Today will bring a wave of central bank speakers, including speakers from the Bank of England, the Bank of Canada and the Riksbank and, of course, Jay Powell and Janet Yellen in the U.S. Yellen is expected to touch on the improved outlook and extra stimulus help for families while urging more spending. As for Powell, he should reiterate his pledge to delay tightening until deep into the recovery. Both should also address the deficit and debt sustainability.
In past commentaries, we discussed how growing divergence in monetary policy has become a key driver in the foreign exchange markets. The heavy central bank meeting calendar over the past two weeks has only emphasized the importance of policy divergence as a driver of relative currency performance. With this in mind, here’s a summary of recent central bank actions: - The Federal Reserve: While initial focus might have been on forecast changes, the statement, guidance and tone were largely unchanged. Most importantly, the Fed signaled comfort with the rise in rates and pushed back on the need, or desire, to manage yields.
- The European Central Bank: After weeks of increasing rhetoric, the central bank followed through by upscaling monthly asset purchases and pushed back on rising yields.
- The Bank of Canada: Despite better-than-expected data, the bank’s monetary policy remained little changed with the bank also expressing comfort with higher yields. Should economic data continue to the upside, expect markets to increasingly price in tapering.
- The Reserve Bank of Australia: The bank continues to be dovish and provide guidance toward a 2024 rate lift-off. The bank has also pushed back on higher yields.
- The Bank of England: The bank acknowledged a faster return of inflation, didn’t push back on higher yields and set itself up to upgrade forecasts in May.
- The Bank of Japan: The bank published results from its policy review but struggled to balance accommodation with sustainability. The bank widened its yield curve control trading band but downplayed the move while hinting at the possibility for further rate cuts and pulling back on asset purchases.
This backdrop of growing monetary policy and policy rate divergence represents the realization that countries will emerge from the pandemic at a considerably different pace around the world. Beyond extraordinary U.S. fiscal policy, there are also significant differences in vaccine deployment. In the U.S., the timeline for normalization of activity has been materially accelerated. Meanwhile in Europe, countries are facing more challenges, including a temporary halt of one vaccine. This divergence in fiscal, vaccination and infection trajectories is likely to challenge the narrative of a synchronized recovery. Based on differences in the vaccination rate, the timing of when various countries can sustainably normalize economic activity could be measured in quarters rather than weeks or months.
With the U.S. expected to add to its fiscal stimulus lead through a large infrastructure package, the U.S. should remain at the forefront in both the pace at which countries exit the pandemic and the follow-through in growth thereafter. As such, the U.S. dollar should receive support, especially against non-commodity G10 currencies. However, U.S. exceptionalism is also expected to be accompanied by global optimism. This optimism should somewhat offset U.S. dollar strength and lead to some divergence in the foreign exchange markets, as illustrated by the Canadian dollar sitting at its strongest level since the first quarter of 2018. | |
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