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The U.S. inflation report was another blow to investors, as it was much higher than estimated at 7.5% year-on-year. Fixed income markets saw a sell-off following this news, but the effect on foreign exchange markets was less clear. Emerging market currencies even reacted with a rally, completely different from previous Fed hiking cycles. News of a possible further escalation of the Ukraine crisis, which reached markets at the end of the day on Friday, only partially dampened the mood. The Brazilian real finished at the top of the weekly rankings, closely followed by other Latin American currencies. G10 commodity currencies such as the Australian, New Zealand and Canadian dollars also outperformed. The markets are coming to the conclusion that the conflict around Ukraine could strengthen commodity currencies around the world.
It seems that the Federal Reserve has reached something of a tipping point due to the latest inflation shock. James Bullard, a voting member of the FOMC, stated that he is now in favor of raising interest rates even outside of scheduled meetings – which has not happened since 1979. For the foreseeable future, markets will continue to focus almost exclusively on two factors: inflation rates and central bank policy. The first are due on Tuesday in the US (producer price inflation) and on Wednesday in the UK (consumer price index). The latter will come out in speeches by five Federal Reserve representatives, ECB President Lagarde and Chief Economist Lane. The minutes of the Fed's last meeting will also be published on Wednesday, but they are of course three weeks old. Below are the main currencies in detail.
ECB President Lagarde continued to try to temper market expectations of ECB rate hikes. She had little success with that, until the tensions in Ukraine flared up at the end of the day on Friday and interest rates fell again as a result. Markets are currently expecting 50 basis points of rate hikes in 2022, but a future increase of just 0.7%. This seems far too little to us given the strength of inflationary pressures. There is hardly any market-shattering news on the agenda this week. Attention will be on the leaders of the 'dovish' faction within the ECB, Lagarde and chief economist Lane, who will both speak publicly this week. If any of them prove to be sensitive to the reality of inflation in any way, that would be good news for the euro.
The key news from the UK is that GDP is proving resilient growth at 6.5% year-on-year in the last quarter of 2021. This should give free rein to the hawks at the Bank of England. The news from the U.S. should now put them in an even stronger position, as getting inflationary pressures under control is becoming the top priority for policymakers around the world. 'Partygate' still doesn't seem to have an impact on the markets. The focus will be entirely on the CPI inflation report from the UK this week. According to forecasts, this inflation will be the same or slightly higher than last month's, but the recent positive surprises in inflation worldwide keep things exciting for traders.
January's inflation report was also shocking. Inflation hit a new 40-year high of 7.5%. Even more worryingly, prices are now starting to rise everywhere. Moreover, there is now also price pressure on the housing market. This difficult factor is a particular concern, as price pressures are not expected to ease any time soon. In the following days, U.S. Treasury yields rose sharply again, but these increases were offset by news that the U.S. believes Russia is about to invade Ukraine. We expect producer prices to fall slightly again this week. Even more important will be the various speeches by representatives of the Federal Reserve. We expect them to reaffirm rising inflation concerns and hint to markets that, if inflation data does not start coming down soon, rate hikes of more than 25 basis points are to be expected at every meeting.
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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