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Three Questions: Week of March 14

CalendarMarch 14, 2022

Good morning, and welcome to Three Questions - a look at the big uncertainties facing currency markets in the week ahead.

Here are some of the things we're watching:

1. What will the Fed signal on Wednesday?

At its rate-setting meeting this week, the Fed is virtually certain to raise interest rates by 25 basis points. Such a move would be largely in line with expectations set by Chair Jay Powell in recent congressional testimony, but there is greater uncertainty on the path of rates beyond this meeting.

Market participants are pricing between six and seven hikes over the remainder of 2022 and will be seeking confirmation of this from Powell’s press conference, the pattern of dissents, and participants’ projections of inflation and rates-- the “dot plot”. With inflation at multi-decade highs and an increasing number of items contributing to price rises, the dot plot is likely to largely ratify these expectations.

If the dot plot puts the median estimate for Fed funds rate at 1.6 percent for December 2022, it would be a slightly dovish surprise. It would nevertheless represent a huge shift from projections just three months ago, when 1.6 percent was the median estimate for year-end 2023. Front-loading hikes on such a scale could seem a sufficient course correction.

The issue of front-loading still leaves open the pattern of near-term rate hikes. Zero dissents or one (from St. Louis Fed Governor James Bullard) in favour of a 50 basis-point hike would be an indication that a series of gradual rate 25 basis-point hikes is seen as enough for now, perhaps with a pause at a meeting later in the year to take stock. Multiple dissents would be a sign of a more sizeable hawkish constituency that wants rates to rise sooner and faster.

The pace of balance sheet reduction will be another critical issue. Powell has said in the past that he thinks this should happen largely “in the background,” implicitly suggesting a preference for passive runoff rather than active asset sales. Concerns that a flatter yield curve may heighten recession fears could lead to more reliance on asset sales as a complement to a somewhat slower pace of rate hikes. However, this seems unlikely given greater theoretical and practical uncertainty about the channels through which balance sheet expansion and contraction affect the economy.

Bottom line: We think the Fed will hike 25 basis points and deliver hints of a policy path for 2022 that largely aligns with current market expectations.


2. What will the Brazilian central bank decide?

The Brazilian central bank is expected to raise the benchmark SELIC rate by 100 basis points to 11.75 percent on Wednesday. It is very likely to deliver a hike of at least this magnitude, and could go farther, deciding to take rates to 12 percent.

Brazil has followed an aggressive hiking cycle over the past year, bringing the rate up from just 2 percent last March with recent moves coming in 150 basis-point increments. At its last meeting in early February, the bank implied that a slower pace of increases could be appropriate, and its reference scenario was based on the SELIC peaking at 12 percent.

But a sharp rise in commodity prices has led to an acceleration in inflation, which at 10.5 percent is running well above the central bank’s 3.5 percent target - and its 4.75 percent tolerance band. The BCB as an institution has tended to skew hawkish in recent decades anyway, and its mandate now features an inflation target that will ratchet down to 3.25 percent in 2023 and 3 percent in 2024. In the face of renewed price pressures, the bank’s reference scenario for the peak SELIC rate is also likely to move closer to the market’s estimate of 13.75 percent.

While the outlook for inflation and growth in Brazil do not look favorable, the real has been one of the strongest performers in global currency markets in 2022. Investors have been attracted by high interest rates, and also by the fact that the country produces many of the same minerals and foodstuffs as Russia and Ukraine. These factors should continue to support the real, at least in relative terms, in an environment marked by a more aggressive Fed and concerns about geopolitical risk.


3. Will the Old Lady of Threadneedle Street retain her hawkish stance?

The Bank of England will almost certainly raise rates for a third consecutive time, prioritizing its fight against inflation over insulating the economy against downturn risks - but the mix of hawks and doves on the rate setting committee could shift radically relative to February.

Numbers due for release on Tuesday are likely to indicate continued improvement in the labour market, with the unemployment rate scraping 4 percent, and wage growth nearing 4.6 percent year-over-year.

The economy performed significantly better than hoped in January, with high-frequency data indicating growth will top 1.1 percent on an annualized basis in the first quarter. In February, Bank projections showed no expansion over the same period.

And inflation pressures are exploding. Massive increases in energy prices unleashed by the war in Ukraine are lifting headline price growth toward 7.5 percent, threatening an unanchoring in inflation expectations. A recent Bank survey shows consumers now see prices rising 3.2 percent over the next two years - up from the previously-assessed 2.4 percent - and five-year expectations have climbed to 3.3 percent.

The case for tighter policy is highly persuasive.

But the conflict poses a serious longer-term threat to the British economy. Confidence levels are already suffering, and huge increases in living costs are likely to hit household consumption in the months to come. Business investment levels look vulnerable to a fall - and overly-aggressive rate hikes could worsen the damage.

Against this backdrop, we think the number of Monetary Policy Committee members voting for a 50 basis point move - numbering four out of nine in February - is likely to fall, perhaps to zero. Although no forecast updates will be provided, statement language might also be modified to soften the Bank’s tightening bias and preserve optionality. And - insofar as the pound reacts to domestic developments - the exchange rate might fall, with yield curves flattening as terminal rate expectations drop.

When feeling sufficiently threatened, birds of a different feather can flock together.




GBP Claimant Count Rate, February

CAD Housing Starts, February


USD Retail Sales, February

CAD Consumer Price Index, February

USD Department of Energy Weekly Oil Inventories

USD Federal Reserve, Rate Decision

BRL Central Bank of Brazil, Rate Decision


EUR Consumer Price Index, February

GBP Bank of England, Rate Decision

USD Weekly Jobless Claims

JPY Bank of Japan, Rate Decision


CAD Retail Sales, January

USD Baker Hughes Weekly Rig Count


“While defense spending accounts for a significant share of Russia’s economy, the sum itself is rather modest, especially by “great-power” standards. Russia spent an estimated $60 billion on defense in 2020, compared to Germany’s $50 billion outlay.”

Project Syndicate: Putin's Potemkin Military

“What does this look like in a year? Trade will look less like a fully connected network where everyone trades with everyone. Instead, there will be two clusters with some parties that trade between both networks perhaps via intermediaries, perhaps covertly but a great many who do not.”

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“[Charles Goodhart] predicted that inflation in advanced economies will settle at 3% to 4% around the end of 2022 and remain at that level for decades, compared with about 1.5% in the decade before the pandemic.”

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War on the Rocks: Is the West laissez-faire about economic warfare?