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Risk assets struggled very badly everywhere last week. Inflation rates are getting worse and central banks are increasingly alarmed about the need to bring inflation down. DInterest rates skyrocketed all over the world. Interestingly, European interest rates – in response to the ECB's clearly hawkish stance – rose more sharply than US yields this time. Peripheral interest rates in Europe rose the fastest. This is a bit ominous. There was a sell-off in equities, and the U.S. dollar regained its status as a favored safe-haven asset. The exchange rate of the dollar rose against every major currency in the world.
This week's meeting of the Federal Reserve is particularly important for the currency markets. Following Friday's nasty inflation data, U.S. markets are now pricing in a 25% chance of a 75 basis point rate hike. The Bank of England meeting is also shaping up to be nerve-wracking: markets are evenly split between a 25 and 50 basis point hike. Central banks everywhere are bracing themselves to fight inflation. In the short and medium term, currency movements will mainly be determined by the rate at which interest rates rise in the various regions. Below are the main currencies in detail:
Last week's May meeting of the ECB made it clear that this central bank is now really becoming hawkish. It announced that government bond purchases will cease on July 1 and took a crucial, highly unusual step by already committing to rate hikes of 25 basis points in July and 50 basis points in September. In addition to high inflation, peripheral spreads are now also a concern for the ECB, as they rose considerably last week. Nevertheless, peripheral yields are still historically quite low and the central bank has indicated that the fight against inflation is the top priority for the time being.
There is nothing on the agenda in the eurozone this week that could shock markets, so attention will continue to be focused on the other side of the pond, where the Federal Reserve has its June meeting.
Trading in the British pound was quite good last week. The currency fell against the dollar but rose against all other G10 currencies. This is a sign that the market is likely to be very short on the pound and that a lot of bad news has already been priced in at current levels. The remarkably large positive revision of the PMI index for economic activity in May also supported trade in the pound, as such a PMI indicates that the Bank of England may be too negative about the British economy. We expect a 25 basis point rate hike on Thursday, but calls for a 50 basis point hike – a hawkish counterpoint in the Monetary Policy Committee – are likely to be loud enough to strengthen the pound.
Friday's U.S. inflation data was clearly bad news for the Federal Reserve. The headline figure was again the highest in decades at 8.6%, dismissing expectations that inflation was at its highest point a few months ago. Core inflation was also higher than expected, so price pressures are building and are everywhere. Of particular concern is the acceleration of inflation in the housing market, which is normally one of the most stable components of the index. The market reacted reflexively, and that was understandable: everything was sold, the US dollar was bought. Now it's the Federal Reserve's turn. It must meet the extremely high expectations of the market. It is likely that even a 50 basis point hike and a hawkish press conference will not be enough to sustain the dollar's rally.
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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.
