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We've been saying it for a while now: in the near future, the currency markets will be determined mainly – or even entirely – by the pace at which the various central banks tighten their policy, and then mainly by inflation figures. This was true last week for the Norwegian krone, which became a top performer when Norges Bank became the first of the G10 countries to start a cycle of interest rate hikes.
In this context, we are struck by the fact that market expectations regarding the actions and statements of these central banks are remarkably 'dovish'. While the Federal Reserve seemed to be simply confirming what many had already expected by signaling that the tapering will begin in November, the market reacted with a sharp rise in yields – suggesting that most traders found this surprisingly hawkish.
The sell-off in U.S. yields made it clear that markets are bracing for the tapering of monetary stimulus. As a result, the major emerging market currencies suffered and all ended the week lower against the dollar. The Russian ruble was an exception: it was supported by rising energy prices, especially in Europe. The impact of the Evergrande crisis in China is still limited.
Now that we have the September meetings of the major central banks behind us, macroeconomic data should be the focus again, and of course inflation figures in particular. This week, the flash report on eurozone inflation in September will be published. Markets expect both the headline and the headline number to jump, with inflation in the Eurozone approaching that in the US and the UK. Below are the major currencies in detail.
As in the US, macroeconomic data from the eurozone is starting to point to stagflation. The PMI indicators for economic activity were lower (albeit compared to last month's high figures). They were dominated by supply chain disruptions, production constraints and increased pricing power. We are confident that this week's important flash inflation report confirms this.
Market strategists are now revising their expectations for both the headline and core numbers upwards, but we still think there's room for a surprise. This could mean that the ECB, unlike other central banks, can no longer afford to wait any longer to reduce monetary accommodation. And then we could be bullish on the single currency.
The British pound was torn between the Bank of England meeting, which was clearly hawkish, and reports of supply constraints, soaring energy prices and the emergence of shortages. The former, in our view, will ultimately have the most impact, particularly as there is a reasonable chance that interest rates will rise in the UK sooner than in all the other major G10 countries, and perhaps even as early as this year. We see the recent weakness in the pound as a buying opportunity, as appreciation is expected in all G10 countries in light of the tightening of monetary policy.
The Federal Reserve's September meeting seemed to take markets by surprise: it had been thought that the message would be 'dovisher', although the suggestion that tapering will start as early as the next meeting was widely expected. Perhaps the markets got anxious from the 'dot plot', in which a majority of participants indicated that they expect a rate hike as early as 2022 instead of 2023. In any case, U.S. bond yields skyrocketed. The dollar was dragged along – although the rise in prices could have been stronger given the huge jump in bonds.
In our view, any moves due to the debt ceiling conflict can be ignored this week; We regard this as purely political theatre. We will turn our attention to the release of the PCE deflator, which has traditionally been the Fed's preferred measure of inflation.
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:
Ebury makes international markets more accessible with tailored 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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- Market knowledge and tailor-made foreign exchange services
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