Central Banks’ Diverging Paths: Rate Decisions Shape Currency Markets

Apr 8 , 2024 | 3min read

In March 2024, central banks were in the driver’s seat for currency markets. Both the Federal (Fed) and Bank of England (BoE) have decided to maintain the rates in a range of 5.25% to 5.50%[1] and 5.25%[2] respectively. With the Federal Open Market Committee (FOMC) being slightly more dovish as the committee maintained the 3 rate cuts outlook for 2024, this is supported by Powell who mentioned that it might be appropriate to start easing conditions and slow the pace of quantitative tightening although it continues to be data driven.

In contrast, there are also surprises from both Bank of Japan (BoJ) and Swiss National Bank (SNB). BoJ took a historic step and hiked interest rates to a range of 0% to 0.10% for the first time in 17 years[3]. However, there is no clear indication that more would follow which causes the Japanese Yen (JPY) to remain weak. While SNB became the first G10 central bank to lead the cutting cycle as it cut rates by 25bp to 1.5%[4]. This is largely due to the inflation forecast being clearly softer and below the target while being concerned about the appreciation of the real exchange rate4. This might change the plans of other central banks as they may take cues from SNB to start cutting rates earlier as well.

Views on Equities

Given Powell’s stance during the recent FOMC meeting of being “not far” from gaining the confidence needed to commence easing, the “Big 4” macro tailwinds (resilient growth/earnings, disinflation, the dovish pivot in global monetary policy, and AI enthusiasm) will still be expected to propel equities in the near term. Based on Bank of America's latest Global Fund Manager Survey, Earnings Per Share (EPS) optimism is at a two-year high, and the biggest percentage of respondents say recession unlikely in next 12 months since 22 February 2024[5]. Despite investors' optimism, strategists have been providing some cautious insights in recent weeks regarding higher yield risk, stretched valuations and positioning, and an increasingly cautious macro backdrop[6].

Given an increasing number of European businesses are talking about artificial intelligence (AI) this quarter, catching up to the other US enterprises. According to Société Générale, it is optimistic about both Japanese and European shares due to the strength of US earnings. They believe that there is a common trend between the regions in terms of improving shareholder return, dividends hitting new highs in Europe and share buybacks rising.[7] Hence, we see opportunities in Eurozone banks whom has been reaping benefits from the higher bond yields as return on equity has reached 10.5%, its highest level since the Global Financial Crisis, while valuation remains at the lower spectrum (P/B at 0.74x)[8].

Looking at Asia, the Chinese AI ecosystem experienced a strong rally last week, with Alibaba-backed Chinese AI startup Moonshot AI announcing a significant breakthrough for its Kimi chatbot, which can now process up to 2 million Chinese characters during conversations, outperforming the existing homegrown AI models[9]. This indicates prospective options for applying and monetizing Artificial Intelligence amid the present AI boom. However, China’s property market remains weak as home prices dropped for an eighth straight month in February 2024 despite increasing government efforts to shore up the sector[10]. As a result, we remain cautious about investing in Chinese equities and keep an eye out for opportunities in prospective AI beneficiaries.

Views on Fixed Income

With the Fed keeping its rate-cut outlook during the recent FOMC meeting, we continue to expect investment grade bonds to be supported by the falling government bond yields. As rate hikes are likely over, yield curves are pricing in several cuts while credit spreads are not pricing in economic risks[11]. Hence, given that the all-in yields are still at historically high levels, this presents an excellent opportunity for more risk-adverse investors who are hoping to lock-in elevated returns for the longer run. For industries to focus on, we favour opportunities in defensive names within the energy, utilities, and financials sectors.

Views on Currency

Despite BoJ finally hiking interest rates to a range of 0% to 0.10% for the first time in 17 years[12], it will continue to buy up Japanese Government Bonds in support of the markets. It was so well supported that the JPY hardly appreciated and in fact weakened further after there was no clear indication that more would follow as markets feel it’s a more dovish hike as the interest rates gaps with most of the majors are still wide. Meanwhile, SNB became the first G10 central bank to lead the cutting cycle as it cut rates by 25bp to 1.5%[13]. This is largely due to the inflation forecast being clearly softer and below the target while being concerned about the appreciation of the real exchange rate. This might change the plans of other central banks as they may take cues from SNB to start cutting rates earlier as well. Gold was the clear winner having seen a meteorite rise to 2230 USD based on 28 March 2024.

Meanwhile, volatilities spike as funding currencies were generally weaker in the month with Swiss Franc (CHF) being the most sort after. JPY traded to a 1990 low[14] on the 27 March 2024 prompting an emergency meeting from the Japanese offices and further warnings of interventions. The Chinese Yuan (CNH) was finally allowed to weaken past 7.20 to 7.25[15] back to the weaker side. Here is what we think.

JPY: Still no significant change even after the hike. BOJ passive-aggressive move didn’t help either. However, this time we are suggesting being more careful with BOJ, and really do not want to be caught short JPY for now. We could see an intervention if JPY weakness persist[16].
British Pound (GBP): We don’t like the pound as BOE is still adopting a wait and see attitude. More consolidation ahead with some biasness on the downside.
Euro (EUR): Growing signs of economic weakness as policymakers are unsure on the timing of a rate cuts. Nothing new here as Euro continues to trade on the weaker side in a lower sideways pattern.
CHF: The currency is likely to consolidate with a potential to weaken further ahead especially with the surprise rates cuts.

Source:

[1] The Federal Reserve holds interest rates steady. Here's the impact on your money. - CBS News

[2] Bank of England leaves interest rates at 5.25% but signals future cuts | Interest rates | The Guardian

[3] Bank of Japan scraps radical policy, makes first rate hike in 17 years | Reuters

[4] Swiss central bank cuts rates in surprise move, getting ahead of global peers | Reuters

[5] Investor Optimism Hits 2-Year High, Yet Division Over AI, Magnificent 7 Bubble Emerges: Onset Of The Great Rotation? | Markets Insider (businessinsider.com)

[6] Bank J. Safra Sarasin Ltd

[7] “Run with the bulls”: Societe Generale lifts S&P 500 target (afr.com)

[8] Big Picture - No value in overcrowded places

[9] Chinese start-up Moonshot AI raises US$1 billion in funding round led by Alibaba and VC HongShan amid strong interest for OpenAI-type firms (yahoo.com)

[10] China's home prices fall for eighth consecutive month - VnExpress International

[11] UBS House View – Daily Asia, as of 12 Feb 2024