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Interest rates continued to rise relentlessly around the world last week. The defining yield on 10-year U.S. Treasuries is now flirting with the 3% level, which is psychologically important. Stock prices fell and the dollar rallied, supported by both safe-haven capital flows and interest rate differentials. At the close of the week, the greenback was at the top of the G10 rankings, and also higher against most emerging market currencies. The yuan's price decline continued. The weakness of this currency – combined with a general wave of risk aversion – is depressing the prices of Asian currencies.
This week, investors will be fully focused on central bank meetings. The Federal Reserve meets on Wednesday. A 50 basis point rate hike is already certain for the markets, but they now want to know how hawkish Chairman Powell's announcements will be. It will be difficult for Powell to come up with a hawkish surprise, as a huge amount of short-term tightening is already priced in.
The Bank of England meeting will follow on Thursday. A rate hike of 25 basis points is expected, but there is still quite a bit of uncertainty about the tone the MPC will take. The week will be closed by the April U.S. jobs report, due on Friday. The wage figure will be the most important: it will show the extent to which there are second-round effects (consequences of renegotiation of wages). These would make it more difficult to tackle the inflation problem. Below are the major currencies in detail.
The flash report on inflation in the eurozone in April had another nasty surprise in store for the ECB: headline inflation remained at a sky-high 7.5%, while the core index appears to have risen rapidly, from 2.9% to 3.5%. This is another sign that energy prices are not the only factor causing inflation, and that price pressures are everywhere. In the meantime, producer prices appear to have risen again: 36.8% is a historic record. This means that even more inflation is to be expected. The communication from the ECB is now slowly starting to change. People are beginning to face up to this reality, but the turnaround is not yet fast enough to support the euro against the US dollar.
The Bank of England's meeting next Thursday will provide another opportunity for policymakers to clarify how they see the issues surrounding inflation and potential economic stagnation. It is likely that there will be 'hawkish' votes against, who want a 50 basis point rate hike, but a 'dovish' dissent is also possible, from members who oppose policy changes. In the short term, the exchange rate of the British pound – which has so far simply fallen in line with the euro against the dollar – will be determined by the distribution of votes between these three schools of thought.
The trade-driven GDP growth in the US in the first quarter was a negative surprise, but that essentially does not change the picture of the US economy. It is suffering from demand surpluses and widespread price pressures. We expect the Federal Reserve to acknowledge this on Wednesday, announce a 50 basis point rate hike and significantly increase the pace of balance sheet shortening.
The question now is whether there will be a price correction for the dollar ('buy the rumour, sell the news'), especially given the pace of the rally in recent days. We maintain that it will be difficult for the Fed to issue even more hawkish signals than the markets already expect. The dollar's rally has already priced in the existing interest rate differentials – and a little more – especially in the eurozone.
About Ebury:
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:
- Financial services normally reserved for large multinationals
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