Cable Rally Might Continue on Neutral or Dovish US CPI

Expectations for what the Fed will do at the next meeting are shifting quickly, with forecasts of a sticky core inflation reading complicating the situation. Only easing inflation might allow the recent rally in cable to continue.

Big Hike, Small Hike or No Hike?

Until last Friday, there was a solid consensus that the Fed would hike by 50bps at the next meeting. But the collapse of three banks in less than a week prompted a shift in expectations over the last couple of days. 50bps is now off the table, and traders increasingly bet there won't be a hike. According to the latest data from CME, only 76% of analysts expect a 25bps hike, down from 98% just 24 hours ago.

Last week, in testimony before Congress, Powell suggested that the Fed could increase the pace of rate hikes, depending on how hot incoming data would be. The first of the two key data points before the FOMC meeting didn't change the expected directionality. February NFPs were higher than expected, but the unemployment rate also increased. There was also a sizeable birth-death adjustment. These factors helped alleviate some worries that the labour market was getting too tight. That is, before the market was distracted by the SVB saga.

Sticky Core VS SVB Contagion

Monthly inflation is expected to stay at the same growth rate of 0.5%, but the annual rate is expected to come down to 6.1% from 6.4% prior. Although an improvement, it's still over three times the target rate. Nevertheless, the Fed pays the most attention to the core number, which is expected to pick up the pace slightly to 0.5% from 0.4% monthly. Annual core inflation is expected to remain steady at 5.6%, revealing concerns for a "sticky" inflation figure.

The question now is whether the Fed prioritises trouble in the banking sector over getting inflation under control. The general cause for the bank failures and worries that other banks might be in a similar situation is the sudden increase in interest rates meant to control inflation. A pause in rate hikes might help banks but could hurt the credibility of the Fed in its fight against inflation, along with the battle itself. The Fed operates under the theory that expectations drive inflation, and if the Fed is not expected to deliver the hikes necessary to control inflation, the worry is that inflation could rebound. Unfortunately, we are unlikely to get any more guidance from Fed officials before the meeting, as they are in the pre-FOMC blackout period.

Cable Breaks Higher After Wedge Pattern

The low at $1.18 signalled the end of a wedge pattern, which could be either the leading or ending variation. The upward spiral to $1.22 suggests corrections might offer opportunities for another leg up, completing the formation with the ending variation. However, failing to move past $1.2263 or $1.2348 might shift chances towards the leading variation instead. In that case, it will not be very likely to revisit $1.2392 or higher.

A drop to $1.2095 or the $1.20 handle might encourage additional bets towards the predominant trend direction in the short term. Losing $1.1925 might provoke short positions towards $1.18, favouring the leading wedge variation instead.

Key Takeaways

The collapse of three banks has shifted expectations for the next Fed meeting away from a 50bps rate hike and towards a more dovish stance. A 25bps hike is still largely expected, but there is a risk that the Fed may prioritise trouble in the banking sector over getting inflation under control, depending on how sticky core inflation is. Cable has rallied in response, with traders wagering that a pause in rate hikes could help contain potential contagion.