts this year. The Fed’s benchmark index is now in a range of 5.25% to 5.5%, a peak reached a year ago.
Policymakers have been highlighting the balanced labor market and slowing inflation for weeks, indicating they see a growing case for lower borrowing costs in the world’s largest economy.
“The upcoming FOMC meeting will serve to lay the groundwork for a rate cut in September, as the Fed makes the case for moving policy from restrictive territory to a more neutral base,” said James Knightley, chief international economist at ING.
Some market observers, such as former New York Fed President William Dudley and Mohamed El-Erian, have even argued for more aggressive easing than is currently expected. In separate Bloomberg Opinion columns, Dudley said the Fed should consider cutting rates this week, and El-Erian warned of a “policy mistake” if the central bank kept rates too high for too long.
U.S. Treasuries are on track to end July on a three-month rally, the last time they have been since mid-2021. Growing conviction in rate cuts has sent the Bloomberg index of U.S. government debt to a two-year high this month. Two-year yields have fallen on the news of looser monetary policy, leading to a narrowing of the spread over 10-year bonds.
U.S. stock markets, however, are entering the week on somewhat more fragile footing, partly because several corporate earnings reports have raised doubts about consumer sentiment. The S&P 500 index ended its longest streak without a 2% decline since the start of the global financial crisis in 2007 on Wednesday.
A look at market volatility shows how important the week — which will also feature a U.S. jobs report and corporate results from Meta Platforms Inc., Microsoft Corp. and Apple Inc., among others — is for traders.
A gauge of the S&P 500’s implied price movements over the next week jumped to nearly a full point above expected volatility two weeks from now, a signal that uncertainty here and now is higher than over the longer term.
Bank of England
Markets are divided over whether the Bank of England will make its first rate cut since the pandemic on Thursday, beyond the current 5.25%.
While inflation has eased from 10% a year ago to 2% of the central bank’s target, unemployment is rising, service sector price growth remains high and the economy has rebounded from a minor recession. A 10% increase in the minimum wage in April and the new Labour government’s plan to raise it alongside above-inflation pay increases for as many as 5 million public sector workers pose upside risks to prices.
Since the July elections, three of the “hawks” on the Monetary Policy Committee have defended their position against any monetary easing. Only one of the two “doves” has made the opposite argument.
Whatever the outcome, the decision will likely impact bonds and sterling. Swaps on Friday were pricing in about a 50% chance of a quarter-point cut this week, with two such moves seen as a near certainty this year.
Economists think the BOE will change its mind. Bank of America Corp., Deutsche Bank AG and Nomura Holdings Inc. estimate that policymakers are split five to four in favor of a cut this month. ING Groep NV expects six of them to support action. Bloomberg Economics also forecast a cut.
“In a busy week for important data, the BOE meeting on August 1 is packed with action and updated forecasts,” said Orla Garvey, senior portfolio manager for fixed income at Federated Hermes Limited.
A rate cut would boost British government bonds, already buoyed by prospects of monetary easing and hopes of political stability after Labour’s landslide election victory. The yield on two-year bonds is at its lowest in more than a year.
For sterling, a rate cut would not be as beneficial because it would reduce its attractiveness in the carry trade. Sterling is the best-performing currency in the Group of 10 this year, and major banks and investors including JPMorgan Chase & Co. and Amundi are forecasting further gains to $1.35, up nearly 5% from current levels. Bullish bets are at their highest level on record.
What Bloomberg Strategists Say…
“The recent market turbulence has unsurprisingly sparked a number of counter-narratives around equities, fixed income and other market positions. It may be dangerous to say this, but in some ways the current situation is very different from what we have seen before.”
— Cameron Crisis, macroeconomic strategist
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–With assistance from Winnie Hsu, Aline Oyamada, Philip Aldrick, Steve Matthews and Elena Popina.
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