Central bank watch: FOMC and BoE take centre stage

There are multiple drivers of financial markets this week, including progress on trade talks, with a meeting scheduled between China and the US, suggesting that trade tensions between the world’s two largest economies are easing. This is helping the dollar to stage a mini comeback and US futures to rise early on Wednesday. The gold price is also lower However, there are still reasons for caution, geopolitical risks are heating up between India and Pakistan, two nuclear powers, and the Fed could add to the pressure on risk sentiment if they sound unlikely to cut interest rates in the coming months. It could be another day of twists and turns for financial markets.

Fed watch

The Federal Reserve will announce its latest interest rate decision on Wednesday at 1900 BST. The market expects no change in rates. Shortly after this, the Fed chair Jerome Powell, will hold a press conference, which could be the most important one of his career so far. How will he address the ever-changing tariff risks, attacks on his position by the President of the US, and the recent market turmoil?

The fight back against Trump

The Fed chair will need to balance guiding markets about the future of monetary policy at the same time as defending the Fed from pressure from the US administration. Powell needs to use skillful rhetoric to reinstate the Fed’s independence and its commitment to protecting the US economy from inflation risks, regardless of whether the US President wants interest rate cuts.

US stock markets look like they have exhausted gains, after a strong recovery rally in recent weeks, although futures are edging higher on Wednesday. For investors, uncertainty over global growth, combined with heightened concerns about the outlook for corporate earnings, is limiting risk sentiment. The question now is, will an unchanged Fed be the catalyst that triggers another move lower in stock markets?

A hawkish lean from the Fed expected

The market is expecting a mere 1.9% chance of a rate cut on Wednesday. There are currently 3.5 rate cuts priced in by the Fed Fund Futures market for the rest of this year, with interest rates expected to end the year around 3.5%. Rate cut expectations have been scaled back since Friday’s upside surprise to April’s Non-Farm Payrolls report, previously there had been 4 cuts priced in by financial markets. This suggests that the market could be prepping for a hawkish lean from Fed chair Powell at this week’s press conference.

The market reaction is tricky to predict. On the one hand, a hawkish lean from the Fed could spook markets and remind us that the recent market rally was a correction in a downtrend. The impact on the dollar is also difficult to predict. The US dollar has fallen sharply since the start of April. USD/CHF is down more than 7.2%, EUR/USD is higher by 5% and GBP/USD is up by 3.6%. The sell off in the US dollar spread to Asia in May, since the start of this month, the dollar has weakened by more than 5% vs. the Taiwan dollar, and by more than 2% vs. the Thai Baht and the Malaysian Ringgit. This may be a sign that the depreciation of the dollar has another leg to go, even though the USD is the weakest currency in the G10 FX space so far this year.

A  relatively ‘hawkish’ Fed could stem the decline in the USD in the short term, and it is rising in early trade on Wednesday. However, investors are still willing to diversify beyond the USD, which could limit a long-term recovery. Added to this, the dollar has not benefitted from the recent surge in US Treasury yields. The 10-year yield is higher by more than 15bps in the past week, and the 2-year yield is lower by 14 bps, at the time of writing.

Higher yields are not supportive of the dollar in the current environment, as they also hint at movement out of US assets. This is a slow drip for now, and we still expect the USD to remain the world’s reserve currency for some time, but it highlights the challenges faced by traders in the current environment.

This move out of US assets is linked to the Fed. If there is no Fed Put in this era of political instability under President Trump, then the attractiveness of US assets, particularly stocks, diminishes.

The BoE put on a united front

On Thursday at just after midday, the Bank of England will announce their latest policy decision. A 25bp rate cut is now fully priced in, with a strong chance of a further rate cut in June also priced in by the market. If the BOE cuts rates in May and June, it would be the first back-to-back rate cuts since 2009, and it would suggest that the doves have control at the Bank.

Speeches from BOE members have started to focus on deflation and the risks to economic growth. The BOE will also releasee their latest Monetary Policy report at this meeting, and we expect that its forecasts for growth and inflation will also be revised down.

BoE forecasts to reflect deflation risks

The previous forecasts from February saw a sharp reduction in GDP forecasts for 2025, to 0.4%, while CPI was revised higher to 2.8%. We expect the GDP forecast for 2025 to remain steady, or slightly higher, with forecasts for 2026 revised lower from the current 1.5% for GDP. The 3% CPI forecast for 2026 looks rich too us, as deflation risks mount, and as the oil price hovers around the $60 per barrel mark.

The market is expecting all 9 voting members of the MPC to vote for a rate cut tomorrow. However, there could at least one vote for a 50bp rate cut, which would reinforce the dovish stance at the BOE.

The BoE to scale back cautious language on rate cuts

The language used by the Governor Andrew Bailey in his press conference could also change. We expect the Governor to shift away from the BOE’s previous message that rates will be cut in a ‘gradual and careful manner’. Instead, the BOE could inject more urgency into their expectations for rate cuts, as the global economic backdrop has changed dramatically in recent weeks.

The Pound outlook

The pound has been a main beneficiary of dollar weakness and was a top performer in the G10 FX space at the start of this week. However, it is giving back gains on Wednesday as the dollar gains on hopes of a positive outcome from the US/ China trade talks. The pound is broadly weaker on Wednesday, and GBP/JPY is also down 0.3% so far on Wednesday, EUR/GBP is also higher, which suggests that a dovish BOE could weigh on GBP in the short term.

The outlook for GBP/USD will depend on two things: 1, how reluctant the Fed is to cut interest rates, which could boost the dollar in the long term, and 2, how the trade talks go with China and the US.