Central banks turn hawkish. Will the Fed trail behind?

After weeks of tier one economic reports from all corners of the world, the lack of market moving data outside of the Reserve Bank of New Zealand’s rate decision meant the possibility of quiet consolidative trade. However that was the complete opposite of what we saw this week as the central banks of New Zealand and the U.K. dropped hints of tightening. 
 
Sterling soared today on the back of Bank of England member Vlieghe’s comment that rates could rise as soon as the first half of next year if the job market recovers faster than expected. This was followed almost immediately by Prime Minister Johnson’s comment that there is nothing in recent COVID data that will delay their June 21st reopening. Vlieghe’s optimism and the rally in the pound is consistent with the improvements in data and the central bank’s overall forecast for a faster recovery. When they last met in early May, the BoE said they expect the economy to return to pre-pandemic levels by the end of the year. Even though they also slowed asset purchases, sterling sold off at the time because the central bank did not change their guidance on when interest rates will rise. This is one of the first times we’ve heard a policymaker be so specific about early tightening and as a result, we look for GBP/USD to climb to fresh 3 year highs and EUR/GBP to head towards 2020 lows in the coming weeks.
 
This follows the Reserve Bank of New Zealand’s forecast of a rate hike in the second quarter of 2022. This was the first official forecasts from the central bank since the pandemic and for now is a call that is more aggressive than the Federal Reserve and the European Central Bank. Hence we expect NZD and GBP to outperform other major currencies in the weeks ahead. 
 
The big question now is who will shift their guidance next.  All eyes are on the Federal Reserve with the PCE deflator scheduled for release on Friday. The personal consumption expenditure deflator is one of the Fed’s favorite inflation measures. The PCE index is expected to rise sharply with economists looking for 2.9% year over year increase in core rates. While the Fed has made it clear they see any increase in inflation as transitory, a larger than expected increase could drive USD/JPY higher. However any gains could be mitigated by personal income and personal spending numbers which are expected to be softer. For today’s reports jobless claims continued to fall but unexpected declines were reported in durable goods and pending home sales. The Fed may not be the last to tighten but for now with more negative than positive disappointments, the dollar could underperform as traders expect the Fed to lag behind.
 
Higher oil prices helped the Canadian dollar resumed its rise against the greenback but euro and the Australian dollar failed to participate in the rally. That could change tomorrow for the single currency as we look for upticks in German import prices and Eurozone confidence numbers. Global inflationary pressures have increased while euro area reopenings should bolster confidence.