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In the post-corona era, the negative correlation between inflation in the US and the exchange rate of the dollar seems to be one of the important correlations. The US CPI (consumer price index) was once again clear: headline inflation was well above 5% for the fifth month in a row. Yields didn't react as strongly to this, but the U.S. dollar lost ground against all other major world currencies last week. The only exceptions were the Japanese yen, which was under pressure due to the continued rise in commodity prices and risk appetite, and the Turkish lira, which fell again due to Erdogan's jumps in interest rates.
There aren't many macroeconomic releases or policy announcements this week. Keep an eye out for the September inflation report from the United Kingdom, which will be released on Wednesday. This could confirm expectations about a rate hike in 2021. On Friday, we will get the PMI indicators for economic activity in the Eurozone. These will give us an up-to-date picture of the extent to which the economic recovery there is weakening – although the market still expects strong growth. Below are the major currencies in detail.
The euro was one of the laggards between both currencies and risk assets last week. Most of them outperformed the dollar. For the time being, it seems that the ECB will continue to lag behind the other major central banks when it comes to tapering accommodative monetary policy. Markets didn't price in rate hikes until much later in this decade. In this context, we have downgraded our forecasts for the euro against other G10 currencies and emerging market currencies. Market expectations for the October PMI indicators appear to be quite subdued. So there is room for a positive surprise, and that would be good for the single currency.
The good labour market data and industrial production data from the United Kingdom bring an interest rate hike by the Bank of England in 2021 a step closer. It looks like the Bank of England will be faster than the Federal Reserve. Markets are currently seeing a one-third chance that this first small rate hike will be decided at the MPC's next meeting in November. This week's CPI report is therefore decisive, as it will be the last key data point for the committee's decision. Both the headline and core figures are expected to be above 3%, while the lifting of energy price caps will add even more fuel to the inflation fire. We think this is enough to be sure of a rate hike in 2021. This would provide significant support to the British pound.
Another month of high inflation: headline inflation above 5% and core inflation above 4%. Our expectation is now really coming true, as inflationary pressures are unlikely to be short-lived, as the Fed hoped to be this summer. With the U.S. budget deficit in the double digits and real interest rates in deep negative territory, we believe there is still considerable room for the rally in risk assets in general and commodities in particular. These are not necessarily favourable conditions for the US dollar, so our advice remains to exchange the greenback for one of its counterparts, especially currencies from emerging commodity-exporting countries.
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:
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