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By: Enrique Diaz-Alvarez
From a strictly technical point of view, the U.S. economy is now in recession. The Federal Reserve's interest rate hikes are now determined on a meeting-by-meeting basis and are entirely dependent on inflation and labor market data. This realization caused a sharp drop in yields in the U.S., which in turn brought the dollar down against almost every major currency in the world. The euro was a surprising exception: it is still struggling due to the slow but steady restriction of the flow of gas from Russia. Last week's frontrunners were Latin American commodity currencies, led by the Brazilian real, which rose nearly 6% against the dollar.
Now that both the Federal Reserve and the ECB have effectively jettisoned their forward guidance, interest rate hikes by central banks are more dependent than ever on the numbers. All attention will therefore be focused on the US employment report, which will be published on Friday. For the time being, the labour market appears to be remarkably resilient to the stagnation of the economy. The Bank of England, which meets on Thursday, is expected to hike another 50 basis point rate. This bank, too, is likely to place less emphasis on explicit forward guidance, or to abolish it entirely. Below are the main currencies in detail:
Inflation in the eurozone was another upside surprise. This confirms what we already expected, namely that the ECB's rate hikes will have to go much further than interest rate markets have been willing to assume so far. However, the inflation figures were overshadowed by the news that gas flows from Russia continue to decline and by the announcement of several demand-curbing measures. Of course, none of this is positive for the euro. This week will be a holiday week with little news. Traders are looking forward to next Thursday's ECB Economic Bulletin hoping to learn more about central banks' plans for further interest rate hikes.
The British pound continues to largely follow the prices of risk assets. Last week's equity rally pushed the currency to the top of the G10 rankings, well ahead of both the dollar and the euro. For the pound, everything now revolves around the Bank of England meeting, which takes place next Thursday. Interest rate markets were almost evenly split between a 25 basis point rate hike and one of 50 basis points after market close on Friday. This means that we can already count on and trading will be volatile on Thursday. In our view, it will be difficult for the MPC to buck the hawkish trend among G10 central banks. We expect a bigger jump in interest rates, and a rally in the British pound as a 'side effect'.
The figures make it clear that the U.S. economy has now contracted slightly for two quarters in a row, but we wouldn't call the current economic climate "recessionary." The unusual combination of stagnant growth, full employment and very high inflationary pressures led the Fed at its meeting on Thursday to effectively shelve all forward guidance and announce that further rate hikes will be data-dependent. Friday's wage and inflation data made it clear that inflation is still not easing to desirable levels and the high Employment Cost Index (ECI) figures increasingly indicate that a wage-price spiral is developing. Given all this, we think markets are overly optimistic with their expectation that the Fed will raise rates to just below 3.25% at most.
Markets are now awaiting Friday's U.S. non-farm payroll report, which excludes the agricultural sector. Another month of healthy job growth is expected, against a backdrop of full employment. We turn our attention to the wage figures, to see if there is indeed the trade-off between higher prices and higher wages mentioned above.
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Ebury Makes international markets more accessible with tailor-made foreign exchange services and flexible trade credit for businesses. Ebury works with more than 12,000 organisations and carries out €12 billion in foreign exchange transactions in 140 different currencies. The company has offices in the United Kingdom, the Netherlands, Spain, and Poland. Ebury's priorities:
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On behalf of Holland Gold, Paul Buitink and Joris Beemsterboer interview various economists and experts in the field of macroeconomics. The aim of the podcast is to provide the viewer with a better picture and guidance in an increasingly rapidly changing macroeconomic and monetary landscape. Click here to subscribe.
