USD and stock markets wobble after slew of hawkish statements from policymakers

Stock markets fell and the USD rally wobbled yesterday, 17^th January 2024, after a raft of statements from central bankers and strong US retail data dampened expectations for near-term rate cuts.

For some time now there has been a noticeable gap between statements made by policy makers at central banks and market expectations for rate cuts. As recently as last week, the CME Fedwatch tool showed that market participants had priced in a 70% chance of a rate cut in the Fed’s target rate in March. But analysts have cautioned against this type of market optimism for some time now, with inflation – especially core inflation – looking stickier than central banks had hoped. 

The initial trigger for the market slide was an interview with European Central Bank (ECB) President, Christine Lagarde, on the sidelines of the World Economic Forum in Davos where she called market expectations for a spring rate cut “unhelpful”. Asked if she agreed with fellow ECB governing council members who have signalled a rate cut is expected this summer, Lagarde said: “I would say it is likely too, but I have to be reserved.”

Lagarde said that the ECB would have the information it required on wage pressures by late spring and that this data would be necessary before any decision was made to lower borrowing costs. She made special reference to EU inflation in the services sector – 4% in December – and wage growth – 5.2% over 2023 – as barriers to cutting rates.

Lagarde’s statements were followed by data releases from the US, showing that retail sales had increased more than expected in December – up 0.6% vs a market forecast of 0.4%. The Federal Reserve had already made it clear that it was already wary of cutting rates too early and the new data had an immediate impact, with the chances of a March rate cut falling to 60% overnight.

Elsewhere, UK inflation figures came in higher than expected and Christopher Waller, a member of the Federal Reserve’s governing board, warned against rushing to slash interest rates, saying that the Fed needs to “take our time to make sure we do this right”. His comments were backed up by Gita Gopinath, first deputy managing director of the IMF, who this morning told the Financial Times that:

“The job is not done. [Central banks] must move cautiously. Once you cut rates, it solidifies expectations of further rate cuts, and you could end up with much larger loosening — which can be counter-productive.”

For traders, the lack of clarity in the fundamentals is unhelpful. Markets seem comfortable with the EUR/USD around the 1.09 mark and heightened geopolitical tensions are underpinning support for the USD in general.

In the short term, traders are advised to keep a close eye on data coming out of the US, as well as any forward-looking statements made by policymakers on both sides of the Atlantic, as this will give the clearest notion of how serious central banks are about keeping rates elevated over the next few months.

Technical Analysis

Following Christopher Waller’s speech on Wednesday, the dollar appreciated and the EUR/USD declined almost 0.5%, falling below the 1.09 level to a low of 1.0845. After an attempt to break below the upward channel (yellow), the price remained above the support of the 200-day SMA (yellow) and rallied briefly above 1.09. The bounce up was likely due to Lagarde’s stance on pushing back rate cuts to next summer.

Following the morning’s volatility, the price rebounded to the same level as yesterday’s open (1.0874). Although the broad trend remains negative, the market appears indecisive. Any upward moves could see the 26-day EMA (blue) resistance come into focus at 1.0930, and beyond that, the 1.1000 psychological handle.

On the other hand, a move lower could indicate a test of the 200-day EMA (yellow) at 1.0830, and further downside moves could see the price reach 1.0700.