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In the middle of last week, there was some volatility in the G10 currencies. This was mainly a reaction to the confusing signals from Thursday's ECB meeting. Still, these currencies ended the week virtually unchanged – trading is preparing for the fireworks expected this week.
We have been warning for some time that developments in currency markets will be determined by the different responses of central banks to the global spike in inflationary pressures. This week this is certainly true, as both the Federal Reserve and the Bank of England are expected to announce when they will end their extremely loose monetary policy.
As a result, for the first time in some time, there is considerable uncertainty about the actual monetary policy decisions and the tone of policymakers' statements. This promises interesting developments and volatility in the markets. This crucial week concludes with the US non-farm payrolls (jobs report excluding the agricultural sector) for October. This will also be an important data point in the context of 'stagnation or inflation'. Below are the major currencies in detail
Last week's ECB meeting was a confusing exercise in unclear communication. Lagarde seemed 'DovisherMarkets were not convinced, and expectations of rate hikes were effectively brought forward. Perhaps most bizarrely, Lagarde seemed to implicitly believe that the ECB is better at estimating future inflation than other central banks, while the track record of the ECB's forecasts is abysmal. In any case, no market-shaking news is expected from the eurozone this week. The Federal Reserve meeting will therefore be the main event to look forward to.
The budget was hawkish – increasing spending and raising taxes more than expected – but this had little effect on the British pound. In the UK, too, markets are focused exclusively on expectations of central bank policy tightening. Investors are now fully pricing in the fact that the benchmark interest rate will rise by 15 basis points on Thursday.
We expect this first rate hike in a large developed economy to be followed through by the Bank of England. The crucial question is how unanimous the members of the Monetary Policy Committee support the decision. If a large majority is in favour of the rate hike, we think, based on our knowledge and experience, that this will be quite 'Bullish' for the pound sterling. Looking beyond the short term, we expect the Bank of England to continue to lead the way in tapering monetary accommodation, with other major economies following suit. In our view, this is an extremely 'Bullish' signal for the pound.
U.S. bond yields continue to rise steadily. This is because markets are pricing in the reality that inflationary pressures and deficits will persist for longer than the consensus expected just a few months ago. One trend that is clearly emerging is that higher Treasury yields are only positive for the dollar if they reflect higher real interest rates, and not if they are the result of additional hedges against inflation.
Of course, the exchange rate of the dollar this week will be determined by the Fed's meeting. The FOMC is expected to announce that the pace of monthly bond purchases will be reduced. It's not so much the announcement per se, but the exact speed of the tapering that matters, and whether the Fed will resist the two full rate hikes in 2022 that markets have priced in. The U.S. jobs report will also be important. This will clarify whether there is a decrease in the burgeoning wage pressures that emerged in the previous report.
By: Enrique Diaz-Alvarez
Enrique Diaz-Alvarez is chief risk officer and heads Ebury's analyst team in New York. Because of his drive, passion and thorough knowledge, Enrique is recognized by Bloomberg as one of the most accurate predictors of market movements.
About Ebury:
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